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Accounting Equation | In addition to the general ledger having debits equal to credits, the account balances must satisfy the accounting equation, which is: Assets = Liabilities + Stockholders’ Equity Asset accounts (normally debit balances) include: • Cash • Accounts receivable • Inventory • Prepaid expenses • Equipment For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Liability accounts (normally credit balances) include: • Accounts payable • Loans payable • Wages and payroll taxes payable • Interest payable • Deferred or unearned revenues Stockholders’ equity accounts (normally credit balances) include: • Common stock • Retained earnings • Accumulated other comprehensive income • Treasury stock (a subtraction) NOTE: The asset accounts normally have debit (or left side) balances, which is consistent with the total amount of the asset account balances appearing on the left side of the accounting equation. The liability accounts normally have credit (or right side) balances, which is consistent with the total amount of the liability account balances appearing on the right side of the accounting equation. The stockholders’ equity accounts normally have credit (or right side) balances, which is consistent with the total amount of the stockholders’ equity account balances appearing on the right side of the accounting equation. | This is a cheet sheet Question |
Example 1 | If Jay Corporation borrows $10,000 from its bank, Jay Corporation’s asset Cash increases by $10,000 and its liability Loans Payable increases by $10,000. Thus, the accounting equation remains in balance. The debits and credits are as follows: debit Cash for $10,000; credit Loans Payable for $10,000. If Jay Corporation repays $3,000 of the loan amount, Jay Corporation’s asset Cash will decrease by $3,000 and its liability Loans Payable will decrease by $3,000. As a result, the accounting equation remains in balance. The debits and credits are as follows: debit Loans Payable for $3,000; credit Cash for $3,000. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Recording Revenues and Expenses | When a corporation earns revenues (such as fees for having provided services for a client), the corporation’s assets will increase and its stockholders’ equity will increase. Similarly, when the corporation pays its monthly rent, the corporation’s assets decrease and its stockholders’ equity decreases. Since a corporation will have thousands of transactions involving revenues and expenses, it is useful to have: • Separate accounts for every type of revenues, and • Separate accounts for every type of expenses. The revenue and expense accounts should be thought of as temporary stockholders’ equity accounts or subaccounts of stockholders’ equity. Next, we list just a few examples of the hundreds of revenue and expense accounts typically used by a company. Revenue accounts (normally credit balances) include: • Sales of product A • Fees earned from services • Interest earned on bank accounts Expense accounts (normally debit balances) include: • Cost of goods sold • Salaries expense • Rent expense • Interest expense NOTE: Since revenues increase stockholders’ equity, the revenue accounts will have credit balances. Since expenses decrease stockholders’ equity, the expense accounts will have debit balances. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Example 2 Jay Corporation provides a customer with $4,000 of services and allows the customer to pay in 30 days. As a result, Jay Corporation’s assets increase by $4,000 and its stockholders’ equity increases by $4,000. Because Jay Corporation has earned the $4,000, it is recorded with a debit to Accounts Receivable for $4,000 and a credit to Fees Earned for $4,000. Example 3 Jay Corporation paid $1,500 for the current month’s rent. This causes a decrease in Jay Corporation’s assets and a decrease in its stockholders’ equity. The debits and credits are: debit Rent Expense for $1,500; credit Cash for $1,500. NOTE: A complete list of a company’s general ledger accounts in which amounts can be recorded is known as the chart of accounts. Accounts can be added when necessary. An internal report that lists the general ledger accounts which have balances (with the debit balances listed in one column and the credit balances listed in another column) is known as a trial balance. | This is a cheet sheet Question |
Accrual Method of Accounting | The accrual method (as opposed to the cash method) of accounting is the preferred method for measuring and reporting a corporation’s revenues, expenses, gains, losses, and net income for a month, year, etc. The accrual method is also the preferred method for reporting a corporation’s assets, liabilities, and stockholders’ equity at the end of the accounting period. Under the accrual method, revenues are reported in the accounting period in which they are earned (which is often different from the accounting period when cash is received). For example, if a business earns $1,000 today by providing consulting services, but issues an invoice stating that the client has 30 days in which to pay, the business reports the $1,000 as today’s revenue. Today’s accounting entry is: debit Accounts (or Fees) Receivable for $1,000; credit Fees Earned (Revenues) for $1,000. Under the accrual method, expenses are reported in the accounting period in which they occur or match revenues (which is often different from when cash is paid). For example, if a company incurs an $800 emergency repair today but has 10 days in which to pay the vendor’s invoice, today’s accounting entry is: debit Repairs Expense $800; credit Accounts Payable $800. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. The accrual method of accounting is necessary so that revenues are reported in the period when they are earned, and expenses are matched with the related revenues or are reported in the period in which a cost is used up. NOTE: Our focus is on financial accounting and financial reporting which culminates with a company’s financial statements. We do not discuss income tax reporting, which may require or allow for recognizing revenues and/or expenses differently. | This is a cheet sheet Question |
Adusting Entries | For a company’s financial statements to comply with the accrual method of accounting, it is likely that some adjusting entries must be recorded before the financial statements are issued. Typically, the adjusting entries include recording some expenses that have occurred, but the bookkeeper did not yet record the transactions in the accounts. For instance, a company may have incurred interest expense on its bank loan, but the interest payment is not due until the loan is due in 60 days. Another common example of an adjusting entry is the depreciation of certain assets. Assume that a company purchased equipment last year at a cost of $120,000 and the equipment is expected to be used for 5 years or 60 months. Each month the company’s accounts must include the following adjusting entry: debit Depreciation Expense for $2,000; credit Accumulated Depreciation Expense for $2,000. It is also possible that revenues were earned, but the sales invoice has not yet been issued. As a result, an adjusting entry will be needed to report the revenues earned on the income statement and to report the receivable on the balance sheet. Accountants often categorize adjusting entries into three types: accruals, deferrals, and other. You can learn more by visiting our topic Adjusting Entries. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Financial Statements | The main objective of recording the huge number of business transactions is to generate a complete set of financial statements. The complete set includes the following: • Balance sheet (or statement of financial position) • Income statement (or statement of earnings, statement of operations, profit and loss) • Statement of comprehensive income (if a company has certain types of transactions) • Statement of cash flows (SCF or cash flow statement) • Statement of stockholders’ equity In addition to the amounts appearing on the face of the financial statements, the company must include notes to the financial statements. The notes are necessary to disclose important information regarding the amounts shown (or not shown) on the face of the financial statements. You can learn more by visiting our topic Financial Statements. | This is a cheet sheet Question |
