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Accrual Accounting for Conner Consultants: Recording, Preparing Financial Statements, and Closing Process

This chapter explains the accounting for accruals using Conner Consultants as an example. It covers recording accrual events, preparing financial statements, the closing process, matching concept, and accounting for interest-bearing receivables and payables.

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Accrual Accounting for Conner Consultants: Recording, Preparing Financial Statements, and Closing Process

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  1. Chapter Two Accounting for Accruals

  2. Accrual Accounting Virtually all of the major companies operating in the United States use accrual accounting. Let’s demonstrate accrual accounting by describing seven events that relate to a company named Conner Consultants.

  3. Record basic accrual events in a horizontal financial statements model. LO 1

  4. Increase assets (cash). • Increase stockholders’ equity (common stock). Asset Source Transaction Event 1: Conner Consultants was started on January 1, 2008, when it acquired $5,000 cash by issuing common stock.

  5. Increase assets (accounts receivable). • Increase stockholders’ equity (retained earnings). Asset Source Transaction Event 2: During 2008, Conner Consultants provided $84,000 of consulting services to its clients but no cash has been collected. New Event

  6. Increase assets (cash). • Decrease assets (accounts receivable). Asset Exchange Transaction Event 3: Conner collected $60,000 cash from customers in partial settlement of its accounts receivable. New Event

  7. Increase liabilities (salaries payable). • Decrease stockholders’ equity (retained earnings). Claims Exchange Transaction Event 4: The instructor earned a salary of $16,000. No cash has yet been paid to the employee. New Event Salaries Expense

  8. Decrease assets (cash). • Decrease liabilities (salaries payable). