Chapter 3 Fundamentals of Financial Accounting PDF

POST-GRADUATE CERTIFICATE IN ACCOUNTING FUNDAMENTALS OF FINANCIAL ACCOUNTING Learning Objectives – Chapter 3 – Operating Statements & the Statement of Earnings: After this lesson, you will be able to understand: 1. The business operating cycle and explain the necessity for the per...

POST-GRADUATE CERTIFICATE IN ACCOUNTING FUNDAMENTALS OF FINANCIAL ACCOUNTING Learning Objectives – Chapter 3 – Operating Statements & the Statement of Earnings: After this lesson, you will be able to understand: 1. The business operating cycle and explain the necessity for the periodicity assumption. 2. The business activities that affect the elements of the statement of earnings. 3. The accrual basis of accounting, the revenue and expense recognition principle and the matching process to measure net earnings. 4. The preparation of a multistep statement of earnings. 5. Explain the difference between net earnings and cash flow from operations. 2  The Operating Cycle (cash-to-cash cycle) The operating (or cash-to-cash) cycle is the time it takes for a company to pay cash to suppliers, sell those goods and services to customers, and collect cash from customers. Begin Purchase or manufacture products or supplies on credit. Pay creditors Deliver product or provide service to customers on credit. Receive payment from customers. 3 Elements on the Statement of Earnings Revenues Increases in assets or settlement of liabilities from ongoing operations. Expenses Decreases in assets or increases in liabilities from ongoing operations. Gains Increases in assets or settlement of liabilities from non-operational or peripheral transactions. Losses Decreases in assets or increases in liabilities from non-operational or peripheral transactions. 4 Elements on the Statement of Earnings (continued) 5 How Are Operating Activities Recognized and Measured? Cash Basis Revenue is recorded Expenses are recorded when cash is received. when cash is paid. 6 How Are Operating Activities Recognized and Measured? (Continued) Accrual Accounting Assets, liabilities, revenues, and expenses should be recognized when the transaction that causes them occurs, not necessarily when cash is paid or received. S / GAA Required by - Required by - International FR Generally Financial Acceptable P Reporting I Accounting Standards Principles 7 Principles Upon Which the Statement of Earnings is Prepared: 1. Revenue Principle – recognize revenue when have passed on the ownership not necessarily when cash received. 2. Expense Principle – recognize expense when it is incurred not necessarily when cash paid. 3. Matching – Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid. 8 Revenue Principle Situation #1 – cash is received BEFORE revenue is earned If cash is received before the company delivers goods or services, the liability account DEFERRED REVENUE is recorded. Cash is received before revenue is earned - Cash Received Cash (+A) xxx Deferred revenue (+L) xxx 9 Revenue Principle (Continued) Situation #1 – cash is received BEFORE revenue is earned When the company delivers the goods or services DEFERRED REVENUE is reduced and REVENUE is recorded. Cash is received before revenue is earned - Cash Company Received Delivers Cash (+A) xxx Deferred revenue (+L) xxx Revenue will be recorded when earned. Deferred revenue (-L) xxx Service revenue (+R) xxx 10 Revenue Principle (Continued) Situation #1 – cash is received BEFORE revenue is earned Typical liabilities that become revenue when earned include... CASH COLLECTED REVENUE (Goods or services due to over time will (Earned when goods customers) become or services provided) Rent collected in advance Rent revenue Deferred air traffic revenue Air traffic revenue Deferred subscription revenue Subscription revenue 11 Revenue Principle (Continued) Situation #2 – cash is received ON the date revenue is earned When cash is received on the date the revenue is earned, the following entry is made: Company Delivers AND Cash Received Cash (+A) xxx Revenue (+R) xxx 12 Revenue Principle (Continued) Situation #3 – cash is received AFTER revenue is earned If cash is received after the company delivers goods or services, an asset TRADE RECEIVABLES is recorded. Cash is received after revenue is earned - Company Delivers Trade receivables (+A) xxx Revenue (+R) xxx 13 Revenue Principle (Continued) Situation #3 – cash is received AFTER revenue is earned When the cash is received the TRADE RECEIVABLES is reduced. Cash is received after revenue is earned - Company Cash Delivers Received Trade receivables (+A) xxx Revenue (+R) xxx Cash will be collected. Cash (+A) xxx Trade receivables (-A) xxx 14 Revenue Principle (Continued) Situation #3 – cash is received AFTER revenue is earned Assets reflecting revenues earned but not yet received in cash include... CASH TO BE REVENUE COLLECTED (Earned when (Owed by and already goods or services customers) earned as provided) Interest receivable Interest revenue Rent receivable Rent revenue Royalties receivable Royalty revenue 15 The Matching Process Situation #1 – cash is paid BEFORE expense is incurred If cash is paid before the company receives goods or services, an asset account, PREPAID EXPENSE is recorded. Cash is paid before expense is incurred - $ Paid Prepaid expense (+A) xxx Cash (-A) xxx 16  The Matching Process (Continued) Situation #1 – cash is paid BEFORE expense is incurred When the expense is incurred PREPAID EXPENSE is reduced and an EXPENSE is recorded. Cash is paid before expense is incurred - $ Expense Paid Incurred Prepaid expense (+A) xxx Cash (-A) xxx Expense will be recorded when incurred. Expense (+E) xxx Prepaid expense (-A) xxx 17 The Matching Process (Continued) Situation #1 – cash is paid BEFORE expense is incurred Typical assets and their related expense accounts include... as used over CASH PAID FOR time becomes EXPENSE Supplies inventory Supplies expense Prepaid insurance Insurance expense Buildings and equipment Depreciation expense 18 The Matching Process (Continued) Situation #3 – cash is paid AFTER the date expense is incurred If cash is paid after the company receives goods or services, a liability PAYABLE is recorded. Cash is paid after expense is incurred - Expense Incurred Expense (+E) xxx Payable (+L) xxx 19 The Matching Process (Continued) Situation #2 – cash is paid ON the date expense is incurred When cash is paid on the date the expense is incurred, the following entry is made: Expense Incurred AND Cash Paid Expense (+E) xxx Cash (-A) xxx 20 The Matching Process (Continued) Situation #3 – cash is paid AFTER the date expense is incurred When cash is paid the PAYABLE is reduced. Cash is paid after expense is incurred - Cash Expense Paid Incurred Expense (+E) xxx Payable (+L) xxx Cash will be paid. Payable (-L) xxx Cash (-A) xxx 21 Relationship between balance sheet and income statement A = L + SE Assets Liabilities Next, let’s see how Revenues and Debit for Credit for Debit for Credit for Expenses affect Increase Decrease Decrease Increase Retained Earnings. Contributed Capital Retained Earnings Other Components Debit for Credit for Debit for Credit for Debit for Credit for Decrease Increase Decrease Increase Decrease Increase 22  The Expanded Transaction Analysis Model Net losses and dividends Net earnings increase Retained Earnings decrease Retained Earnings. Retained Earnings. Debit for Credit for Decrease Increase Revenues and Gains Expenses and Losses Debit for Credit for Debit for Credit for Decrease Increase Increase Decrease 23 Analyzing Some of Sun-Rype’s Transactions (a) Sun-Rype sold fruit-based beverages and snacks to customers for $3,520 in cash. The cost of these sales was $1,960. Debit Credit (a) Cash (+A) 3,520 Sales Revenue (+R, +SE) 3,520 Cost of Sales (+E, -SE) 1,960 Inventories (-A) 1,960 (b) Sun-Rype sold food and beverage products to retail outlets for $3,020; $2,020 was received in cash and the rest was due from the outlets. The cost of products sold was $1,400. Debit Credit (b) Cash (+A) 2,020 Trade Receivables (+A) 1,000 Sales Revenue (+R, +SE) 3,020 Cost of Sales (+E, -SE) 1,400 Inventories (-A) 1,400 24 Analyzing Some of Sun-Rype’s Transactions (Continued) (c) Sun-Rype received $345 from customers, including $75 for sales made in December and the rest from January sales. Debit Credit (c) Cash (+A) 345 Trade Receivables (-A) 75 Sales Revenue (+R, +SE) 270 (d) Sun-Rype signed contracts with new clients and received $50 cash. The company earned $40 immediately by performing services for these clients; the rest will be earned over the next several months. Debit Credit (d) Cash (+A) 50 Service Revenue (+R, +SE) 40 Deferred Service Revenue (+L) 10 25 Analyzing Some of Sun-Rype’s Transactions (Continued) (e) Sun-Rype paid $740 in advance for the following: $160 for insurance covering the next four months beginning January 1, $450 for rent of warehousing facilities for the next three months beginning January 1, and $130 for advertising to be run in February. Debit Credit (e) Prepayments (+A) 740 Cash (-A) 740 (f) Sun-Rype paid $731 for utilities, repairs, and fuel for delivery vehicles, all considered distribution expenses. Debit Credit (f) Distribution Expenses (+E, -SE) 731 Cash (-A) 731 26 Exercises to work on from Chapter 3 E3-1 E3-2 E3-3 E3-4 E3-12 (self practice) 27