Internal Controls | It is critical that a company have internal controls to safeguard its assets. In the area of accounting and bookkeeping, it is best to separate some of the duties. In other words, instead of one person handling the cash, recording the amounts in the accounts, making the bank deposits, reconciling the bank statement, and preparing the financial statements, it is wise to separate the responsibilities between two or more people. For example, the person receiving and handling the cash should not be the person recording the amounts in the general ledger. The amounts on the company’s bank statement should be reconciled with the amounts in the company’s records by someone not involved with recording the amounts. Customer credit memos should be approved by someone not involved in the accounts receivable transactions. The reason for separating (or segregating) duties is to minimize losses. For instance, if one person handles all the transactions, then only one person (if dishonest) could falsify records so that the loss is not detected for months. With the separation of responsibilities, it is less likely for two dishonest employees to be working together to steal some of the company’s assets. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Bank Reconciliation | As often as is feasible and soon after a bank statement is received, the company should reconcile the bank statement. This involves comparing the detailed information on the bank statement with the detailed information in the company’s pertinent general ledger account. The bank reconciliation is important for several reasons, including: • To be certain that the general ledger accounts are complete and accurate • To be certain of the company’s cash amount to avoid writing checks for more than the actual checking account balance • To report the correct amount of cash on the company’s balance sheet Having an independent person prepare the bank reconciliation may result in finding some questionable amounts being deducted from the company’s bank account. You can learn more by visiting our topic Bank Reconciliation. | This is a cheet sheet Question |
Accounts Receivable | Accounts receivable arise when a company sells goods on credit. For instance, some companies provide its customers with goods and/or services and allow them to pay the amount owed 30 days later. If a customer does not pay the amount owed, the company will report Bad Debts Expense for the amount not collected. Because of this risk, a company should review its new customer’s credit rating before selling to the customer on credit. If there is some uncertainty, the company should require the customer to pay with a credit card when the goods are shipped. While there will be a credit card processing fee, the company may be avoiding a complete loss of the amount of the sale. The amounts owed by customers should be reviewed often. Accounting software will generate a report known as an aging of accounts receivable. This report sorts each credit customer’s balance into columns such as: current, 1-30 days past due, 31-60 days past due, 61-90 days past due, and 90+ days past due. This report allows for a quick review of the amounts that the company has not yet collected. Monitoring accounts receivable is critical because the company needs to collect the amount it is owed so it can pay its employees, accounts payable, loans payable, etc. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Accounts Payable | Accounts payable is a general ledger liability account containing the amounts owed to vendors/ suppliers. The amount owed is supported by vendor invoices that have been entered in the accounting system. To avoid entering a bogus invoice or an incorrect invoice amount, it is common to use what is known as the three-way match. The name refers to the requirement to match (compare or reconcile) the details contained in the following: 1. Vendor’s invoice 2. Company’s purchase order 3. Company’s receiving report A vendor’s invoice is entered in Accounts Payable only after the three-way match is completed. If some amounts are owed, but the three-way match is not completed, an adjusting entry will be recorded in a liability account such as Other Accrued Liabilities. You can learn more by visiting our topic Accounts Payable. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Bonds | Bonds are a form of long-term debt for the issuer. (For the buyer of the bonds, the bonds are an investment.) | This is a cheet sheet Question |
Bonds Payable | As part of the entry to record the issuance of bonds, the issuer will record the face value of the bonds in a long-term (or noncurrent) liability account entitled Bonds Payable. Typically the issuer of the bonds agrees to pay the bondholders: • interest every six months (semiannually), and • the face or maturity value when the bonds come due Why Bonds? Why Not Common Stock? Bonds are different from common stock in that usually: • the issuer of the bonds does not give the bondholders any ownership interest • the semiannual interest payments must be made when due • the maturity amount must be paid when the bonds come due • the issuer’s interest expense qualifies as an income tax deduction (whereas dividends are not tax deductible) As a result of the above features, the money raised from issuing bonds will be less costly than the money raised from issuing shares of common stock. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Face Value of Bonds | The amount appearing on the face of the bonds is also known as the following: • face value • par value • principal amount • stated value • maturity value | This is a cheet sheet Question |
Interest Rate on Bonds | The interest rate shown on the face of the bonds is the annual interest rate that will be used to determine the semiannual interest payments. This interest rate is also known as: • face interest rate • stated interest rate • contractual interest rate • nominal interest rate • coupon interest rate Typically the stated interest rate will not change and is therefore considered to be a fixed rate. This will result in the semiannual interest payments being the same amount. The formula for the semiannual interest payments is: face interest rate X face value of the bond X 6/12 of a year. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Market Interest Rates | We stated that the bonds’ semiannual interest payments and maturity value are both fixed in amount. However, the market interest rates for similar bonds are likely to change daily due to events occurring throughout the world. The market interest rate is also known as: • effective interest rate • yield-to-maturity • discount interest rate • desired interest rate Market Interest Rates and the Value of | This is a cheet sheet Question |
Existing Bonds | When market interest rates decrease, the value of existing bonds will increase. The reason is the fixed amounts of the cash payments (interest and maturity value) will become more attractive and therefore more valuable. When market interest rates increase, the value of existing bonds will decrease. The reason is the fixed cash payments for interest and maturity value have now become less attractive and therefore less valuable. To recap, the market value of existing bonds will move in the opposite direction of the change in the market interest rates. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Bonds Sold at Par Value | When a corporation offers bonds having a stated interest rate of say 8% and the market interest rate for similar bonds is 8%, the bonds will sell at their par or maturity value. Bonds selling at their par value are said to be sold at 100, which means 100% of the bonds par value. Therefore, a $100,000 bond will sell for $100,000 and will be recorded as follows: Cash $100,000 Bonds Payable $100,000 | This is a cheet sheet Question |
Bonds Sold at a Discount | If bonds having a stated interest rate of 8% are offered on a day when the market interest rate is 8.2%, the bonds will sell for less than their par or maturity value. Perhaps the bonds will sell for 98 or 98% of face value. This means that a $100,000 bond will sell for $98,000. Assuming there is no accrued interest on the date the bond is issued, the journal entry for the issuance of the bond will be: Cash $98,000 Discount on Bonds Payable $2,000 Bonds Payable $100,000 Discount on Bonds Payable is a contra-liability account which is always presented on the balance sheet with Bonds Payable. The combination of these two account balances means the book value or the carrying value of the bonds payable is $98,000 ($100,000 minus $2,000). Over the life of the bonds, the discount on bonds payable must be amortized to interest expense. | This is a cheet sheet Question |
Bonds Sold at a Premium | If bonds having a stated interest rate of 8% are issued on a day when the market interest rate is 7.9%, the bonds will sell for more than the par value or maturity value of the bonds. Perhaps the bonds will sell for 101 or 101% of face value. Therefore, a $100,000 bond will sell for $101,000. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Assuming there is no accrued interest on the date the bond is issued, the journal entry for the issuance of the bond will be: Cash $101,000 Premium on Bonds Payable $1,000 Bonds Payable $100,000 Premium on Bonds Payable is an adjunct liability account which is always presented with Bonds Payable. The combination of these two account balances means the book value or the carrying value of the bonds payable is $101,000 ($100,000 plus $1,000). Over the life of the bonds, the premium on bonds payable must be amortized to interest expense. | This is a cheet sheet Question |
Straight-line Amortization of Discount or Premium | If the amount of the discount or the premium on bonds payable is not significant, the corporation may amortize the discount or premium using the straight-line method of amortization. This means that each accounting period during the life of the bonds the same amount of discount or premium will move from the balance sheet to interest expense. | This is a cheet sheet Question |
