Occur at the end of every reporting period to ensure:

-matching principle:revenue is recognized when it is realized realizable or earned and expenses are recognized in the period where they contribute to the production of revenue

some accounts are valued at market value rather then original cost including:

investments:at market value

inventories: at lower of cost or market value

receivables: at net realizable value rather then face value

(net realizable value: amount of cash firm expects to collect) 

common aspect: each adjustment involves at least one balance sheet and one income statement account but not cash account (except when reconciling cash itself)

accural:asset or liability increases, or builds up, as time passes. 

example: intrest receivable from bank or intrest payable related to a loan

deferral: asset or liability decreases as time passes

capitalization: item originally recorded on balance sheet when acquired or received. 

end of period: do we have all of asset/owe all of liability?

yes: no adjusting entry

no: adjust

profitability: what did management do with available assets?

return on assets= Net Income + Interest (1 – tax rate)

Average total assets

add back intrest because assets come from borrowing or owners adding. adding back interest offsets this and shows how much made before assets and dividends

turnover: how much revenue was generated by each dollar invested in assets? allows better comparison of other companies

total asset turnover = sales revenue/ average total assets

example: 8000/ (4200 + 5200) = 1.7:1

liquidity: nearness to cash or ability to pay current liabilites

current assets: working assets as in cash  and things expected to be realized in cash, sold, or consumed during the normal operating cycle

cash: cash and equivalents (short-term, marketable investments)

realized in cash: accounts and notes recievable

sold: merchandise inventory

consumed: supply inventory and prepaid items

operating cycle:

if operating cycle < 12 months treated as 1 year

if cycle > 12 months the longer period is used

"moneys command over resources, its purchasing power, is the basis of its value and future ecomomic benefits"

holding to little: nonearning or earns low intrest, loses purchasing power in times of inflation

to much: meet normal needs of company, avoid need to borow = interest costs, financial flexibility

classification:

cash: unrestricted, immediate access(money orders, bank drafts, current checks). restricted, delayed access (sinking funds, compensating balance, funds in escrow)

equivalents: short term highly liquid investments that are:

readly convertible into cash

near maturatity so that the risk of change in value is small

3 months or less from original maturity, typically

(commercial paper, treasury bills, money market funds)

near cash: close to cash, postage stamps, advances, unreceived checks (post dated checks, postage, unreceived checks)

general:

competent and trustworthy employees

defined authority and responsibility

segregation of duties

sufficient records and documentation

physical control of assets and records

cash handling process:

receive/open lock boxes

record receipt, deposit, disburse, and reconcile

petty cash or imprest account fund

goals:

short term: higher rate of return

long term: appreciation in value, control and/or influence (50%)

forms:

non-financial (land, art, jewlery)

financial, another firms debt and equity securities

debt security

if have the intent and ability to hold debt securities of others until maturity then report at amortizied cost

~classified as long term assent until due within a year

if intent is to dispose of before maturity, account for as trading or available for sale

equity securities: 3 sets of instruction depending on ownership:

own more then 50%, own 20-30%, or own under 20%

consolidate: when have controlling financial interests, voting stock greater then 50% (equity can become an asset)

except when control temporary or doesnt rest with owner of voting 

majority

equity method: can have significant influence on financial decisions (20-30%) Ex: own 30%. company makes 100 in net income. your company debit investment 30 credit income on investment 30. pays 100 in dividends your company debits cash 3 credits investment 3.

own under 20%: year end valuation: readily marketable: report at cost. not ready: mark to market value. may be recorded as unrealized gain on income statment.

trading: bought debt/equity with intent to earn short term profit. high turnover. always current assets, cash flows are operating.

available for sale: all other investments except held to maturity and trading. current or long term classification, cash flows classified as investing

buy: same as trading sell: in same year bought, same as trading

net income plus items not immediate results of operating activities. 

unrealized gains/losses on abailbe for sale securities

foreign corrency translation = changes in exchange rate

adjustments to mim. pension liability that is underfuneded

hedging gains and losses

reporting costs

after net income on income statment

additional componet of owners equity

separate statment

In recent years, falsifying revenue has increasingly become the accounting scam of choice.”     “Half of all SEC accounting-fraud cases from 1987 to 1997 involved revenue hoaxes” ¹

**no definition just important to acknowledge 

SAB 101: revenue recognition in financial statements, dec 3 1999, no later then fourth quarter of fiscal year, beginning december 15 1999

companies had to review their revenue recognition criteria

~before transfer of title: generally not permissible, unless percentage of completion method (substance over form)

