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Balance Sheet- shows entity’s resources and claims on those resources Assets: things or rights Recognition: past event, control, brings future economic benefits (ALL THREE) Liabilities: obligations to parties other than shareholders Recognition: past event, present obligation, reduces future economic benefits (ALL THREE) Equity: assets less liabilities Both assets and liabilities need to be probable and need to have reliable measurement to be recorded Current Asset: expected to be sold/bring economic benefits through sale in next 12 months Current Asset: expected to be paid in next 12 months
A = L + OE
Income Statement: shows shareholders wealth from beginning of period to the end, increase in company’s wealth means an increase in OE or (A-L) Income Statement>>> Start of period balance +contributions (new share issues) +Profit (-loss) (revenues and expenses) +increases in reserves (increase asset due to market) -distributions (dividends) End of period balance Increasing owner’s equity: Contributions, share capital (issue shares, increase cash, increase share capital) Profit valuation increases Transaction and events (increase cash, increase revenue – interest received)
Decreasing owner’s equity: Distributions, dividends Transactions and costs (loss, valuation decreases) (decrease cash, decrease revenue – interest paid) 1
PROFIT (REVENUE – EXPENSES) – DISTRIBUTIONS OF DIVIDENDS = RETAINED PROFITS *income statement does not show retained profits > Dividends are not an expense Revenue (gains): increases in economic benefits during the accounting period in form of inflows or enhancements of assets or decreases of liabilities (resulting in increase in OE) Expenses: decreases in economic benefits in form of outflows or depletion of assets or increases of liabilities (resulting in decrease in OE) OE = contributions + opening retained profits + revenue – expenses – distributions of shareholders Note: REVENUE – EXPENSES relates to the income statement!!!! Only when good or service is provided can you recognise it as an asset or liability A Increases –> debit Decreases –>credit = L increases-> credit decreases ->debit + OE increases ->credit decreases ->debit Underlying assumptions: Accrual basis: events and transactions are recorded when they are incurred Going Concern: company will continue to operate for the foreseeable future Qualitative Characteristics: UNDERSTANDABILITY: .Ability of user to understand information depends on their capabilities and way information is displayed -relevant but complex transactions should be included COMPARABILITY: Consistency throughout entity and between entities Users be informed of policies + their changes and effects RELVENCE: Affected by materiality 2 .
no assets overstated. selling inventory Dr Cash or Accounts receivable (A) Cr Inventory 3 . caution exercised in making estimates.g. no expenses understated Completeness Constraints Timeliness Cost versus benefit of information ACCOUNTING CYCLETransaction: economic event that affects the business and needs to be recorded in its financial statement External: exchange of items of economics value Internal: adjustments GENERAL LEDGER: collection of all accounts for a business (ledgers provide balance!) During a period we recognise and match revenues earned and expenses incurred to determine profit >>matching principle Revenue recognised when all actions associated with earning the revenue have been performed Expenses recognised when revenue it helps to generate is recognised or when cost is incurred If we have received revenue but have not provided goods it is a liability until goods are provided EXAMPLE: Magazine subscription paid at start of year $144 – after one month we can recognise 1/12th of revenue From publisher’s perspective: 01/07 Dr Cash (A) 144 Cr Unearned Revenue (L) 144 31/07 Dr unearned revenue (L) 12 Cr Revenue (A) 12 Matching Principle: e.- Evaluate decisions about allocations of resources MATERIALITY: Information may be immaterial and impair understandability Could omission affect decisions of users RELIABILTY: Faithful representation of transactions (no error or bias) Prudence.
unearned revenues (liability) . prepayments (asset) Example: Van insurance premium of $1200 due each year 31 May (each month .Revenues: accrued revenues (asset).$100 of services used) Journal entry of insurance company: 31 May Dr Cash (A) 1200 Cr unearned revenue (L) 1200 30 June Dr unearned revenue (L) 100 Cr revenue (R) 100 Journal entry for business insured: 31 May Dr Prepayment (A) Cr cash (A) 30 June Dr Insurance payment (E) Cr prepayment (A) 1200 1200 100 100 Some businesses record payments as expenses or part prepayment. Andrew borrowed $10000 from a bank for a motorcycle Payments of $282 are made at first of each month (including $83 interest) Journal entries Bank make > 1 Nov 1999 Dr Loan Receivable (A) Cr cash (A) 1 Dec Dr Cash (A) Cr interest revenue (R) Cr loan receivable (A) 31 Dec Dr interest receivable (A) Cr interest revenue (R) 1 Jan 2000 Dr Cash (A) Cr interest revenue (R) 10000 10000 292 83 209 83 83 292 83 4 . part expense>> 31 May 30 June Dr Insurance Expense (E) Cr cash (A) Dr Prepayment (A) Cr insurance expense (E) 1200 1200 100 100 ANOTHER EXAMPLE: Nov 1 1999.Dr Cost of goods sold (E) Cr Sales Revenue (R) ADJUSTING ENTRIES Made necessary by the period assumption 4 main types: .Expenses: accrued expenses (liability).