Effective Interest Rate Method of Amortizing Discount or Premium | If the amount of the discount or the premium is significant, the initial amount of the discount or premium should be reduced by using the effective interest rate method of amortization. Under this method the market interest rate on the date that the bonds were issued is multiplied times the book value (carrying value) of the bonds at the start of each six-month period. The resulting amount is the amount debited to Interest Expense for the six-month period. The difference between the interest expense and the actual interest payment is the amount of the Discount or Premium that is being amortized in the current period. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Accrued Interest on Bonds Payable | Since most bonds pay interest semiannually, the issuer of the bonds will have accrued interest expense and accrued interest payable if the bonds are outstanding on any of the other 363 days of the year. To illustrate, assume that on June 1 a corporation issued $3,000,000 of bonds with a stated interest rate of 6% (and the market interest rate is also 6%), the corporation will be incurring interest expense of $180,000 per year; $15,000 per month; $500 per day. Also assume that the corporation prepares monthly financial statements. This means that on June 30 (and on the last day of every month), the corporation must record an adjusting entry to debit Accrued Interest Expense for $15,000 and credit Accrued Interest Liability for $15,000. When the corporation makes its December 1 interest payment of $90,000 the balance in Accrued Interest Liability will be $0 for that day. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Bank Reconciliation | The bank reconciliation is also known as the bank statement reconciliation or the bank rec. In accounting, a corporation’s checking account is considered to be part of its cash (which is reported on the corporation’s balance sheet). We will assume that the corporation has a separate general ledger cash account for each of its bank checking accounts. It is unusual for the balance in the bank account (balance per bank) to be the same as the balance in the corporation’s general ledger account (balance per books). Further, it is common for neither of these balances to be the true amount to be reported on the corporation’s balance sheet. Our approach to the bank reconciliation is to add and/or subtract the necessary adjustments to the appropriate balances. After the adjustments, both the balance per bank and the balance per books will show the same, true amount of cash. | This is a cheet sheet Question |
Adjustments to the Balance per Bank | A tip for listing the adjustments for the bank reconciliation is: “Put it where it isn’t.” For instance, a check that had been written and recorded in the company’s books, but has not yet cleared the bank account, will be an adjustment to the balance per bank. (The balance per bank is the ending balance on the bank statement or the balance available through the bank’s online access.) Here is a list of the common adjustments to the balance per bank: • Deduct: outstanding checks • Add: deposits in transit • Add/deduct: bank errors The adding and subtracting of these adjustments should result in the Adjusted (or Corrected) Balance per Bank. | This is a cheet sheet Question |
Adjustments to the Balance per Books | Again, the tip for listing the adjustments is: “Put it where it isn’t.” For example, the bank service charge is on the bank statement, but it is not yet on the books. Therefore the bank service charge is an adjustment to the balance per books. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Here is a list of common adjustments to the balance per books: • Deduct: bank service charge for maintaining the company’s checking account • Deduct: bank fee for processing a returned check • Deduct: bank deduction for a deposited check that was not paid by the bank on which it was drawn (for example, an NSF check or a check drawn on a closed bank account) • Deduct: check printing charge • Deduct: automatic loan payment • Add: electronic transfer into the account • Add: interest received from the bank • Add/deduct: correction of company errors The adding and subtracting of these adjustments should result in the Adjusted (or Corrected) Balance per Books. | This is a cheet sheet Question |
Journal Entries for Adjustments to Books | Without journal entries to record the adjustments to the balance per books, Cash and at least one other account will have incorrect balances. (The reason is the double-entry system of accounting and bookkeeping.) | This is a cheet sheet Question |
Internal Control | For internal control purposes (to safeguard a company’s assets), it is best if the company’s bank statement reconciliation is prepared by someone that does NOT write checks, record receipts, or enter amounts in the company’s general ledger cash account. For instance, at a small business it would be best if the owner reconciled the bank statement instead of the bookkeeper. | This is a cheet sheet Question |
Balance per Bank | The balance per bank is the ending balance appearing on the bank statement (and/or in the bank account) before the bank reconciliation adjustments for outstanding checks and deposits in transit. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Balance per Books | The balance per books is the ending balance appearing in the company’s appropriate general ledger account before the bank reconciliation adjustments for bank fees, deposited checks that were returned, electronic transfers, errors, etc. | This is a cheet sheet Question |
Adjusted Balance per Bank | The adjusted balance per bank is the true or corrected balance after the bank statement balance has been adjusted for items such as outstanding checks and deposits in transit. When the adjusted balance per bank is equal to the adjusted balance per books, the bank statement is said to be “reconciled”. This adjusted, true balance is the amount that should be reported on the company’s balance sheet. | This is a cheet sheet Question |
Adjusted Balance per Books | The adjusted balance per books is the true or corrected balance after the general ledger accounts have been adjusted for items such as bank fees, deposited checks that were returned, etc. When the adjusted balance per books is equal to the adjusted balance per bank, the bank statement has been reconciled. This adjusted, true balance is the amount that should be reported on the company’s balance sheet. The adjustments to the balance per books must be journalized and posted to the company’s general ledger accounts. | This is a cheet sheet Question |
Outstanding Checks | Outstanding checks are the checks that a company has written but which have not yet cleared the company’s bank account. | This is a cheet sheet Question |
Deposits in Transit | Deposits in transit are a company’s receipts (such as checks and currency from customers) that are recorded in a company’s general ledger account, but are not yet recorded in the company’s bank account. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Bank Service Charge | The bank service charge is often a monthly fee charged by a company’s bank for maintaining the company’s bank account. This will be an adjustment to the balance per books that credits the company’s general ledger account Cash and debits an account such as Bank Fee Expenses. | This is a cheet sheet Question |
NSF Check | An NSF check is a check that was not paid by the bank on which it was drawn because the checking account on which it was drawn did not have a sufficient balance. (NSF is the acronym for not sufficient funds.) An NSF check is also referred to as a “rubber check” since the check is said to have “bounced.” An NSF check that was deposited by a company will result in a deduction by the company’s bank for the amount of the check and also a fee for handling the returned check. The company must credit its general ledger account Cash for the amount of the NSF check and debit another account (which is often Accounts Receivable). | This is a cheet sheet Question |
Bank Fee for NSF Check | A company’s bank charges a fee for having to process a deposited check that had been returned due to insufficient funds. Since the bank charges the company’s checking account, the company must reduce the balance in its general ledger. This will be an adjustment to the balance per books that will credit the company’s general ledger account Cash (and debit another account). | This is a cheet sheet Question |
Bank Credit Memo | A bank credit memo is used by a bank to indicate that an amount is being added to a company’s bank account. As a result, the company will have an adjustment to the balance per books that will debit the company’s general ledger account Cash (and credit another account). For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Bank Debit Memo | A bank debit memo is used by a bank to indicate that an amount is being deducted from a company’s bank account. As a result, the company will have an adjustment to the balance per books that will credit the company’s general ledger account Cash (and debit another account). | This is a cheet sheet Question |
