Intermediate Accounting September 28 th , 2010

1. Intermediate AccountingSeptember 28th, 2010 • Intro to Course: A. Syllabus B. Student Enrollment & Wait List C. Student Questions • Introduce Chapter 3: The Accounting Information System • Assignments for Thursday, Sept. 30th: A. Readings: Chapter 1 and IFRS pp. 3-7 B. Codification CE1-2 and CE1-3 C. Chapter 1: CA1-3 and CA1-15 D. Take-Home Introductory Quiz

2. Chapter 3 Learning Objectives • Understand basic accounting terminology • Use double-entry rules to record basic business activity, prepare adjusting entries and closing entries • Understand how the steps in the accounting cycle lead to preparation of the financial statements: A. Income Statement B. Statement of Stockholders’ Equity C. Balance Sheet D. Statement of Cash Flows • Identify the information found on the Four Financial Statements and how they link (talk) to each other

3. Basic Accounting Terminology • Journal • Ledger • Posting • Trial Balance • Adjusting Entries • Financial Statements • Closing Entries • Reversing Entries • Event • Transaction • Account • Real Account • Nominal Account • Debit • Credit • T Accounts

4. Debits and Credits • An Account shows the effect of transactions on a given asset, liability, equity, revenue, or expense account. • Double-entry accounting system (two-sided effect). • Recording done by debiting at least one account and crediting another. • DEBITSmust equalCREDITS.

5. Debits and Credits • An arrangement that shows the effect of transactions on an account. • Debit = “Left” • Credit = “Right” Account An Account can be illustrated in a T-Account form.

6. Debit & Credit Review

7. Balance Sheet Equation Debits and Credits Summary Balance Sheet Income Statement Normal Balance

8. Balance Sheet Equation Debits and Credits Summary Balance Sheet Income Statement Liability Equity + Revenue = Asset Expense - Debit Credit Debit Credit Normal Balance Credit

9. Debits and Credits Summary Balance Sheet Income Statement - + Asset Liability Equity Revenue Expense = = Debit Credit

10. Debits and Credits Summary Balance Sheet Income Statement - + Asset Liability Equity Revenue Expense = = Debit Credit

11. The Accounting Cycle Illustration 3-6 Transactions 9. Reversing Entries 1. Journalize Transactions 8. Post-closing trial balance 2. Post Entries to Ledger 7. Closing Entries 3. Trial Balance 6. Financial Statements Work Sheet 4. Adjusting Entries 5. Adjusted trial balance

12. What information is found on the four required financial statements? • Income Statement • Statement of Changes in Owners’ (Stockholders’) Equity • Balance Sheet • Statement of Cash Flows

13. Income Statement(P&L) • This financial statement is intended to provide information related to the results of an entity's operations for a specific time period; typically a year, quarter, or month. • Includes: Revenues, Expenses, Gains & Losses • Net Income is also called: Net Earnings, Net Profit, Return, Results and/or Bottom Line • Income Statement is also known as: • “Statement of Earnings” • “Statement of Results of Operations” • “Profit and Loss Statement”

14. The Income Statement The Kroger Co. Consolidated Statements of Operations For the year ended February 2, 2008 (in millions) Sales $ 70,235 Merchandise Costs(COGS) 53,779 Gross Profit or Margin $16,456 Operating Expenses -14,155 Operating Profit (EBIT) $2,301 Other Income & (Expenses) - 474 Income before taxes $1,827 Income Tax Expense - 646 Net Earnings $1,181

15. Statement of Owners Equity(or Statement of Stockholders’ Equity) • The Statement of Stockholders’ (Owners’ ) Equity “connects” the Balance Sheet to the Income Statement. • It shows the beginning and ending balances of the owners’ equity accounts (from the balance sheet), and the increases or decreases in each of the accounts. • The Net Income (or net loss) from the Income Statement increases (or decreases) the Owners Equity and is shown on the Statement of Stockholders’ Equity.