all accounts in income statement are closed in general ledger and posted to profit/loss summary To the ledgers ->> Expenses Bal 500 Revenue P/L summary 500 P/L summary 500 Bal 1000 P/L Summary Expenses 500 Revenue 1000 Retained Profit 500 Dividend Declared P/L Summary 100 Ball 100 Retained Earnings Div Declared 100 P/L Summary 500 Journal Entries for revenue account 5 .account in ledger . Transfer closing balances from revenue and expense accounts to profit and loss summary 2. Transfer closing balances from profit and loss summary and dividend declared accounts to retained profits Profit and loss summary .Cr loan receivable (A) Journal entries Andrew makes> 1 Nov 1999 Dr cash (A) Cr bank loan (L) 1 Dec Dr Interest expense (E) Dr bank loan (L) Cr cash (A) 31 Dec Dr Interest expense (E) Cr interest payable (L) 1 Jan 2000 Dr Interest payable (L) Dr bank loan (L) Cr cash (A) 209 10000 10000 83 209 292 83 83 83 209 292 Adjusting entries > adjusted trial balance > closing entries > post-closing trial balance Retained Profits (closing) = Retained Profits (opening) + Revenue – Expenses – Dividends Steps: 1.
adjusting and reversing entries and closing entries Accumulated depreciation (I don’t know if you have covered this but it is in chapter 5. makes profit of $3000 this is a revenue item. Accumulated depreciation is 8000+8000=16000 and book value is 50 000-16000=34000. But so would the contra account (acc depn).Dr Piano tuning fees (R) 28600 Dr Piano Repair fees (R) 24380 Cr P/L Summary 52980 General Journal Entry for Expense account Dr P/L Summary 300 Cr Insurance expense (E) 100 Cr Depreciation expense (E) 100 Cr Interest expense (E) 100 Journal entry to close P/L Summary Dr P/L summary $XXX Cr Retained Profits $XXX General journal: used for everything like sales returns or purchase returns. credit transactions(not relating to inventory). cost would be removed from the ledger. net loss on sale of $5000 Dr Cash 29 000 Cr Truck asset Dr Truck accumulated depreciation 16000 Dr Loss on sale of truck 5000 50000 RECIEVABLES Accounts receivable: entity makes a sale on credit terms Dr a/c receivable (A) balance sheet Cr sales revenue (R) income statement And if we sell goods 6 . Sold for $37000. Truck sold for $37000 at end of second year. if you haven’t covered it don’t worry) Building depreciated annually by X Dr Depreciation expense X Cr accumulated depreciation X If truck were sold (originally bought at 50000) at any time. Dr Cash Cr Truck asset Dr Truck accumulated depreciation Cr gain on sale of truck 37 000 50000 16000 3000 If truck had been sold for 29000.
Dr COGS (E) Cr Inventory (A) income statement balance sheet RISK: not all accounts receivable will be paid (customer goes bankrupt) .want balance sheet to show net realisable value 2.5 mil Cr a/c receivable $2.Accounts reciveable needs to reflect this expectation .We create an allowance for doubtful debt 2 approaches 1. 5% failure in past years Dr Bad debts (E) $5 mil Cr ADD (contra) $5 mil Company is now aware will not receive 2.5 mil Ledgers ADD Bad Debts Expense 5 mil Allowance for doubtful debts A/c receivable $2.5 mil Op bal $45 mil Bad debts $5 mil Closing Bad $47.5 mil of a/c receivable Dr ADD (contra) $2. ALLOWANCE METHOD Estimate year’s bad debts expense -determine allowance for doubtful debts -write off bad debts against allowance 2 methods to determine ADD Net credit sales method: assume certain level of sales will cause a given level of bad debts (2% for example) Ex: $100 mil credit sales. DIRECT WRITE OFF METHOD Written off when given evidence Dr Bad debts (E) Cr a/c receivable (A) -does not relate expense to revenue .5 Revenue A/c Receivable $100 mil A/C Recievable 7 .
Reinstate receivable Dr a/c receivable (A) Cr allowance of doubtful debts (contra) 2. higher allowance factor applied against that debt Sometimes debts that have been written off are recovered 1.5 mil AGING METHOD Longer degt has been outstanding.Op Bal $400 mil Revenue $100 mil Closing Bal $497. Record collection of cash Dr cash (A) Cr a/c receivable (A) 8 .5 mil ADD $2.
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