ACCOUNTING SYSTEM

 How do business activities affect the income statement?

 How are business activities measured?
 How are business activities reported on the income statement?
OPERATING CYCLE
REPORTING PERIODIC INCOME TO USERS

 Recognition issues: When should the effects of operating activities be recognized (recorded)?
 Measurement issues: What amounts should be recognized?
ELEMENTS OF INCOME STATEMENT
OPERATING REVENUE

 Increases in assets or settlements of liabilities from the major or central ongoing operations of the business
OPERATING EXPENSES

 Expenditure vs Expenses
 Expenses are outflows or the using up of assets or increases in liabilities from ongoing operations incurred to
generate revenues during the period
 Companies can categorize expenses by either function (production, research, marketing, general operations) or
nature (salaries, rent, supplies, electricity) (GAAP – function; IFRS – function or nature)
HOW ARE OPERATING ACTIVITIES RECOGNIZED & MEASURED?

 Cash basis accounting - revenues are recorded when cash is received and expenses are recorded when cash is paid
 Accrual basis accounting - revenues are recognized when they are earned and expenses when they are incurred to
generate revenues
REVENUE RECOGNITION PRINCIPLE

 When the company transfers promised goods or services to customers

 In the amount it expects to receive.
REVENUE RECOGNITION PRINCIPLE
REVENUE RECOGNITION PRINCIPLE
REVENUE RECOGNITION PRINCIPLE
AMOUNT OF REVENUE RECOGNIZED IN JANUARY???
EXPENSE RECOGNITION PRINCIPLE

 Matching of costs with benefits

EXPENSE RECOGNITION PRINCIPLE
EXPENSE RECOGNITION PRINCIPLE
EXPENSE RECOGNITION PRINCIPLE

AMOUNT OF EXPENSE RECOGNIZED IN JANUARY???

EXPANDED TRANSACTION ANALYSIS MODEL
TRIAL BALANCE
 Chipotle purchased food, beverage, and packaging supplies costing $369,800, paying $289,800 in cash and owing
the rest on account.
 At the beginning of January, Chipotle paid $79,700 cash in advance for prepaid expenses for rent, insurance, and
advertising.
 During the first quarter, Chipotle sold food to customers for $1,071,700; $25,700 was sold to universities on
account (to be paid by the universities next quarter) and the rest was received in cash in the stores.
 Chipotle paid $40,800 for management training expenses.
 Chipotle paid employees $177,000 for work this quarter and $73,900 for work last quarter
 Chipotle sold for cash land costing $9,000 at a loss of $4,200.
 Chipotle received $39,000 cash from customers paying on their accounts.
 During the quarter, Chipotle paid suppliers $73,500 on accounts payable. It also paid $35,900 on utilities payable
and $28,400 in income taxes incurred for part of the first quarter of 2019.
 Chipotle paid $75,400 for utilities used during the quarter and paid $18,700 for repairs and maintenance of its
facilities and equipment during the quarter.
 Chipotle paid $75,400 for utilities used during the quarter and paid $18,700 for repairs and maintenance of its
facilities and equipment during the quarter.
 Chipotle received $1,200 cash as interest revenue earned during the quarter.
 During the quarter, Chipotle sold gift cards to customers for $21,900 in cash.
*Net sales is sales revenue less any returns from customers and other reductions.
For companies in the service industry, total operating revenues is equivalent to net
sales. The 2014 ratio for Chipotle using reported amounts (from Exhibit 3.1) is
(dollars in thousands):
ACCOUNTING CYCLE
ADJUSTING ENTRIES
ADJUSTING ENTRIES
ADJUSTING ENTRIES

 During the first quarter of 2015, customers redeemed a portion of the gift cards for $17,300 in food service.
(Deferred Revenues)

 Investments owned by Chipotle earned $200 in additional interest revenue for the quarter, but the cash will be
received in the next quarter. (Accrued revenues)
ADJUSTING ENTRIES

 Supplies Supplies include food, beverage, and paper products for Chipotle. At the end of the quarter, Chipotle counted
$16,100 in supplies on hand, but the Supplies account indicated a balance of $385,100(Deferred Expenses)

 Investments owned by Chipotle earned $200 in additional interest revenue for the quarter, but the cash will be received
in the next quarter. (Accrued revenues)

 Prepaid Expenses Among a few other times, the Prepaid Expenses account includes:

• $88,000 paid at the beginning of the quarter for rental of facilities at $22,000 per month,
• $48,000 for insurance coverage for six months beginning January 1, 2015, and
• $3,400 for advertising during the quarter.
ADJUSTING ENTRIES

 Chipotle estimates depreciation to be $122,400 per year.

 Contra accounts
 Net Book Value (NBV - also called the book value or carrying value)
ADJUSTING ENTRIES

 Wages Chipotle’s employees earned $67,200 in wages for working two days at the end of the quarter. They will be
paid in the next quarter.
 Interest on Debt Chipotle borrowed $2,000 in long-term notes payable and had other interest-bearing obligations
of $14,000 (of the $285,900 in Other Liabilities) at the beginning of the quarter. There are two components when
borrowing (or lending) money: principal (the amount borrowed or loaned) and interest (the cost of borrowing or
lending). The interest rate on Chipotle’s borrowings is 5.0 percent. Long-Term Notes Payable and a portion of
Other Liabilities (the principal) were recorded properly when the money was borrowed. Their balances do not
need to be adjusted. However, interest expense is incurred by Chipotle over time as the money is used, and it will
be paid in the future.
 Chipotle received a utility bill for $14,900 for usage during the quarter. The bill will be paid next quarter.
CLOSING THE BOOKS

 Permanent (real) &Temporary (nominal) accounts

 The closing entries have two purposes:

1. To transfer the balances in the temporary accounts (income statement accounts) to Retained Earnings.
2. To establish a zero balance in each of the temporary accounts to start the accumulation in the next accounting
period.