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The statement of cash flows: reports the cash receipts and cash outflows classified
according to operating, investment and financing activities.
The statement of stockholder's equity: reports the amounts and sources of changes
in equity from transactions with owners.
The footnotes of the financial statements: allow uses to improve assessment of the
amount, timing and uncertainty of the estimates reported in the financial
statements.
The most accurate way to measure the results of enterprise activity would be to measure
them at the time of the enterprise's eventual liquidation. Business, government, investors,
and various other user groups, however, cannot wait indefinitely for such information. If
accountants did not provide financial information periodically, someone else would.
The periodicity or time period assumption simply implies that the economic activities
of an enterprise can be divided into artificial time periods. These time periods vary, but
the most common are monthly, quarterly, and yearly.
The information must be reliable and relevant. This requires that information must be
consistent and comparable over time and also be provided on a timely basis. The shorter
the time period, the more difficult it becomes to determine the proper net income for the
period. A month's results are usually less reliable than a quarter's results, and a quarter's
results are likely to be less reliable than a year's results. Investors desire and demand that
information be quickly processed and disseminated; yet the quicker the information is
User Comments
Posted by Jeanette @ 2003-10-25 14:15:45.
same period --- allow comparision
basic assumption in preparing financial statements is ---- the firm will continue in
operation,--- going concern,'
assigning revenue - expenses ---- base on matching principle
Posted by GiGi @ 2004-01-29 06:25:01.
remember that there are 4 types of financial statements
b. explain why the accounts must be adjusted at the end of each period.
Why?
Most external transactions are recorded when they occur. The employment of an
accrual system means that numerous adjustments are necessary before financial
statements are prepared because certain accounts are not accurately stated.
Some external transactions might not even seem like transactions and are
recognized only at the end of the accounting period. Examples include unrecorded
revenues and credit purchase.
A necessary step in the accounting process, then, is the adjustment of all accounts to an
accrual basis and their subsequent posting to the general ledger. Adjusting entries are
therefore necessary to achieve a proper matching of revenues and expenses in the
determination of net income for the current period and to achieve an accurate statement
of the assets and equities existing at the end of the period.
Adjustment principles
What to adjust?
Each adjusting entry affects both a real account (assets, liability, or owner's equity) and a
nominal or income statement account (revenue or expense). The four basic types of
adjusting entries are:
1. deferred expenses that benefits more than one period: for example, prepaid
expenses (e.g. prepaid insurance, rent) are expenses paid in advance and recorded
as assets before they are used or consumed. When these assets are consumed,
expenses should be recognized: a debit to an expense account and a credit to an
asset account. Another example is depreciation. The cost of a long-term asset is
allocated as an expense over its useful life. At the end of each period depreciation
expense is recorded through an adjusting entry: a debit to a depreciation expense
account and a credit to an accumulated depreciation account (a contra account
used to total the past depreciation expenses on specific long-term assets).
2. accrued expenses that incurred but not yet paid or recorded: examples are
employee salaries and interest on borrowed money. At the end of the accounting
period, the accrued expense is recorded through an adjusting entry: a debit to an
expense account (i.e. Salaries Expense) and a credit to a liability account (i.e.
Salaries Payable).
3. accrued revenues that earned but not yet received or recorded: also called
unrecorded revenues. Examples include interest revenues, rent revenues, etc. Such
revenues accumulate with the passing of time, but the firm may have not received
the payment or billed the client. An adjusting entry should be: a debit to an asset
account (i.e. Accounts Receivable) and a credit to a revenue account (i.e. Interest
Revenue).
4. unearned revenues that are revenues received in cash before delivery of
goods/services: examples are magazine subscription fees, customer deposits for
services. These "revenues" are not earned yet and thus should be recorded as
liabilities. An adjusting entry should be: a debit to a liability account (i.e.
Unearned Revenue) and a credit to a revenue account (i.e. Revenue).
User Comments
Posted by GiGi @ 2004-01-29 06:26:22.
accrual system!!! definition
Posted by Gina @ 2004-02-03 22:17:33.
accrual based accounting recognizes the impact of a business event as it occurs,
regardless of whether transaction affected cash
Posted by Gina @ 2004-02-03 22:20:20.