Journal Entries | Journal entries are required to record in the company’s general ledger accounts the bank reconciliation items shown as adjustments to the balance per books. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Balance Sheet | The balance sheet is also known as the statement of financial position and it is one of the five external financial statements issued by U.S. corporations. The balance sheet reflects the balances in all of the corporation’s asset, liability and stockholders’ equity accounts as of the final moment of the date shown in the heading. Note: Typically the final moment of the balance sheet is the last instant of the last day of an accounting period, such as midnight of December 31, June 30, etc. This is different from the other four external financial statements (income statement, statement of comprehensive income, statement of stockholders’ equity, and statement of cash flows) which report the amounts that occurred during a period of time such as the year ended December 31, the three months ended June 30, etc. The format for the balance sheet is similar to the accounting equation: assets = liabilities + stockholders’ equity | This is a cheet sheet Question |
Assets | Assets are the resources that a corporation owns as a result of a purchase transaction. Examples of a corporation’s assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, vehicles, etc. | This is a cheet sheet Question |
Liabilities | Liabilities are the obligations that a corporation owes as of the final moment of the date shown in the heading of the balance sheet. Examples of liabilities include accounts payable, loans payable, accrued expenses payable, customer deposits, deferred revenues, bonds payable, etc. Liabilities are claims against a corporation’s assets. Liabilities (along with stockholders’ equity) can also be thought of as a source of a corporation’s assets. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Stockholders’ Equity | Stockholders’ equity is equal to the amount of a corporation’s assets minus the amount of its liabilities. The stockholders’ equity section of the balance sheet is divided into several parts: • Paid-in (or contributed) capital • Retained earnings • Accumulated other comprehensive income • Treasury stock Stockholders’ equity (along with liabilities) can be thought of as a source of a corporation’s assets. Stockholders’ equity is also viewed as a claim against the assets; however, it is a residual claim since the creditors’ claims (liabilities) must first be satisfied. | This is a cheet sheet Question |
Generally Accepted Accounting Principles | A balance sheet distributed by a U.S. corporation must comply with generally accepted accounting principles, which are commonly known as GAAP or US GAAP. US GAAP is very comprehensive and includes a wide range of concepts, rules, practices, etc. Currently the authoritative group for establishing the U.S. accounting standards is the Financial Accounting Standards Board or FASB (pronounced faz-bee). As a result of the accounting rules, assets may be reported at various amounts. Here are a few examples: • Certain marketable investment securities will be reported at market value • Inventory is often reported at the lower of cost or net realizable value • Land used in a business will be reported at its cost and will not be depreciated • Buildings and equipment will be reported at cost minus accumulated depreciation • Some very valuable intangible assets (trade names, logos, excellent reputation, management, etc.) that were not purchased in a transaction are not reported on the balance sheet The above list reveals that the amounts reported or not reported for assets means that the amount reported for stockholders’ equity is NOT the fair market value of the corporation. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Classified Balance Sheet | A classified balance sheet is a balance sheet having various groupings or classifications. For example, the assets will be presented under one of the following classifications: • Current assets • Investments • Property, plant and equipment • Other assets Liabilities will be classified as follows: • Current liabilities • Noncurrent liabilities (or long-term liabilities) Current Assets Current assets include cash and assets that will turn to cash within one year of the balance sheet’s date (unless the operating cycle is longer than one year). Examples of current assets include cash, temporary investments, accounts receivable, inventory, supplies, and prepaid expenses. | This is a cheet sheet Question |
Current Liabilities | Current liabilities are obligations that have occurred as of the date in the heading of the balance sheet and must be paid within one year of the balance sheet date (unless the operating cycle is longer than one year). Examples of current liabilities include accounts payable, short-term loans, current portion of a long-term loan, wages payable, accrued expenses, customer deposits, deferred revenues, and income taxes payable. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Working Capital | Working capital is the amount of current assets minus the amount of current liabilities. If a corporation has $150,000 of current assets and $120,000 of current liabilities, its working capital is $30,000. | This is a cheet sheet Question |
Current Ratio | The current ratio is calculated as current assets divided by current liabilities. If a corporation has $150,000 of current assets and $120,000 of current liabilities, its current ratio is $150,000/$120,000 or 1.25 to 1. | This is a cheet sheet Question |
Property, Plant and Equipment | This section of the classified balance sheet reports the long-term assets used in a business. These assets are sometimes referred to as fixed assets and/or plant assets. Some of the assets in this classification are: • Land • Land Improvements • Buildings • Machinery and Equipment • Vehicles • Furniture and Fixtures The property, plant and equipment section will also report the accumulated depreciation pertaining to these assets. Accumulated depreciation is presented as a subtraction and the remainder is often shown with the word “net”. This net amount is the book value (or carrying value) of the property, plant and equipment, and it is also the amount that has not yet been allocated to depreciation expense. The book value of these assets should not be interpreted to be the assets’ fair market value (FMV). FMV could be more than or less than the book value of any or all of these assets. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Notes to the Balance Sheet | In addition to the amounts appearing on the face of the balance sheet, there will also to be a reference such as “See notes to the financial statements.” or “The accompanying notes are an integral part of the financial statements.” The notes to the financial statements are especially important because a corporation may have a significant liability for which the amount of the obligation cannot be determined as of the final moment of the accounting period. Therefore, this significant liability and other important information will be disclosed in the notes to the financial statements. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Why Adjusting Entries are Necessary | Adjusting entries are required at the end of each accounting period so that a company’s financial statements reflect the accrual method of accounting. Without adjusting entries, a corporation’s financial statements will likely report incorrect amounts of revenues, expenses, gains, losses, assets, liabilities, and stockholders’ equity. | This is a cheet sheet Question |
Common Characteristic of Adjusting Entries | Every adjusting entry will involve: • At least one balance sheet account, and • At least one income statement account Therefore, if a required adjusting entry is omitted, both the company’s balance sheet and its income statement will not report the correct amounts. Adjusting entries are usually dated as of the final day of the accounting period. As is the case with all journal entries, every adjusting entry must have debit amounts equal to the credit amounts. | This is a cheet sheet Question |
Types of Adjusting Entries | Adjusting entries are often categorized as follows: • Accruals • Deferrals • Others For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Accruals (or accrual-type adjusting entries) refer to the adjusting entries that must be recorded prior to issuing the financial statements because a business transaction occurred, but it is not yet recorded in the company’s general ledger. Two examples are: • Electricity and gas used by the company in June but not billed by the utility until July • Wages earned by hourly paid employees, but not processed until the following week Without the accrual adjusting entries for these examples, the company’s balance sheet will report too little in liabilities and too much in stockholders’ equity, and the income statement will report the incorrect amount of expenses. Deferrals (or deferral-type adjusting entries) refer to the adjustments needed because an amount that was recorded in the general ledger pertains to one or more future accounting periods. To illustrate, assume that on December 1, a company recorded its $2,400 payment for six months of property insurance for December through May. At December 31, one month of the insurance cost (1/6 of $2,400) has expired and should be reported on its December income statement as Insurance Expense of $400. The remaining $2,000 of unexpired insurance (5 months X $400) must be reported on the December 31 balance sheet as a current asset such as Prepaid Insurance or Prepaid Expenses. In effect the unexpired cost of $2,000 is being deferred until it becomes Insurance Expense in January through May. All of this will be achieved through a series of deferral adjusting entries. Others include the adjusting entries to record depreciation, bad debts, and adjustments for valuing some investments. | This is a cheet sheet Question |