16. The Statement of Changes in Stockholders’ (Owners’) Equity Beginning equity + Investment by owners + Net income or – Net Loss – Distribution to owners = Ending equity`

17. Articulation • There is a linkage between the three financial statements. This is know as articulation. Statement of Equity Income Statement Balance Sheet

18. Articulation Income Statement Net Income $ 1,181 Statement of Stockholders’ Equity Retained Earnings, beg $5,501 Add Net Income 1,181 Other 4 -Dividends - 206 Retained Earnings, end $6,480 Balance Sheet Total Assets $22,299 Total Liabilities $17,385 Stockholders’ Equity: Common Stock 947 Add’l Paid in Capital 3,031 Accum. other comp. loss (122) Retained Earnings 6,480 Treasury Stock (5,422) Total Stockholders’ Equity 4,914 Total Liabilities & Equity $22,299

19. The Balance Sheet ASSETS = LIABILITIES + OWNERS’ EQUITY The equality (or “balance”) must always be maintained. The balance sheet is also known as: • TheStatement of Financial Position, or • TheStatement of Financial Condition Provides information on what the entity owns (assets) and what groups of people have claims on those assets (creditors or owners) at any particular point.

20. A Classified Balance Sheet shows Current and Long-term Information: Assets Current Assets: Cash $ 100 Accounts receivable 251,000 Inventory 298,900 Prepaid expenses 50,000 Total current assets $ 600,000 Long-term Assets: Land $ 125,000 Plant & equipment 1,075,000 LESS: Accumulated Depreciation (283,200) Total long-term assets 916,800 Total assets $1,516,800 Liabilities Current Liabilities: Accounts payable $501,000 Short-term note payable 50,000 Total current liabilities $551,000 Long-term liabilities: Bonds payable 300,000 Total liabilities $851,000 Stockholders’ equity Common stock, $400,000 Retained earnings 265,800 Total stockholders’ equity 665,800 Total liabilities & Stockholders’ Equity $1,516,800

21. What all Economic Decision Makers Want to Know Economic decision makers attempt to predict future cash flow. Will I be paid? When will I be paid? How much will I be paid?

22. Keep your Eye on the Ball. In the Game of Business Cash is the Ball!

23. Cash Flow Statement Cash Inflows Ending Cash Beginning Cash Operating Investing Financing Cash Outflows

24. Kroger’s Statement of Cash Flows

25. Articulation Information from all three of the other FinancialStatements is found on the Cash Flow Statement. They are linked or articulate with each other. Statement of Equity Income Statement Balance Sheet Cash FlowStatement

26. The Accounting Cycle: During the period: Analyze and record transactions At the end of the period: Adjusting entries and Adjusted Trial Balance Closing entries Review of the Mechanics

27. Asset Liability Equity Debit Credit Credit Expense Revenue Debit Credit Normal balance in account The Account and the Debit-Credit Convention

28. Using T-Accounts • A T-Account can help you simplify and solve seemingly complex problems. Put in what you know • If there only one unknown, you can solve for it • If there are multiple unknowns, you can recognize where you need more information • Example: • Given: • 12/31/10 balance in supplies inventory: $700 DR. • Supplies expense for y/e 12/31/10: $950 DR • $850 of supplies were purchased during the year ended 12/31/10 • Question: • What was the balance in supplies inventory on 1/1/10?

29. Using T-Accounts • A T-Account can help you simplify and solve seemingly complex problems. Put in what you know • If there only one unknown, you can solve for it • If there are multiple unknowns, you can recognize where you need more information • Example: • Given: • 12/31/10 balance in supplies inventory: $700 DR. • Supplies expense for y/e 12/31/10: $950 DR • $850 of supplies were purchased during the year ended 12/31/10 • Question: • What was the balance in supplies inventory on 1/1/10?

30. Using T-Accounts • A T-Account can help you simplify and solve seemingly complex problems. Put in what you know • If there only one unknown, you can solve for it • If there are multiple unknowns, you can recognize where you need more information • Example: • Given: • 12/31/10 balance in supplies inventory: $700 DR. • Supplies expense for y/e 12/31/10: $950 DR • $850 of supplies were purchased during the year ended 12/31/10 • Question: • What was the balance in supplies inventory on 1/1/10?