Revenue Principle: basis for recording revenues (ie tells when to record revenue and the
amounts).
Matching Principle: basis for recording expensis (ie direction to ID all expenses during
the period, measure them, and match them against the revenues earned in that period).
c. explain why the accrual basis of accounting produces more useful income
statements and balance sheets than the cash basis.
Revenue is something earned through the sale of goods or services. Not all cash receipts
are revenues; for example, cash received through a loan is not revenue. Expenses are the
cost of goods or services used to generate revenues. Not all cash payments are expenses;
for example, cash dividends paid to stockholders are not expenses. Net income is the
difference between revenues and expenses. It is reported on the income statement, and is
the focus in evaluating a firm's profitability.
Most companies use the accrual basis accounting, recognizing revenue when it is
earned (the goods are sold or the services performed) and recognizing expenses in the
period incurred, without regard to the time of receipt or payment of cash. Net income is
revenue earned minus expenses incurred.
Under the strict cash basis accounting, revenue is recorded only when the cash is
received and expenses are recorded only when the cash is paid. Net income is cash
revenue minus cash expenses. The matching principle is ignored here, resulting
inconformity with generally accepted accounting principles.
Today's economy is considerably more lubricated by credit than by cash. And the accrual
basis, not the cash basis, recognizes all aspects of the credit phenomenon. Investors,
creditors, and other decision makers seek timely information about an enterprise's future
cash flows. Accrual basis accounting provides this information by reporting the cash
inflows and outflows associated with earnings activities as soon as these cash flows can
be estimated with an acceptable degree of certainty. Receivables and payables are
forecasters of future cash inflows and outflows. In other words, accrual basis accounting
aids in predicting future cash flows by reporting transactions and other events with cash
consequences at the time the transactions and events occur, rather than when the cash is
received and paid. Accrual accounting generally provides a better indication of
performance than cash basis of accounting since it increases the comparability of income
statements and balance sheets across periods.
Liabilities are the financial obligations that the firm must fulfill in the future.
Liabilities are typically fulfilled by payment of cash. They represent the source of
financing provided to the firm by the creditors.
Equity Ownership is the owner's investments and the total earnings retained
from the commencement of the firm. Equity represents the source of financing
provided to the firm by the owners.
Balance sheet accounts are classified so that similar items are grouped together to arrive
at significant subtotals. Furthermore, the material is arranged so that important
relationships are shown.
The table below indicates the general format of balance sheet presentation:
Current Assets
Current liabilities
Long-term investments
Long-term debt
Owner's equity
Intangible assets
Capital stock
Other assets
Current Assets:
They are cash and other assets expected to be converted into cash, sold, or consumed
either in one year or in the operating cycle, whichever is longer. The operating cycle is
the average time between the acquisition of materials and supplies and the realization of
cash through sales of the product for which the materials and supplies were acquired. The
cycle operates from cash through inventory, production, and receivables back to cash.
Where there are several operating cycles within one year, the one-year period is used. If
the operating cycle is more than one year, the longer period is used.
Current assets are presented in the balance sheet in order of liquidity. The five major
items found in the current asset section are:
Cash: valued at its stated value. Cash restricted for purpose other than payment of
current obligations or for use in current operations should be excluded from the
current asset section.
Accounts receivables: amounts owed to the firm by its customers for goods and
services delivered. Valued at the estimated amount collectible.
Prepaid expenses: they are expenditures already made for benefits (usually
services) to be received within one year or the operating cycle, whichever is
longer. Typical examples are prepaid rent, advertising, taxes, insurance policy,
and office or operating supplies. They are reported at the amount of un-expired or
unconsumed cost.
Long-Term Investments:
Often referred to simply as investments, they are to be held for many years, and are not
acquired with the intention of disposing of them in the near future.
Investments in tangible fixed assets not currently used in operations, such as land
held for speculation.
Investments set aside in special funds such as a sinking fund, pension fund, or
plant expansion fund. The cash surrender value of life insurance is included here.