~after period of sale: when collectibility of receivable is questionable

installment sales: portion of gross profit recognized as cash received

cost recovery method: no gross profit recognized until cost of product is recovered

contingencies: condition, situation, set of circumstances involving uncertainty as to possible gain or loss. ultimately resolved when one or more future events occur or fail to occur. (gains are generally not until realized)

indirect allowance method: used if already have basis of estimate 

recognize the expense in same year as credit sale (year end adjust)

less allowance for bad dents is a contra asset account

use one B/S account to estimate another. (A/R used to determine allowance for bad debts accoutns) balance sheet orientated

at year end categorize receivables by age (aging method) then estimate the uncollectible accounts that will occur

receivables are presented at their net realizable value

use one I/S account to estimate another (income statement)

all events the same except year end adjustment calculation

year end adjust enty based on experience, example 5% credit sales not collected

accounts receivable turnover ratio:

the higher the turnover, more credence to current ratio, liquidity good

net credit sales/ avg accounts receivable

ex.: 8000/ (4000+6590)/2 = 1.51 A/R turning over, collected, 1.51 times a year

average number of days to collect receivables ratio:

365 (days in year)/ A/R turnover ratio: example: 365/1.51=241. 

on average takes 241 days to collect receivables. fewer days is best

goods awaiting sale, in course of production (work in process) and good to be consumed directly or indirectly in production (raw materials and supplies)

importance: purpose of non-service business (dollar size, liquidity, carrying costs such as insurance and storage)

costs included with inventory (all costs to bring to sellable/usable condition/location): cost of goods purchased, all costs to get inventory in a selling condition and transporation (freight in), intransit insurance, warehousing and handling. 

perpetual: figured after each event occurs (more bookkeeping)

keeps track of cogs every time sale is made, always up to date inventory record. counting inventory not necessary but spoilage theft etc. possible

periodic: figured at end of period, less bookkeping more practical

inventory never up to date, counting required

keeps track of units as sold, easy to manipulate

if want highest net income sell cheapest inventory first, lowest taxable sell more expensive, anything is possible

this method used only when can identify specific units. 

average:

periodic: take averages at the end of the period

perpetual: average is recalculated after each new purchase

easy and objective, less manipulatable, gives values between earliest and latest prices!

first in first out

periodic and perpetual give same amounts

usually matches physical flow, COGS cant be manipulated, ending inventory valued at latest cost so current assets and ratios are more reflective of present costs but cogs/net income and other ratios may be misleading

last in first out:

periodic, at end of period takes last items bought and assumes they are the ones sold

perpetual: actually accounts for inventory removed as sales happen

more work, better application of matching principle (only deducts expenses that contribute to revenue this year, most recent costs go into income statement) 

net income and ratios like that are more reflective of present costs, inventory assets and other ratios may be misleading, COGS may be manipulated

liquidity is improved by reducing cash outflows, taxes. if prices rising lifo gives that result

when utility of goods may be at less then cost the difference should be recognized as a loss, accomplished by stating goods at the lower level or market value

inventory turnover ratio: cogs/average inventory

ex: 4800/900=5.3 inventory turning over or replaced 5.3 times a year

the higher the turnover the more credence in ratio. liquidity is good

average days to sell inventory: 365/inventory turnover ratio

ex: 365/5.3=69, on average takes 69 days to sell good

slower moving inventory is harder to sell

operating cycle: average # of days to convert sales+average days to convert credit sales, receivables, to cash = operating cycle

ex: 69 days + 241 days = 310 days

prepaid expense: adjusting entry always includes a debit to an expense and a credit to an asset. prepaid expenses create future benefits so recorded as asset at time of purchase but the benefits expire in future periods and that is when they are expensed.

ex. debit supplies expense credit supplies after ending inventory is taken to bring supplies to current value

depreciation expense is similar to prepaid expenses. depreciation allocates cost of an asset to expense. 

ex. buy something with 60 month useful life, use 1 month so should expense it with the revenue it helps to produce. entry: debit depreciation expense, credit accumulated depreciation

unearned revenue: always includes debit to a liability and a credit to a revenue. used when some of unearned revenue has been earned in the year. 

ex. debit unearned revenue credit revenue

accurals are the opposite of prepayments. they occur when the cash flow accurs after either the expense is incurred or the revenue is earned. 

accured expense: when a company has incurred an expense but has not yet paid cash or recorded an obligation to pay it should still record the expense. adjusting entry will always include a debit to expense and a credit to liability

ex: salaries. have not paid salaries for a few weeks by end of period but those salaries helped to earn revenue that period. debit salaries expense and credit salaries payable. same method used for other expenses such as receiving a bill for utilities but paying it in the next period. 