31. Accrual Accounting Accrual accounting provides a better basis for predicting future cash flows than does cash flow accounting. Cash flow accounting reports cash receipts and disbursements as they occur. Accrual accounting reports on effects of events that ultimately have cash effects. • Focuses on economically meaningful event (revenue recognition) • Matches outflows with the inflows they help to generate (expense recognition)

32. Cash Basis vs. Accrual Basis Most companies must use accrual-basisaccounting to comply with GAAP: • recognize revenue when it is earned and • expenses in the period incurred, • without regard to the time of receipt or payment of cash, Under the strict cash basis, companies • record revenue only cash is received, and • record expenses only when cash is dispersed. • nothing is recorded unless Cash changes hands. The Cash Basis violates matching. Plus you get a lot of surprises because you have no record of assets other than cash and no record of upcoming payables.

33. Accrual Accounting Recognition of Revenue & Expenses Revenues are recognized when they are both: • Earned – business has substantially accomplished what it must do to be entitled to the benefits represented by the revenue. • Realized – business has received cash or a claim to cash (can estimate how much the business will ultimately receive). Expenses are recognized according to one of the following practices: • Direct - match expense to the specific revenue it helps generate • Systematic and rational – match expense to periods in which it helps to generate revenue • Immediate – expense in period the cost is incurred (conservatism)

34. Adjusting Entries are required for: Recognizing revenue for the period. Matching expenses with revenues they helped generate. Adjusting entries are required every time financial statements are prepared to comply with GAAP What to record: Events not journalized during period (e.g. consumption of supplies) Costs that expire with passage of time (e.g. rent, insurance, building deterioration) Any unrecorded items (e.g. wages earned in current period but not paid until next period) Accrual Accounting Results in the Need for Adjusting Entries

35. Prepayments (deferrals): Prepaid expenses – the cash flow precedes the expense recognition (i.e., prepaid rent) Unearned revenue – the cash flow precedes the revenue recognition (i.e. unearned rent revenue) Accruals (pull the revenue or expense into the current period) Accrued expense – the expense recognition precedes the cash flow (i.e. interest expense and interest payable) Accrued revenue – the revenue recognition precedes the cash flow (i.e. interest receivable and interest income) Estimated items: Accounts are updated based on subjective estimates as of the end of the period (i.e., bad debt expense, depreciation expense). Periodic inventory: Inventory-related accounts (i.e. inventory, cost of goods sold) are adjusted based on an end of period physical count). Types of Adjusting Entries

36. Adjusting Expenses for Prepayments Recording Accrued Expense Prepayments made in cash and recorded as assets (cash precedes expense) Expense incurred but not yet recorded in books (expense precedes cash) Adjusting Entries: Matching Expenses

37. Example: On December 1, 2010, a firm paid its landlord $9,000 for rent for the following 12 months. The payment was recorded by debiting “Prepaid Rent” and crediting “Cash”. What adjusting entry will be necessary on December 31? Adjusting Entries – Prepaid Asset

38. Adjusting Entry: Debit Credit Rent Expense $750 Prepaid Rent $750 If no adjusting entry is made, will Assets be under or overstated on the Dec. 31 Balance Sheet? Rent Expense be under or overstated on the Income Statement? Net Income be under or overstated on the Income Statement? Owners Equity be under or overstated on the Balance Sheet? Adjusting Entries – Prepaid Asset

39. Example of Prepaid Adjustment • You pay a property tax assessment of $6,000 on December 1, 2010, to cover the period from December 1, 20010 to May 31, 2011. What is the adjusting entry needed for December 31? Two scenarios: • you recorded the December 1 payment as a prepaid asset, and • you recorded the December 1 payment as an expense • Note that a time line can be useful in organizing data on some questions

40. Example of Prepaid Adjustment • You pay a property tax assessment of $6,000 on December 1, 2010, to cover the period from December 1, 2010 to May 31, 2011. What is the adjusting entry needed for December 31, 2010? Two scenarios: Dec ‘10 Jan ’11 Feb ’11 Mar ’11 Apr’11 May ’11 • you recorded the December 1 payment as a prepaid asset, and • Property Tax Expense $1,000 • Prepaid Property Taxes $1,000 • you recorded the December 1 payment as an expense

41. Example of Prepaid Adjustment • You pay a property tax assessment of $6,000 on December 1, 2010, to cover the period from December 1, 2010 to May 31, 2011. What is the adjusting entry needed for December 31, 2010? Two scenarios: Dec ‘10 Jan ’11 Feb ’11 Mar ’11 Apr’11 May ’11 • you recorded the December 1 payment as a prepaid asset, and • Property Tax Expense $1,000 • Prepaid Property Taxes $1,000 • you recorded the December 1 payment as an expense • Prepaid Property Taxes $5,000 • Property Tax Expense $5,000

42. Example of Accrued Expense • On January 15, 2011, you receive an invoice for $8,000 for copier maintenance for the last quarter of 2010. Is any entry needed on the books at December 31, 2010?