Current Liabilities:
They are obligations that are reasonably expected to be liquidated either through the use
of current assets or the creation of other current liabilities within one year or within the
operating cycle, whichever is longer. They are not reported in any consistent order. A
typical order is: Notes payable, accounts payable, accrued items (e.g. accrued warranty
costs, compensation and benefits) income taxes payable, current maturities of long-term
debt, etc.
The excess of total current assets over total current liabilities is referred to as working
capital. It represents the net amount of a company's relatively liquid resources; that is, it
is the liquid buffer, or margin of safety, available to meet the financial demands of the
operating cycle.
Long-Term Liabilities
They are obligations that are not reasonably expected to be liquidated within the normal
operating cycle but, instead, at some date beyond that time. Bonds payable, notes
payable, deferred income taxes, lease obligations, and pension obligations are the most
common long-term liabilities. Generally they are of three types:
Obligations arising from the ordinary operations of the enterprise such as pension
obligations and deferred income tax liabilities.
Owner's Equity:
The complexity of capital stock agreements and the various restrictions on residual equity
imposed by state corporation laws, liability agreements, and boards of directors make the
owner's equity section one of the most difficult sections to prepare and understand. The
section is usually divided into three parts:
Additional paid-in capital: the excess of amounts paid in over the par or stated
value.
it highlights certain intermediate components of income that are used for the
computation of ratios used to assess the performance of the enterprise.
Components:
Income taxes: A short section reporting federal and state taxes levied on income
from continuing operations.
intended to be converted into cash as needed within one year or the operating
cycle, whichever is longer. Securities that are intended to be held for more than
one year are called long-term investments.
Realized gains and losses: the difference between the fair market value and the
cost of the securities when they are sold.
Unrealized holding gains and losses: the difference between the fair market
value and the cost of the securities when they are still held by the firm. The gains
and losses are unrealized because securities have not been sold.
In general:
When securities are purchased, they are recorded at cost. The cost of the securities
includes purchase price and any broker's fees or fees paid to acquire securities.
Interest and dividends generally are recognized as revenue when they are
received.
When securities are sold, the cost is compared to the sales price, and the
difference is recorded as a gain or a loss.
At the end of each accounting period, the balance of the controlling account is
adjusted to reflect the current market value of the securities owned.
Trading securities: Debt and equity securities bought and held mainly for sale in
the near term to generate income on price changes. At year end, they are reported
at their fair market value. Any unrealized holding gains or losses are recognized
on the firm's income statement as part of the net income. When they are sold, the
realized gains or losses will also appear on the income statement. Realized gains
and losses are not affected by any unrealized gains or losses recognized before.
Example:
1. 12/1/2002, 100 shares purchased at $80 per share for trading purposes:
Entry: Trading Securities 8000(Debit) | Cash 8000 (Credit)
2. 12/31/2002, the price is $60 per share.
Entry: Unrealized Loss on Investments 2000 (Debit) | Allowance to Adjust ShortTerm Investments to Market 2000 (Credit).
The allowance account is shown on the balance sheet as a contra-asset account:
Trading Securities (at cost) 8000
Allowance Account (2000)
Trading Securities (at market) 6000
The $2000 unrealized loss is reported in the income statement for 2002.
3. 06/12/2003, 100 shares sold at $120 per share.
Entry: Cash 12000 (Debit) | Trading Securities 8000 (Credit) | Realized Gain on
Investment 4000 (Credit)
The $4000 realized gain is reported in the income statement of 2003.
Available-for-sale securities: Debt and equity securities not classified as held-tomaturity or trading securities. The unrealized gains and losses are reported in the
balance sheet as an adjustment to the shareholders' equity (in contrast, the
unrealized gains or losses of trading securities are reported in the income
statement as part of the net income). Other than that, they are accounted for in the
same way as trading securities.
Example:
1. 12/1/2002, 100 shares purchased at $80 per share for trading purposes:
Entry: Available-for-Sale Securities 8000(Debit) | Cash 8000 (Credit)
2. 12/31/2002, the price is $60 per share.