Typical Accruals | The following table shows the balance sheet account and the related income statement account for some typical accruals. (Recall that accruals are necessary so that all of a company’s assets, liabilities, revenues, expenses, and losses are included in the appropriate financial statements.) For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Balance Sheet Account Income Statement Acct Wages Payable Liability Wages Expense Interest Payable Liability Interest Expense Utilities Payable Liability Utilities Expense Repairs Exp Payable or Accrued Exp Payable Liability Repairs Expense Interest Receivable Asset Interest Income Account Title Account Title Type Example of Accrual Entry. On the final day of the accounting period, a corporation had an emergency repair of its heating system. The heating contractor told the corporation that the repair bill will be $3,000 and that an invoice will be sent in the corporation’s next accounting period. Before the current period’s financial statements are distributed the corporation must record an adjusting entry to accrue the $3,000 expense and liability. The journal entry will debit $3,000 to Repairs Expense, and will credit $3,000 to Accrued Expenses Payable. Without this adjusting entry the income statement would show net income which will be too high, the balance sheet will report liabilities which will be too low, and stockholders’ equity which will be too high. | This is a cheet sheet Question |
Typical Deferrals | The following table shows the accounts involved in some typical deferrals. (Recall that the adjusting entries for deferrals are necessary because some of the amounts in the general ledger accounts belong on the income statement of a future accounting period. Those amounts must be reported on the balance sheet dated for the end of the current accounting period.) For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Balance Sheet Account Income Statement Acct Prepaid Insurance Asset Insurance Expense Supplies Asset Supplies Expense Deferred Revenues Liability Revenues Account Title Account Title Type Example 1 of Deferral Entry on December 31. On December 1, a company paid $2,400 for the cost of its property insurance for the 6-month period beginning on December 1. The entire $2,400 was charged/debited to Insurance Expense. On December 31 (the end of its accounting year) an adjusting entry will be needed to defer $2,000 (5 months X $400 per month): Prepaid Insurance will be debited for $2,000 and Insurance Expense will be credited for $2,000. After the December 31 adjusting entry, the debit balance in the asset account Prepaid Insurance will be $2,000; and Insurance Expense will have a debit balance of $400. In each of the next 5 months, adjusting entries will be needed to debit Insurance Expense for $400 and to credit Prepaid Insurance for $400. Example 2 of Deferral Entry on December 31. On December 1, the company paid $2,400 for the cost of its property insurance for the 6-month period beginning on December 1. The entire $2,400 was charged/debited to the asset account Prepaid Insurance. On December 31 (the end of its accounting year) an adjusting entry will be needed to move $400 ($2,400 divided by 6 months) from Prepaid Insurance to expense: Insurance Expense will be debited for $400 and Prepaid Insurance will be credited for $400. After the December 31 adjusting entry, the asset account Prepaid Insurance will have a debit balance of $2,000. In each of the next 5 months, adjusting entries will be needed to debit Insurance Expense for $400 and to credit Prepaid Insurance for $400. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Other Adjusting Entries | The following table shows the balance sheet account and the related income statement account for two of the adjusting entries described as other. Balance Sheet Account Income Statement Acct Accumulated Depreciation Contra Asset Depreciation Expense Allowance for Doubtful Accts Contra Asset Bad Debts Expense Account Title Account Title Type Helpful Process for Preparing Adjusting Entries Accountants often use “T” accounts to visualize the effect of a journal entry on the two (or more accounts) that are involved. Recall that the double-entry system requires the debit amounts to be equal to the credit amounts. The left side of one “T” will show the debit amounts, while the right side of another “T” will show the credit amounts. Our helpful process for preparing adjusting entries has the following steps: 1. Draw two T-accounts, since every entry requires a minimum of two accounts. 2. Indicate the account titles on the horizontal part of each “T”. For every adjusting entry there must be a balance sheet account and an income statement account. 3. Enter the balance prior to the adjusting entry in each of the T-accounts. 4. Determine the correct ending/final account balance for the balance sheet account. 5. Record an adjustment so that the ending amount in the balance sheet account is the correct amount from Step 4. 6. Enter the same adjustment amount into the related income statement account. 7. Write the adjusting journal entry. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Reversing Entries | Reversing entries are typically used in conjunction with the accruals. The reason is that shortly after the current period’s financial statements are distributed, the company will receive the paperwork for the transactions that had been accrued. For example, if a company had accrued a repair expense that occurred at the end of the accounting period, the company will be receiving the vendor’s invoice in the early part of the next accounting period. Similarly, if a company had accrued wages that had been earned near the end of the accounting period, the company will be processing its payroll a few days into the next accounting period. These two examples could result in a double recording (once with the adjusting entry and once with the actual billing transaction or the routine payroll entries that will be processed early in the next accounting period). To avoid the risk of double-recording, reversing entries are processed on the first day of the next accounting period to remove the accrual adjusting entries. To illustrate, let’s assume that on December 30 a retailer had an emergency repair of its heating system. The work was done on December 30 but the bill doesn’t arrive prior to the preparation of the financial statements. As a result, the retailer recorded an accrual adjusting entry dated December 31 which debited Repairs Expense for $3,000 and credited the liability account Accrued Expenses Payable for $3,000. In order to avoid the risk of double-recording, the company will record a reversing entry dated January 1 (the first day of the next accounting period) that debits Accrued Expenses Payable for $3,000 and credits Repairs Expense for $3,000. This will result in a $0 balance in Accrued Expenses Payable and an unusual credit of $3,000 in Repairs Expense. On January 10, the heating contractor’s invoice is received and is approved for payment on January 20. Because a reversing entry was recorded on January 1, the company can record the contractor’s invoice on January 10 with the usual debit to Repairs Expense and a credit to Accounts Payable. After the contractor’s invoice is recorded, the balance in Repairs Expense for the new accounting period will be $0 (the credit of $3,000 on January 1 and the debit of $3,000 on January 10) and the balance in Accounts Payable that pertains to the repair will be $3,000. When the company pays the contractor on January 20, the company will debit Accounts Payable and will credit Cash for $3,000. In short, the use of reversing entries eliminates any special handling of the vendor invoices. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Accounts Receivable | Accounts receivable refers to a company’s unsecured claim for money it is owed by a customer or client for goods and/or services the company had provided on credit (on account). The company that is selling the goods is usually transferring title to its goods at either: • the time the goods are shipped (the terms are FOB shipping point), or • the time the goods are delivered to the buyer (the terms are FOB destination) It is at one of these points that the seller is creating an account receivable and a sale. The sales invoice will also be prepared at the same time and will result in a debit to Accounts Receivable and a credit to Sales. If a company provides services on account, it will debit Accounts Receivable and will credit Service Revenues (or Fees Earned) at the time the service has been completed. | This is a cheet sheet Question |
