Accounting

Study Notes

The operating cycle measures the duration from cash payments to suppliers to cash collection from customers.
Understanding this cycle helps businesses manage their cash flow efficiently.

Financial information is reported over short time periods (monthly, quarterly, annually) to aid decision making.
The frequency of reporting is influenced by the size of the business.
Two critical issues in periodic reporting:
- Recognition issues: Timing of recording transactions and their impacts.
- Measurement issues: Determining the correct amounts to be recorded for transactions.

Structure of the income statement:
- Sales minus Cost of sales yields Gross profit.
- Gross profit minus Operating expenses equals Earnings from operations.
- Adjusting for Non-operating revenues/expenses and gains/losses leads to Earnings before income taxes.
- Subtracting Income tax expense results in Net earnings.

Revenues are increases in assets or reductions in liabilities from the company’s ongoing operations.
- Operating revenues stem from the sale of goods and services.
Expenses are decreases in assets or increases in liabilities that occur to generate revenues.
- Expenses are vital for understanding the overall profitability of the business.

Cost of sales (or Cost of goods sold) represents the cost of products sold to customers; typically the largest expense for manufacturing or merchandising companies.
Gross profit (or gross margin) is calculated as Sales (after discounts, returns, allowances) minus Cost of sales.
Operating expenses encompass all other usual expenses beyond the cost of sales, necessary for daily operations.

The accounting cycle encompasses the systematic process of analyzing, recording transactions, preparing financial statements, and readying records for the subsequent cycle.
Transactions involve exchanges of benefits and obligations with external parties, documented chronologically in the General Journal via journal entries.
The General Ledger accounts are updated accordingly throughout the accounting period.
End-of-period processes emphasize adjustments to correctly account for revenues and expenses, ensuring accurate financial reporting.

Adjusting journal entries are computed to account for transactions that may have changed or require correction over time.
These entries are particularly crucial at the financial period's end to represent the accurate state of various accounts.
The goal is to ensure revenues are recognized when earned and expenses are recorded when incurred, adhering to the revenue recognition principle and the matching process.

Adjusting entries ensure that revenues reflect when they are earned, aligning with real-time earnings realization.
Expenses are matched to the revenues they help generate within the same accounting period.
Assets are reported based on their probable future benefits remaining at period-end.
Liabilities are presented in amounts reflecting future sacrifices of assets or services owed at the end of the period.

Companies typically wait until the accounting period concludes to make adjustments to minimize costs and time associated with daily updates.
Adjusting entries are essential whenever a company intends to prepare financial statements for external users, ensuring accuracy and compliance.