Financial Accounting MidTermI.

Debit vs. CreditA.DebitDebit = left side of T-accountOn the Balance Sheet a debit indicates: 1.An increase in an asset2.A decrease in a liability3.A decrease in shareholders’ equity itemB.

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CreditCredit = Right side of T-accountOn the Balance Sheet a credit indicates:1.A decrease in an asset2.An increase in a liability3.

An increase in shareholders’ equity item** HINT** – Identify two components of each transaction: 1.) what did you get; 2.) where did it come from. The debit is what you got, and the credit is the source of the item you received. For instance, let’s imagine that you purchase a computer with your credit card.

Since the computer is what you received it’s going to result in a debit to the asset account for your computer. The credit will be applied to the credit card liability account for the same amount. II.

What accounts Increase/Decrease with debits and creditsAccount TypeDebit CreditBalance SheetAssets IncreaseDecreaseBalance SheetLiabilitiesDecreaseIncreaseBalance SheetOwner’s EquityDecreaseIncreaseIncome StatementRevenueDecreaseIncreaseIncome StatementCost of goods soldIncreaseDecreaseIncome StatementExpensesIncreaseDecreaseIII.Typical Accounts A.AssetsCashMarketable Securities Accounts receivable Notes receivableInterest ReceivableMerchandise inventoryRaw materials inventory Supplies inventoryWork-in-progress inventoryFinished goods inventoryAdvances to suppliersPrepaid rentPrepaid insurance Investment in securitiesLandBuildings EquipmentFurniture Accumulated depreciationLeaseholdOrganization costsPatents Good willB.LiabilitiesAccounts payableNotes payableInterest payableIncome taxes payableAdvances from customersAdvances from tenants; rent received in advanceMortgage payableBonds payableConvertible bondsCapitalized lease obligationsDeferred income taxC.Shareholders’ EquityCommon stockPreferred stockAdditional paid-in capitalRetained earningsTreasury sharesIV.Purpose of 3 Main Financial StatementsA.

Balance SheetStatement of financial positionSnapshot at a specific point in timeDate is last day of accompanying income statement periodValued at historical or current valuesIncludes assets (investing); liabilities (financing); and owners’ equity (financing)Picture of financial health of a company – GOAL of BALANCE SHEETB.Income StatementShows net income and earningsCovers a period of timeReflects revenues (inflows of assets or reductions of liabilities) from selling goods/services and expenses (outflows of assets or increases of liabilities) used in generating revenueNet income increases retained earnings on balance sheetShows how profitable a company is – GOAL of INCOME STATEMENTC.Cash Flow StatementExplains change in cash from one balance sheet date to the nextGroups activity as operating, investing, or financing Covers a period of timeShows sources and uses of cash and if we have enough cash to continue in business – GOAL of CFSV.

Accrual vs. Cash Basis AccountingA.Cash BasisAccounts for cash in and cash outEasy to useDrawbacks1)Ignores cash received from owners or from borrowing2)Does not match effort of generating inflows with the inflows themselves3)Unnecessarily postpones the time to recognize revenues4)Can distort measurement of operating performance by managing the timing of cash receipts and disbursementsB.Accrual Basis 1.)Revenue RecognitionRecognize revenue at sale if,a.All or most of the services expected to be provided have been performed b.Received cash or a promise to pay (accounts receivable)c.

An exchange with an outside entity has occurredAdjust revenue recognized for d.Any amounts not expected to be collectede.Sales discounts and allowancesf.Sales returns2.)Expense RecognitionAssets = unexpired costsExpenses = expired costsRecognize costs as expenses in the period when recognizing the revenue it helped produce – Matching PrincipleMatch cost expirations caused by revenue (inventory) – Product CostsCost expiration occurs when the benefits of the asset are consumed in operations (marketing, sales and administrative costs) -Period CostsVI.Adjusting EntriesAdjusting entries are journal entries made at the end of the accounting period to allocate revenue and expenses to the period in which they actually are applicable.