Credit Terms | The seller’s credit terms will be indicated on the sales invoice. For example, the seller may have terms of “Net 30 days” or “Due upon receipt.” The term Net means net sales which is the amount of the sales invoice minus any authorized returns and/or allowances. Early Payment Discounts Some sellers offer an early payment discount, which allows a customer to pay less than the net amount if they pay within a stated discount period. (The seller also refers to the early payment discounts as sales discounts or cash discounts.) Example 1. A seller offers an early payment discount stated as “1/10, n/30” or “1/10, net 30”. This means that the customer may deduct 1% from the net amount due if the payment is made within 10 days of the date of the invoice. For instance, if a sale is made for 200 units at $15 each, the gross amount of the invoice is $3,000. If the customer is authorized to return 20 units at $15 each, the net amount is $2,700 and it is due in 30 days. However, the customer may deduct $27 (1% of the $2,700) if $2,673 is remitted within 10 days. Saving 1% by paying 20 days sooner (within 10 days instead of 30 days) is considered to be 18% on an annual basis. An early payment discount of “2/10, n/30” is considered to be 36% on an annual basis. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Bad Debts Expense | When sales or services are provided on credit, there is a risk that the seller or provider will not receive the amount owed by a customer. The amount that is not collected is reported on the seller’s income statement as bad debts expense. Bad debts expense is part of the selling, general and administrative (SG&A) expenses. Typically there are two methods for reporting the bad debts expense: direct write-off method, and allowance method. | This is a cheet sheet Question |
Direct Write-Off Method | Under the direct write-off method, the bad debts expense is not recorded and reported on the income statement until a specific account has been identified as uncollectible and the account is removed from the company’s accounts receivable. At that time, the company debits Bad Debts Expense and credits Accounts Receivable. The problem with the direct write-off method is that the balance sheet will report the full amount of a company’s accounts receivable even though some are likely to be uncollectible. Because of the delay in reporting the bad debts expense on the income statement, this is not the recommended method. (However, for U.S. income tax purposes the direct write-off method is required.) | This is a cheet sheet Question |
Allowance Method | The allowance method requires a company to anticipate that some amount of the accounts receivable will not be collected. In other words, prior to writing off an account receivable, the company will debit Bad Debts Expense and will credit a contra-asset account Allowance for Doubtful Accounts for an estimated amount. The Allowance account is a contra-account to Accounts Receivable and the combined balances is referred to as the net realizable value of the accounts receivable. (On the balance sheet the combined amount is often presented as accounts receivable (net) or accounts receivable—net.) Under the allowance method, there are two ways for estimating the amounts for the accounts Allowance for Doubtful Accounts and for Bad Debts Expense: • Percentage of accounts receivable • Percentage of credit sales For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Percentage of Accounts Receivable | The percentage of accounts receivable is also known as the balance sheet approach, since its focus is on reporting a realistic ending balance in the balance sheet account Allowance for Doubtful Accounts. In other words, the balance in the income statement account Bad Debts Expense is secondary and will depend on the adjustment needed in the Allowance account. In order to determine the balance needed in the Allowance account, companies will review an aging of accounts receivable. The aging sorts the unpaid sales invoices that make up the balance in Accounts Receivable according to the sales invoice dates. The aging of accounts receivable will show the amounts that are current (unpaid but not past due), amounts that are 1-30 days past due, 31-60 days past due, etc. A thorough review of the aging will provide insights as to the potentially uncollectible amounts needed in the Allowance account. A general rule is that the older the unpaid invoice, the more likely that the amount will not be collected in full. Example 2. A corporation’s Accounts Receivable has a debit balance of $130,000. The corporation’s Allowance for Doubtful Accounts has a credit balance of $10,000. Before issuing the financial statements, an aging of accounts receivable is prepared. Based on the aging, the credit manager estimates that $18,000 of the accounts receivable will be uncollectible. Under the percentage of accounts receivable method (balance sheet approach) there needs to be a debit to Bad Debts Expense of $8,000 and a credit to Allowance for Doubtful Accounts of $8,000 (the amount needed to have a credit balance of $18,000). Hence, the balance sheet will report Accounts Receivable – net of $112,000 ($130,000 minus $18,000). Percentage of Credit Sales The percentage of credit sales is sometimes referred to as the income statement approach since the focus is on the amount to be reported as bad debts expense. The objective is to match the appropriate amount of bad debts expense with the credit sales shown on the income statement. In other words, the balance in the Allowance for Doubtful Accounts is secondary and will depend on the amount of the bad debts expense. Example 3. A corporation’s Accounts Receivable has a debit balance of $130,000. The corporation’s Allowance for Doubtful Accounts has a credit balance of $10,000. The corporation uses the percentage of credit sales method and estimates that 0.3% of its credit sales will not be collected. In June the credit sales are $100,000. Hence, on June 30 the corporation will prepare an entry to debit Bad Debts Expense for $300 ($100,000 X 0.3%) and will credit Allowance for Doubtful Accounts for $300. (The objective is to have the June income statement match $300 of Bad Debts Expense with the $100,000 of credit sales). Whatever was the beginning balance in the Allowance account is assumed For personal use by the original purchaser only. Copyright © AccountingCoach®.com. to be the appropriate amount for the receivables that are unpaid from earlier periods. As a result, the Allowance for Doubtful Accounts will now report a credit balance of $10,300. Writing Off an Account When Using the | This is a cheet sheet Question |
Allowance Method | When the allowance method (either the percentage of receivables or the percentage of credit sales) is used and a specific account is identified as uncollectible, it is written off with a debit to Allowance for Doubtful Accounts and a credit to Accounts Receivable. [Note that under the allowance method, the write-off of an uncollectible account does not involve an income statement account. Both Accounts Receivable and the Allowance for Doubtful Accounts are balance sheet accounts. The bad debts expense had already been recorded as a percentage of accounts receivable or as a percentage of credit sales.] Example 4. A corporation has the following account balances: Accounts Receivable debit balance of $130,000; Allowance for Doubtful Accounts credit balance of $10,000. The company has been informed that one of its customers has filed for bankruptcy and the corporation is not expecting to collect any of the $7,000 balance it is owed. Under either of the allowance methods, the corporation will write off the customer’s balance with a debit of $7,000 to Allowance for Doubtful Accounts and a credit to Accounts Receivable for $7,000. | This is a cheet sheet Question |
FOB Destination and FOB Shipping Point | The invoice term FOB destination indicates that the buyer will receive title to the goods when the goods arrive at the buyer’s location. At that point the seller will have a sale and an unsecured account receivable and the buyer will have a purchase of goods and an account payable. Since the seller owns the goods while they are in transit, the seller is responsible for the goods and the cost of transporting the goods until they reach the buyer. The invoice term FOB shipping point indicates that the buyer will receive title to the goods when the goods leave the seller’s location. At that point the seller will have an unsecured account receivable and the buyer will have an account payable. Since the buyer owns the goods while they are in transit, the buyer is responsible for the goods and the cost of transporting the goods after they leave the seller’s dock. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Accounts Payable | Accounts payable are sometimes referred to as trade payables. Accounts payable involve the amounts that a company owes to vendors and others who have supplied goods or services on credit. Accounts payable can also refer to the department within a company that is responsible for reviewing and paying bills. The review is likely to include: • matching the vendors’ invoices with the company’s purchase orders, receiving reports, contracts, etc. • being certain that proper approvals have been obtained • making certain that the general ledger accounts are proper Accounts Payable is also the title of the current liability account in a company’s general ledger. Under the accrual method of accounting, the bills and vendor invoices which have been approved for payment are recorded in Accounts Payable. When the bills and invoices are paid, the amounts are removed from Accounts Payable. Amounts owed but not yet recorded in the Accounts Payable account will need to be accrued through an adjusting entry. The adjusting entry will credit a liability account such as Accrued Expenses Payable or Accrued Liabilities Payable. The debit amounts are typically expense or asset accounts. The balances in Accounts Payable and Accrued Expenses Payable will be reported on the company’s balance sheet under the heading of current liabilities. | This is a cheet sheet Question |
