Principles of FINANCIAL ACCOUNTING C h r i s t i n e J o n i c k , E d. Principles of FINANCIAL ACCOUNTING C h r i s t i n e J o n i c k , E d. Blue Ridge | Cumming | Dahlonega | Gainesville | Oconee Principles of Financial Accounting is licensed under a Creative Commons Attribution- ShareAlike 4. This license allows you to remix, tweak, and build upon this work, even commercially, as long as you credit this original source for the creation and license the new creation under identical terms.
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If you are the copyright owner of images in this book and you have not authorized the use of your work under these terms, please contact the University of North Georgia Press at ungpress@ ung.edu to have the content removed. Published by: University of North Georgia Press Dahlonega, Georgia Cover Design and Layout Design: Corey Parson Cover Image: Scott Rodgerson, CC0 ISBN: 978-1-940771-15-1 Printed in the United States of America, 2017 For more information, please visit: http://ung.edu/university-press Or email: ungpress@ung.edu If you need this document in another format, please email the University of North Georgia Press at ungpress@ung.edu or call 706-864-1556. TABLE OF C ONTENT S Chapter 1: Accounting Cycle for the Service Business—Cash Basis 1 1.1 Introducing Accounts and Balances .2 Net Income—A Critical Amount .3 The Mechanics of the Accounting Process .2 Rules of Debit and Credit .2 The Accounting Cycle .5 Revenue Transactions on Account .6 Expense Transactions on Account .5 Asset, Liability and Stockholders’ Equity Accounts .4 Balance Sheet Account Transactions .6 Account Wrap-Up .7 The Accounting Equation .1 Accounting Equation Broken Out .2 Accounting Transaction Grid .3 Retained Earnings Statement .8 Changes in Stockholders’ Equity. 43 Chapter 2: Accounting Cycle for the Service Business—Accrual Basis 44 2.1 Accrual Basis of Accounting .2 Complete Accounting Cycle .3 Adjusting Entry Accounts .1 Adjusting Entries—Deferrals .4 Adjusting Entries—Deferrals .2 Summary of Revenues .5 Adjusting Entries—Accruals.
77 Chapter 3: Accounting Cycle for a Merchandising Business 83 3.2 Merchandising Income Statement .3 Basic Merchandising Transactions (perpetual inventory system) .1 Merchandising Transactions (perpetual inventory system) with Discounts – The Buyer .2 Merchandising Transactions (perpetual inventory system) with Discounts – The Seller .4 Transportation Costs for Merchandising Transactions .5 Basic Merchandising Transactions (periodic inventory system) .6 Closing Entries for Merchandising Accounts. 99 Chapter 4: Assets in More Detail 104 4.1 Perpetual Inventory System .2 Periodic Inventory System .3 Lower-of-Cost-or-Market Inventory Valuation .4 Physical Inventory Count .2 Bank Card Expense .1 Direct Write-off Method .5 Fixed and Intangible Assets .7 Gains and Losses on Disposal of Assets .1 Disposal of Fixed Assets .8 Gains and losses on the income statement .1 Amortization of an Intangible Asset .2 Investments in Stock .3 Investments in Stock on the Financial Statements .10 Investments in Bonds .1 Held-to-Maturity Securities .2 Purchasing Bond Investments with Accrued Interest and Partial-Year Amortization .3 Selling Bond Investments with Accrued Interest and Partial-Year Amortization. 190 Chapter 5: Liabilities in More Detail 200 5.1 Short-Term Note Payable .2 Long-Term Note Payable .1 Bond Transactions When Contract Rate Equals Market Rate .2 Bond Transactions When Contract Rate is Less Than Market Rate .3 Carrying Amount of Bonds Issued at a Discount .4 Bond Transactions When Contract Rate is More Than Market Rate .5 Carrying Amount of Bonds Issued at a Premium. 228 Chapter 6: Stockholders’ Equity in More Detail 233 6.2 Corporations and Stockholders’ Equity .3 Issuing Stock for Cash .4 Issuing Stock for Non-Cash Assets .7 Stockholders’ Equity Section of the Balance Sheet .9 Cash Dividends Calculations.
248 Chapter 7: Capstone Experiences 255 7.2 Statement of Cash Flows .1 Types of Business Activities .2 Cash Inflows and Outflows .3 Basic Shell of the Statement of Cash Flows (indirect method) .4 Basic Shell of the Statement of Cash Flows (direct method) .5 Comparative Operating Activities Sections – Statement of Cash Flows .3 Financial Statement Analysis .3 Common-size Statements .5 Accounting as a Profession. 305 1 Accounting Cycle for the Service Business—Cash Basis 1.1 INTRODUCING ACCOUNTS AND BALANCES Accounting may be defined as the process of analyzing, classifying, recording, summarizing, and interpreting business transactions. One of the key aspects of the process is keeping “running totals” of “things.” Examples of items a business might keep track of include the amount of cash the business currently has, what a company has paid for utilities for the month, the amount of money it owes, its income for the entire year, and the total cost of all the equipment it has purchased. You want to always have these running totals up to date so they are readily available to you when you need the information.