accured interest is similar. example: note payable of 10000 anual interest rate of 12% fraction of year is 1/12 interest = 100. so interest expense is 100, interest payable is 100

accured revenue: company has earned revenue but has not received cash or recorded amount receivable. adjustment always includes debit to an asset and credit to a revenue. includes interest and accounts receivable. 

ex: provide service but bill is sent in the next accounting period to bring to date record accounts receivable debit revenue credit

degree of influence:

0-20%: insignificant influence, fair value method

most common. examples:

purchase of investment: debit investment (#shares x price per share) credit cash

receipt of dividends: debit cash (shares x dividends per share) credit dividend revenue

sale of investment: if sold for more then cost gain on sale of invesmtents if less its a loss. gain and sales are recorded in income statement as part of net income. cash is always debited (shares sold x amount received per share) a loss is debited by difference and a gain is credited by difference and investment is credited (shares x original price per share)

adjustments to fair value: if increase in fair value debit investment (shares x increase in value per share) credit unrealized holding gain - other comprehensive income

if decrease debit unrealized holding loss-other comprehensive income debit investment (shares x decrease in value per share

20-50% significant influence, equity method

mini-consolidation, uses one balance sheet and one income statement account.

50-100% controlling influence, consolidation method

because more then 50 owns major part of company and can control it. report consolidated financial statements, combine separate statements into a single set of statements

what value to record? fair market value of what is given up or received, whichever is more clearly evident (the same asset can take on many values depending on the deal or type of transaction)

capitalize all costs necessary to get it ready for intended use (mortgage, land cleared, legal fees). if not capitalized expense the remainder

use different accounts if components have differing lives, it will depreciate assets differently. example: building costs 500. components are structure, 400 for 40 years, and elevator, 100 for 20 years. entry will be debit building accessories:100 and building: 400 credit cash 500

amortization: systematic/rational allocation of assets cost over its estimated useful life to periods in which benefits are received. (matching principle) 

-land and assets are not amortized

must use estimates: subjective and differ greatly for same asset

types:

salvage value: estimated amount received at disposal of asset

service life: estimated life that asset will be useful for

physical life: performs until belly up/cost ineffective to maintain

technological life: useful as long as provides needed service

these estimates may change as the assets are used

amortization methods (straight line, double declining)

activity based included on separate card

effect of change should be accounted for in period of change if:

change effects only that period

and future periods if the change effects both

example: historical cost 1000, accumulated depr. is 600, remaining book value is 400. a change now means that asset will last 6 more years with a 100 salvage value. revised depreciaiton expense is 50

update depreciation to time of sale

if abandoned/retired then debit loss on disposal and accum. dep. credit old asset

if sold:

debit cash, accum. depr. and loss on disposal credit old asset

(if sold for a gain then credit gain on disposal)

why does it happen?

inadequate training, work conditions, mental attitude (work and personal), poor internal control, math errors

types:

oversight, completly omit entire transaction/event

misuse of facts: post correct amount to wrong accounts, mistakes in application of accounting principles

math: post wrong amount to correct accounts

deluxe: all/most of the above

statments affected: balance and income sheet only. ripples into retained earnings

amounts involved: materail and immaterial

timing: when made vs. when discovered/corrected

same year: before books closed

after this years books closed: sometime next year or later

possibly never!

working capital: greater buffer, liabilities, solvency got better, less risk of non-payment

current and quick: same as above but quick is more conservative

debt to equity: less creditor risk, increase borrowing capacity, lower debt interest rate

return on sales: higher profitability, stock price increases greater bonus

income statement

balance sheet

retained earnings

cash flows

IS

revenues + gain on sale of investment (or subtract loss) minus expense: = net income (temporary accounts, close into income summary) net income is gross profit margin (sales - cogs) - expenses + other revenue + gains - loss

easiest way: net sales: total sales less returns allowances and discounts subtract total net sales from cogs (beg inventory + freight in less purchase returns and allowances and purchase discounts will give cost of goods available for sale. subtract from ending inventory to get cogs) net sales - cogs = gross profit. 

in income statement: net sales minus cogs = gross profit, subtract selling, general and administrative expenses to get operating income. add nonoperating revenue subtract nonoperating expense (accounts like interest expense and revenue, gains on losses on sale of fixed assets) to get income before taxes. subtract tax expense to get net income!

BS

assets = liab. + SE (all permanant accounts)

RE

balance beg. + issuance of stock + net income - dividends = balance at end of year

Cash

only transactions that involve cash, operating investing and financing activities