Financial Accounting Chapter 3

Introduction to Financial Accounting

• A textbook, Introduction to Financial Accounting, by Henry Dauderis & David Annand, edited by Athabasca University, version 2019 – Revision A, is available under a Creative Commons License (CC BY-NC-SA).
• The text is adaptable, accessible, and affordable.
• This textbook introduces financial accounting concepts, including adjusting entries, the accounting cycle, and the preparation of financial statements.
• The book is designed to help students understand Financial Accounting.

Contributors

• The Lyryx Learning Team is credited for the textbook, composed of Bruce Bauslaugh, Peter Chow, Nathan Friess, Stephanie Keyowski, Martha Laflamme, Jennifer MacKenzie, Tamsyn Murnaghan, Bogdan Sava, and Ryan Yee.

Chapter 3 Learning Objectives

• Understand the timeliness, matching, and recognition Generally Accepted Accounting Principles (GAAP) requirements for adjusting entries.
• Explain and prepare adjusting entries for prepaid expenses, depreciation, unearned revenues, accrued revenues, and accrued expenses.
• Prepare an adjusted trial balance and understand its use.
• Use an adjusted trial balance to prepare financial statements.
• Understand the steps in the accounting cycle.
• Understand and prepare closing entries and a post-closing trial balance.

Concept Self-Check

• GAAP principle of timeliness
• GAAP principle of matching
• GAAP principle of revenue recognition
• Adjusting entries and when they are journalized
• The five types of adjustments are described
• The difference between an unadjusted and adjusted trial balance.
• The four closing entries
• Why the Dividends account is not closed to the income summary
• The difference between a post-closing and adjusted trial balance

The Operating Cycle

• Financial transactions within an accounting period are part of a sequence of operating activities.
• Big Dog Carworks Corp. sequences their activities as follows:
• Beginning with cash on hand
• Cash is used for supplies and expenses
• Revenue earned from repair services
• Cash is collected from customers
• This sequence is called the operating cycle
• Financial statements need to be prepared at specific time intervals to meet GAAP timeliness requirements.
• This means transactions related to incomplete operating cycles in an accounting year need to be recorded and reported.
• Recognition and matching are two important GAAP requirements for recording incomplete operating cycles

Recognition Principle

• GAAP provides guidance when an economic activity should be recognized in financial statements.
• An economic activity is recorded when it meets two criteria:
• It's probable that a future economic benefit will flow to the business.
• The activity's value can be measured reliably.

Revenue Recognition Illustrated

• Revenue is recorded in the accounting period it's earned, not necessarily when cash is received.
• Common method of recognizing revenue:
• When a sale invoice is sent to the customer, and the goods or service are received (possibly before cash is received)
• This creates an asset called Accounts Receivable

Expense Recognition Illustrated

• Costs can be assets or expenses, depending on where they fit in the accounting period
• Costs are assets if they are incurred and will be used to produce revenue in the future.
• Costs are expenses if they are used or consumed during the current accounting period to earn revenue.

Adjusting Entries

• Adjusting entries are used at the end of an accounting period to ensure account balances accurately represent the period's financial activities.
• An unadjusted trial balance shows account balances before adjustments
• These adjustments help the balance and income statements have an accurate representation of the period's financial activity