Vendor Invoice | The sales invoice issued by the supplier of goods or services will be referred to as a vendor invoice by the company receiving the goods or services. The vendor invoice will include the relevant details (date of service or shipment of goods, amounts, payment terms, etc.) concerning the goods and/or services provided. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Purchase Order | A purchase order could be a multi-copy paper document or an electronic document. It is prepared by the company that ordered the goods/services. One copy is sent to the vendor, one is forwarded to the company’s accounts payable person or department, one copy will be kept by the person ordering, etc. The purchase order will specify the goods/services being ordered, the quantity, unit prices, and other information. | This is a cheet sheet Question |
Receiving Document | A receiving document could be a paper document or an electronic record that is prepared by the person receiving the goods. It contains a description and the quantity of goods received. One copy is sent to the accounts payable person or department so that it can be compared with the goods listed on the vendor’s invoice and on the company’s purchase order. | This is a cheet sheet Question |
Three-Way Match | The three-way match is a technique used to verify that a vendor’s invoice is acceptable for payment. The three-way match involves comparing the information shown on three documents: 1) the vendor’s invoice, 2) the company’s purchase order, and 3) the company’s receiving document. After the descriptions, quantities, prices and terms are found to be consistent, the vendor’s invoice can be recorded into the general ledger account Accounts Payable. | This is a cheet sheet Question |
Accrual Adjusting Entry | An accrual adjusting entry is prepared at the end of each accounting period for vendor invoices and/ or other documents that have been received and which represent legitimate obligations, but have not yet been fully processed and therefore not yet recorded in Accounts Payable. These items will likely be reported as the current liability Accrued Expenses Payable or Accrued Liabilities. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Early Payment Discount | An early payment discount is also known as a purchase discount or cash discount. This is sometimes offered by a vendor that has credit terms but wants to encourage faster remittance. For example, a vendor might offer terms of “1/10, n/30” which means that the buyer can deduct 1% of the net amount owed if the amount is paid within 10 days. If the buyer does not pay within 10 days no discount is allowed and the buyer must remit the net amount owed (invoice amount minus any returns and/or allowances). For example, a company ordered and received 1,000 units of goods at $10 each. The vendor invoice reflects these amounts and also terms of 1/10, n/30. The vendor also authorized the company to return 100 units. Hence, the net amount the company must remit within 30 days is $9,000. However, a 1% discount of $90 is allowed if the buyer remits $8,910 within 10 days of the invoice date. | This is a cheet sheet Question |
Trade Discount | A trade discount is a discount expressed as a percentage of a list price. The percentage may vary according to the volume of a customer’s annual purchases. The trade discount allows a seller to have a single catalog with a single price for each item. The seller may then allow a high-volume customer to take a 40% trade discount, a middle-volume customer to take a 30% trade discount, and low-volume customers to take a 20% trade discount. | This is a cheet sheet Question |
FOB Destination and FOB Shipping Point | The invoice term FOB destination indicates that the buyer will receive title to the goods when the goods arrive at the buyer’s location. At that point the buyer will have an account payable (and the seller will have an account receivable). Since the seller owns the goods while they are in transit, the seller is responsible for the goods and the cost of transporting the goods until the goods reach the buyer. The invoice term FOB shipping point indicates that the buyer will receive title to the goods when the goods leave the seller’s location. At that point the buyer will have an account payable (and the seller will have an account receivable). Since the buyer owns the goods while they are in transit, the buyer is responsible for the goods and the cost of transporting the goods after they leave the seller’s dock. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
EOM | EOM is the acronym for end of the month. | This is a cheet sheet Question |
Voucher | In accounts payable, a voucher refers to a document that is used as a “cover sheet” for collecting, attaching and retaining the supporting documents and approvals before a vendor’s invoice can be scheduled for payment. | This is a cheet sheet Question |
End-of-Month Cut-Off | The end-of-month cut-off (or end-of-year cut-off) is an established routine to ensure that all expenses, liabilities, revenues, assets, etc. are reported on the financial statements. For example, under the accrual method of accounting, a series of accrual adjusting entries will be established so that expenses and liabilities that are not yet recorded in Accounts Payable will appear in a liability account such as Accrued Expenses Payable or Accrued Liabilities. | This is a cheet sheet Question |
Duplicate Payment | The term duplicate payment refers to paying a vendor’s invoice twice. This double-payment could occur if a company pays a vendor’s invoice and also makes a payment from a vendor’s statement of open invoices. It could also occur if a vendor sends a customer a second invoice for the same goods. There are two things that could eliminate or reduce the number of duplicate payments: 1) the three- way match, and 2) never pay a vendor from a vendor’s statement (pay only from a vendor’s invoice). | This is a cheet sheet Question |
Vendor Statements | Vendor statements are often received from suppliers when a customer has not fully paid the amounts previously billed by the supplier or vendor. A general rule is: Never pay a vendor from a vendor’s statement. A company should pay only from a vendor’s invoice. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Form 1099-NEC | Form 1099-NEC is an Internal Revenue Service form that must be sent to a person who provided services of $600 or more in a calendar year. A copy is also sent to the IRS. (If the services are provided by a corporation, this form is not required.) | This is a cheet sheet Question |
Form W-9 | Form W-9 is an Internal Revenue Service form that is used to request a taxpayer identification number from an independent contractor (that is not a corporation). The taxpayer identification number is needed when the company prepares Form 1099-NEC to an individual who provided services to the company for $600 or more in a calendar year. Often the taxpayer identification number is the person’s social security number. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Accounting Principles | The financial statements distributed to people outside of a U.S. corporation must be in compliance with generally accepted accounting principles (GAAP or US GAAP). US GAAP includes basic accounting concepts and underlying principles to very complex and detailed accounting standards found in the Financial Accounting Standards Board (FASB) electronic search system known as the Accounting Standards Codification. The following are some of the underlying concepts, principles and assumptions of accounting. | This is a cheet sheet Question |
Cost Principle | The cost principle (or historical cost principle) requires that transactions be recorded at their cost. Cost is defined as the cash amount or the cash equivalent amount at the time of the transaction. Except for certain marketable investment securities and impairments, the recorded amounts are not increased for inflation or market values. However, there are cases when the cost amounts are reduced to amounts that are less than the original cost amount. Example 1. A company purchased land in the year 1983 for $50,000. The company continues to own the land without making any improvements. A recent appraisal indicates the land’s current market value is $475,000. The company’s current balance sheet will report the land at $50,000. | This is a cheet sheet Question |