It is similar to checking what your cash balance in the bank is when deciding if you have enough money to make a purchase with your debit card. We will now refer to these “running totals” as balances and these “things” as accounts. Any item that a business is interested in keeping track of in terms of a running dollar balance so it can determine “how much right now?” or “how much so far?” is set up as an account. There are five types, or categories, of accounts.
WHAT IS A CATEGORY? A category is a classification that generally describes its contents. The table below shows three column headings in bold: Planets, Colors, and Food. These are sample categories. PLANETS COLORS FOOD Saturn Red Pizza Venus Green Brownies Mars Yellow Chicken Earth Blue Eggplant Below each column heading is a list of four items that are actual examples of items that fall into the respective category.
If “Red” appeared under the “Planets” heading, you would immediately assume there was an error. It does not belong there. Page | 1 PRINCIPLES OF FINANCIAL ACCOUNTING ACCOUNTING CYCLE - SERVICE - CASH There are many items that businesses keep records of. Each of these accounts fall into one of five categories.
Assets: Anything of value that a business owns 2. Liabilities: Debts that a business owes; claims on assets by outsiders 3. Stockholders’ equity: Worth of the owners of a business; claims on assets by the owners 4. Revenue: Income that results when a business operates and generates sales 5.
Expenses: Costs associated with earning revenue Different accounts fall into different categories. Cash is an account that falls in the asset category. The Cash account keeps track of the amount of money a business has. Checks, money orders, and debit and credit cards are considered to be cash.
Other than Cash, we will begin by covering accounts that fall into the revenue and expense categories. Revenue is income that results from a business engaging in the activities that it is set up to do. For example, a computer technician earns revenue when they repairs a computer for a customer. If the same computer technician sells a van that they no longer needs for his business, it is not considered revenue.
Fees Earned is an account name commonly used to record income generated from providing a service. In a service business, customers buy expertise, advice, action, or an experience but do not purchase a physical product. Consultants, dry cleaners, airlines, attorneys, and repair shops are service-oriented businesses. The Fees Earned account falls into the revenue category.
Expenses are bills and other costs a business must pay in order for it to operate and earn revenue. As the adage goes, “It takes money to make money.” Expense accounts differ from business to business, depending on individual company needs. The following are some common expenses that many businesses have: Wages Expense Cost of paying hourly employees Rent Expense Cost for the use of property that belongs to someone else Utilities Expense Costs such as electricity, water, phone, gas, cable TV, etc. Supplies Expense Cost of small items used to run a business Insurance Expense Cost of protection from liability, damage, injury, theft, etc.
Advertising Expense Cost of promoting the business Maintenance Expense Costs related to repair and upkeep Miscellaneous Expense Costs that are minor and/or non-repetitive ANY Expense Any cost associated with earning revenue Page | 2 PRINCIPLES OF FINANCIAL ACCOUNTING ACCOUNTING CYCLE - SERVICE - CASH A chart of accounts is a list of all accounts used by a business. Accounts are presented by category in the following order: (1) Assets, (2) Liabilities, (3) Stock- holders’ equity, (4) Revenue, and (5) Expenses. CHART OF ACCOUNTS (PARTIAL) The following table summarizes the categories and accounts discussed so far: ASSETS REVENUE EXPENSES Cash Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Insurance Expense Advertising Expense Miscellaneous Expense 1.2 NET INCOME—A CRITICAL AMOUNT The difference between the total revenue and total expense amounts for a particular period (such as a month or year), assuming revenue is higher, is profit. We will now refer to profit as net income.
The following is a key calculation in determining a business’s operating results in dollars: Revenue - Expenses = Net Income Net income is determined by subtracting all expenses for a month (or year) from all revenue for that same month (or year). A net loss results if total expenses for a month (or year) exceed total revenue for the same period of time. Net income is a result that business people are extremely interested in knowing since it represents the results of a firm’s operations in a given period of time.3 THE MECHANICS OF THE ACCOUNTING PROCESS 1.1 The Journal Financial statements are key goals of the accounting process. In order to prepare them at the end of an accounting period, individual financial transactions must be analyzed, classified, and recorded all throughout the period.
This initially takes place in a record book called the journal, where financial events called transactions are recorded as they happen, in chronological order. Page | 3 PRINCIPLES OF FINANCIAL ACCOUNTING ACCOUNTING CYCLE - SERVICE - CASH When a transaction occurs, two or more accounts are affected. There is also a dollar amount associated with each of the accounts. Determining which accounts are impacted, and by how much, is the first step in making a journal entry.
This is a sample of a few rows in a journal. It has five columns: Date, Account, Post. Date Account Debit Credit In the journal, the column heading Debit means “left” and Credit means “right.” There are other familiar interpretations of these words, so don’t be confused: the terms here only have to do with whether a dollar amount is entered in the left or the right number column. These words may also be used as verbs: To “debit an account” means to enter its amount in the left column.
To “credit an account” means to enter its amount in the right column.2 Rules of Debit and Credit Whether a particular account should be debited or credited is based on (1) the type of account it is and (2) whether the account is increasing or decreasing. RULES OF DEBIT AND CREDIT for Cash and Revenue and Expense accounts Debit CASH when you receive it Cash increases Credit CASH when you pay it out Cash decreases Debit EXPENSES when you incur them Expenses increase Credit REVENUE when you earn it Revenue increases 1.