43. Example of Accrued Expense • On January 15, 2011, you receive an invoice for $8,000 for copier maintenance for the last quarter of 2010. Is any entry needed on the books at December 31, 2010? • Maintenance Expense $8,000 • Accrued Maintenance Payable $8,000

44. A firm purchases $1,000 of supplies on July 14 (there were 0 supplies on hand at that time). On December 31, an end of the year count indicates that the firm has $328 of these supplies remaining. What is the required adjusting entry if the firm recorded the initial acquisition of supplies by debiting “Supplies Inventory”? What is the required adjusting entry is the firm recorded the initial acquisition by debiting “Supplies Expense”? Adjusting Entries Supplies Expense

45. A firm purchases $1,000 of supplies on July 14 (there were 0 supplies on hand at that time). On December 31, an end of the year count indicates that the firm has $328 of these supplies remaining. What is the required adjusting entry if the firm recorded the initial acquisition of supplies by debiting “Supplies Inventory”? Supplies Expense $672 Supplies $672 * If no adjusting entry is made, Assets will be overstated on the Dec. 31 Balance Sheet and Supplies Expense will be understated on the Income Statement (Net Income and Owners’ Equity will both be overstated). Adjusting Entries Supplies Expense

46. A firm purchases $1,000 of supplies on July 14 (there were 0 supplies on hand at that time). On December 31, an end of the year count indicates that the firm has $328 of these supplies remaining. What is the required adjusting entry if the firm recorded the initial acquisition of supplies by debiting “Supplies Inventory”? Supplies Expense $672 Supplies $672 2. What is the required adjusting entry is the firm recorded the initial acquisition by debiting “Supplies Expense”? Adjusting Entries Supplies Expense

47. A firm purchases $1,000 of supplies on July 14 (there were 0 supplies on hand at that time). On December 31, an end of the year count indicates that the firm has $328 of these supplies remaining. What is the required adjusting entry if the firm recorded the initial acquisition of supplies by debiting “Supplies Inventory”? Supplies Expense $672 Supplies $672 What is the required adjusting entry is the firm recorded the initial acquisition by debiting “Supplies Expense”? Supplies $328 Supplies Expense $328 * If no adjusting entry is made, Assets will be understated on the Dec. 31 Balance Sheet and Supplies Expense will be overstated on the Income Statement (NI and Owners’ Equity will be understated). Adjusting Entries Supplies Expense

48. Adjusting Unearned Revenue Recording Accrued Revenue “Revenues” received in cash and recorded as a liability (cash received before revenue earned) Revenues earned but not yet recorded in books (revenue earned before cash received) Adjusting Entries: Recognizing Revenue

49. Example – Adjusting Entry - Unearned Revenue On Oct 31, 2010, you receive a $12,000 payment for rent from Nov 1, 2010 to October 31, 2011. Your fiscal y/e is December 31. • What is the required adjusting entry if the initial entry on Oct 31 debits cash, credits unearned rent revenue • What is the required adjusting entry if the initial entry on Oct 31 debits cash, credits rent revenue

50. Example – Adjusting Entry - Unearned Revenue On Oct 31, 2010, you receive a $12,000 payment for rent from Nov 1, 2010 to October 31, 2011. Your fiscal y/e is December 31. • What is the required adjusting entry if the initial entry on Oct 31 debits cash, credits unearned rent revenue Unearned Rent Revenue $2,000 Rent Revenue $2,000 • What is the required adjusting entry if the initial entry on Oct 31 debits cash, credits rent revenue Rent Revenue $10,000 Unearned Rent Revenue $10,000