Accrual Method of Accounting | The accrual method of accounting (or accrual basis of accounting) is to be used instead of the cash method of accounting due to various accounting principles (matching, revenue recognition). The accrual method results in a better picture of a corporation’s net income during a specified period of time and it results in a better picture of a corporation’s assets and liabilities at any moment in time. Generally speaking, the accrual method of accounting means that revenues and assets are reported when they are earned (not when cash is received) and expenses, losses, and liabilities are reported when the transactions occur (not when cash is paid out). Example 2. A contractor provided emergency service to a client on December 30. The work required the contractor to rent some special equipment for $2,000. The contractor will bill the client $19,000 on January 10 and will pay the equipment rental company on January 10. Under the accrual method of accounting the contractor had revenue of $19,000 in December and equipment rental expense of $2,000 in December. (Under the cash method, the company would report the revenue and expense in January.) For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Matching Principle | The matching principle, which is associated with the accrual method of accounting, requires a company to match expenses with revenues. For example, a retailer’s income statement should match the cost of the goods that were sold with the sales of the goods. It also requires the matching of sales commission expense with the related sales. If these cause and effect relationships are not present, an expense is to appear on the income statement when a cost is used up or has expired. If there is uncertainty, a cost should be expensed immediately. For instance, the cost of a retailer’s ads that were run in December is to be expensed in December, since there is uncertainty as to any future benefit from the ads. | This is a cheet sheet Question |
Full Disclosure Principle | The full disclosure principle requires a company to report information that will make a difference to an investor, lender, or other decision maker. As a result of the full disclosure principle, a company’s financial statements must include notes to the financial statements. | This is a cheet sheet Question |
Economic Entity Assumption | The economic entity assumption allows accountants to prepare financial statements for a sole proprietorship’s business transactions (even though legally there may not be any separation between the owner and the business). The economic entity assumption also results in accountants preparing consolidated financial statements for a group of corporations that have common ownership. | This is a cheet sheet Question |
Periodicity (or Time Period) Assumption | The periodicity (or time period) assumption allows accountants to report financial information for distinct time periods even though a business is an ongoing operation. In other words, the periodicity assumption allows the accountant to report 1) revenue and expense amounts for a distinct time period such as a month, quarter, etc., and 2) asset and liability amounts as of the final moment of the accounting period. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Monetary Unit Assumption | The monetary unit assumption allows accountants in the U.S. to express the results of past business transactions in U.S. dollars. The monetary unit assumption also means that the previously recorded amounts will not be adjusted for inflation since it also assumes that the U.S. dollar does not lose purchasing power over time. Example 3. A company purchased land several years ago for $200,000. The company continues to hold the land without making any improvements. During the time after the land was purchased the general price index for inflation has increased by 5% and the value of land has increased by 15%. The company’s current balance sheet will report the land at $200,000 | This is a cheet sheet Question |
Going Concern Assumption | The going concern assumption means that the accountant believes that the business will be able to continue on (rather than having to be liquidated). This justifies deferring prepaid expenses to the balance sheet and reporting them as an expense in a later accounting period. | This is a cheet sheet Question |
Materiality | The concept of materiality allows a minor violation of an accounting principle if the amount is insignificant. The amount must be very minor in relation to a corporation’s assets and its net income. Example 4. Companies often expense immediately the purchase of assets that have a cost of $500 or less. The justification is that a lender or investor will not be misled with a $500 expense occurring in the first year instead of $100 per year for 5 years. | This is a cheet sheet Question |
Industry Practices | Industries that are regulated by government agencies often have unique financial reporting requirements. As a result, the external financial statements issued by the company may be in the format required by the government. This concept is sometimes referred to as industry practices or industry peculiarities. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Conservatism | The concept of conservatism provides guidance to an accountant who is faced with two acceptable alternative ways for reporting an amount. Conservatism tells the accountant to “break the tie” by using the alternative that will result in less net income and less assets or greater liabilities. The concept does NOT instruct accountants to report the lowest amounts possible. Example 5. Due to advances in technology, most of the items in a company’s inventory have had their value dropped dramatically. Should the company report the loss in value now, or should the company wait until the items in inventory are sold. Conservatism directs the accountant to report the loss now (as opposed to waiting until the items are sold). Consistency Consistency means that the same method of accounting should be followed from period to period. For example, if a U.S. company has adopted the LIFO cost flow assumption for valuing its inventory, it is required to use LIFO in all of the subsequent years. (In the year that a company switched from FIFO to LIFO, the financial statements must communicate clearly that the FIFO consistency had ended.) | This is a cheet sheet Question |
Reliability | Another qualitative characteristic of accounting is reliability. This means that accountants should be reporting amounts that are dependable and free from bias. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Basic Accounting Equation | In accounting (and bookkeeping) the basic accounting equation is: Assets = Liabilities + Owner’s Equity (sole proprietorship) Assets = Liabilities + Stockholders’ Equity (corporation) Assets = Liabilities + Net Assets (not-for-profit organization) Thanks to double-entry accounting (or double-entry bookkeeping) the basic accounting equation will/ must always be in balance. We will demonstrate the double-entry accounting and the accounting equation with eight examples. | This is a cheet sheet Question |
Effect of Owner Investing in a Business | For example, if a person starts a sole proprietorship with $15,000 the accounting equation will show: Assets = Liabilities + Owner’s Equity $15,000 = $15,000 | This is a cheet sheet Question |
Effect of Business Borrowing Money | Next, let’s assume that the company borrows $10,000 from its bank. This will cause the asset Cash to increase by $10,000 and it will cause the liability Notes Payable or Loans Payable to increase by $10,000. The accounting equation remains in balance because both sides of the equation increased by $10,000 For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Purchase of Office Furniture for Cash | If the company pays Cash of $3,000 for new office furniture, the transaction will cause the asset Office Furniture to increase by $3,000 and the asset Cash to decrease by $3,000. Note that the total amount of assets (shown on the left side of the equation) does not change since there was both an increase and a decrease of $3,000 on the left side of the accounting equation: | This is a cheet sheet Question |
Purchase of New Machine with Cash and a Loan | The company buys a new machine for $20,000 by paying $12,000 in cash and signing a promissory note for the remaining $8,000. This transaction causes the asset Machinery to increase by $20,000 and causes the asset Cash to decrease by $12,000 and the liabilities to increase by $8,000: | This is a cheet sheet Question |
Owner Invests Additional Money in Business | Owner’s equity (on the right side of the accounting equation) is affected by several types of transactions. First, owner’s equity increases when the business owner invests personal cash or other assets into the business. For example, if M. Jones invests $20,000 of cash in her business, the company’s asset Cash increases by $20,000 and the owner’s equity account M. Jones, Capital increases by $20,000. The accounting equation continues to be in balance because each side of the equation increased by $20,000: | This is a cheet sheet Question |