Two major types of adjusting entries are:Accruals: for revenues and expenses that are matched to dates before the transaction has been recorded.Deferrals: for revenues and expenses that are matched to dates after the transaction has been recorded.A.AccrualsSome accrued items for which adjusting entries may be made include:-Salaries-Past-due expenses-Income tax expense -Interest income-Unbilled revenueB.

DeferralsSome deferred items for which adjusting entries would be made include:-Prepaid insurance-Prepaid rent-Office supplies-Depreciation-Unearned revenue (in this case, a liability account is credited when the cash is received. An adjusting entry is made once the service has been rendered or the product has been shipped, thus realizing the revenue.)C.Effect of adjusting entriesDebitCreditAsset accountRevenue accountLiability account Revenue accountExpense accountAsset accountExpense accountContra-asset account **Expense accountLiability accountRevenue contra-account Contra-asset account** Contra account: An account, such as accumulated depreciation, that accumulates subtractions from another account, such as machinery. VII.Cash Flow StatementThe cash flow statement explains the reasons for changes in the cash balance, showing sources and uses of cash in the operating, financing, and investing activities of the firm.

The cash flow statement is derived by converting the accrual information to a cash-basis using one the following two methods:;#61607;Direct Method: cash flow information is derived by directly subtracting cash disbursements from cash receipts;#61607;Indirect Method: cash flow information is derived by adding or subtracting non-cash items from net income. A.Classifying Cash Flows1.) OperatingRelates to selling goods and services (income statement, current assets and current liabilities.

)Indicates cash received from the sale of goods and services and cash paid for operating goods and services.2.) InvestingRelates to acquisition and sale of non-current assetsIndicates cash received fro msales of investments and property and equipment; and cash paid for acquisition of investments and property and equipment3.)FinancingRelates to increases and decreases in debt and owners’ equityIndicates cash received from the issue of debt and capital stock; and cash paid for reacquisition of debt and capital stock and the payment of dividends.4.

)Ambiguities in Classifying cash flowsa.) classifying cash received from interest and dividend revenues generated by investments in securities as operating activity. FASB Rule: classify the receipt of cash from interest and dividend revenues as an operating activity but the cash related to the purchase and sale of investments in securities as an investing activity.b.) Same thing with interest on debtshould it appear on statement as operating or financing activity? FASB Rule: classify interest expense as an operating activity but the issue or redemption of debt as a financing activity. B.

How Can a Profitable Firm Run Out of Cash?1.) Net income for a particular period does not equal cash flow from operations2.) Firms experience cash inflows and outflows from investing and financing activities that do not appear directly on the income statement.

C.Columnar Worksheet1.)Step 1: Compute the change in each balance sheet account between the beginning and the end of the year.

Enter the chanes in the noncash balance sheet accounts in the first column of the work sheet using the following rules:Increases in noncash assets reduce cash and therefore appear with negative signs.Decreases in noncash assets increase cash and therefore appear with positive signsIncreases in liability and shareholders’ equity accounts increase cash and appear with positive signsDecreases in liability and shareholders’ equity accounts decrease cash and appear with negative signs.2) Step 2: Classify the change in each balance sheet account as an operating, or investing, or financing activity and enter it in the appropriate column of the work sheet using the same sign as the first column. 3.) Step 3: Sum the entries in the Operations, Investing, and Financing Columns and net the 3 sums to ensure that they equal the net change in cash.

***Things to Remember***In T-accounts the balance are as follows:Asset: balance on the leftLiability: balance on the rightStockholders’ equity: balance on the rightBalance Sheet is written as follows:AssetsLiabilities Stockholders’ equityIncome Statement is written as follows:Sales Other RevenueCost of Goods SoldExpensesNet IncomeStatement of Cash Flows (Indirect Method) is written as follows:Operations InvestingFinancing


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