ACCT 284 Exam 2 Review Ch. 4 Why do we need adjusting entries? They make the accounting records reflect the actual situation They are necessary if cash changes hands at a different time than revenues are earned or expenses incurred Deferral: cash comes before the recognition of revenue or expense o Ex: unearned revenue, prepaid expenses Accrual: cash comes after the recognition of revenue or expense Rules for Adjustments: 1.) Adjustments never involve cash 2.) Adjustments always affect both the balance sheet (A or L) and the income statement (R or E) Types of Adjustments: Deferred Expense (A and E): when an asset is purchased and paid for that last multiple periods o Prepaid expense (asset) – o Expense + Deferred Revenue (L and R): when we receive cash in advance of earning revenue o Unearned revenue (liability) – o Revenue + Accrued Expense (E and L): when an expense is incurred before it is paid o Expense + o Payable (liability) – Accrued Revenue (A and R): when revenue is earned before cash is received o Receivable (asset) + o Revenue – Contra-Account: an account that is an offset to, or deduction from, the primary account Depreciation: an adjusting entry A deferred expense Capitalize the fixed asset purchased (buildings, equipment, etc) Apply matching principle: record a portion of the asset’s cost as depreciation expense each accounting period New account: accumulated depreciation Closing Entries: RED Revenues, expenses, dividends (temporary) NOT balance sheets; they never close (permanent) Accounting Cycle: Analyze Transactions Prepare and post journal entries Unadjusted trial balance Prepare and post adjusting entries Adjusted trial balance Prepare financial statements Prepare and post closing entries Post-closing trial balance Ch. 5 Internal Statement Users: (use managerial accounting) Managers Board of Directors External Statement Users: (use financial accounting) Creditors Investors Government Sarbanes-Oxley Act: created stiffer penalties for fraud and increased internal control requirements Fraud Triangle: o Incentive o Opportunity o Personality/Rationalization Financial Statements: Comparative Financial Statements: separate columns for each period’s results side by side Statement of Stockholder’s Equity: on actual financial statements the Statement of Retained Earnings is a column on this statement. o The other equity accounts make up the additional columns on this statement Multistep Income Statement: Gross Profit – Income from Operations – Income Before Taxes – Income Tax Expense = Net Income Gross Profit = Net Sales – COGS Income from Operations = Selling Expenses + General & Administrative Expenses Income Before Taxes = Other Revenue and Expenses - Operating Expenses: Selling Expenses General and Administrative Expenses EPS: earnings per share ratio Important subtotals: Gross Profit = Sales – COGS (markup) Income from operations Income before taxes Disclosure Process: Press releases: where earnings are usually first announced Annual report: audited and released annually Form 10K: yearly report filed with SEC that gives more detailed information on the business Quarterly Statements: are unaudited and usually include an income statement only Form 10Q: the quarterly report filed with the SEC Form 8K: a report that must be filed with the SEC anytime a major event occurs in the business Annual Report Contents: 5 or 10 year summary of financial data MD&A Management report on internal control Auditor’s report 4 basic financial statements Notes to the statements Recent stock price information Unaudited quarterly data List of directors, officers, and relevant addresses International Financial Reporting Standards (IFRS): accounting rules established by the IASB for use in over 100 countries around the world Qualitative Characteristics of Accounting Information Cross Sectional Analysis Time-Series Analysis ??? Ratio Analysis: Steps to ratio analysis: o Obtain financing o Invest in assets o Generate revenues o Produce net income Debt-to-assets ratio = Total Liabilities / Total Assets Asset Turnover Ratio = Sales Revenue / Average Total Assets Net Profit Margin Ratio = Net Income / Sales Revenue Ch. 6 Types of Business Service o Services provided o Do not sell products o No inventory Merchandising o Sell already made products Manufacturing o Make their inventory o Sell to merchandisers What do you need to keep your assets safe and records accurate? Establish responsibility Segregate duties Restrict access Document procedures Independently verify o Need good set of internal controls Bank Reconciliation Adjustment to Books: (on bank statement we didn’t know about) o Bank Service Charges o NSF Checks o EFT o Interest Adjustments to Bank: (in our books; bank didn’t know about) o Outstanding checks o Deposits in transit Cash and Cash Equivalents Cash equivalents: short-term, highly liquid investments with three months or less to maturity o Represented as a single item on the balance sheet Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory COGS = BI + P - EI Inventory Shrinkage: loss of inventory due to stealing/damage Buy Inventory Sell Inventory Count Inventory Perpetual System Increase Inventory Increase COGS Reduce Inventory Adjust balance to count Periodic System Increase Purchases No entry Record inventory, close purchases, and create COGS Sales Adjustments Gross Sales – Sales Returns and Allowances – Sales Discounts = Net Sales Gross Profit % = Gross Profit / Net Sales Ch. 7 Inventory: Usually company’s largest expenses and biggest assets o Affects assets on balance sheet o Affects expenses on income statement Management is crucial o Satisfy customer needs o Minimize carrying costs of inventory 4 types of inventory: o Merchandise inventory (retailers) o Raw materials inventory (manuacturers) o Work-in-progress inventory(manuacturers) o Finished goods inventory (manuacturers) Merchandiser: o Merchandise Inventory (Asset at first) o When sold becomes COGS (turns into Expense) Manufacturer: o See slides Consignment inventory: belongs to the owner Goods in transit: belong to the owner FOB Shipping Point: belongs to the buyer FOB Destination: belongs to the seller Inventory Costing Methods: Specific Identification FIFO LIFO o LIFO Conformity Rule: if we use LIFO on tax return, we must use LIFO on our financial statements o IFRS does not use LIFO Weighted Average LIFO Highest COGS Lowest net income Lowest ending inventory cost FIFO Lowest COGS Highest net income Highest ending inventory cost Lower of Cost or Market (LCM): choosing the lower priced item between cost or market; always write inventory as lowest amount - May be applied to the entire inventory or to each item separately - Write down the inventory and increase cost of goods sold - By doing this, normal margins can be made when the product is sold o Inventory (A) – o COGS (E) + Net Purchases = Gross Purchases + Transportation in - Purchase returns and allowances - Purchase discounts Inventory Errors: OVERSTATED This year Next Year INVENTORY COGS Understated Overstated Net Income Overstated Understated *OPPOSITES UNDERSTATED INVENTORY COGS Net Income This year Next year Overstated Understated Understated Overstated Ratio Analysis: Inventory Inventory Turnover = COGS / Average Inventory - Average Inventory = (BI + EI) / 2 Days to Sell = 365 / Inventory Turnover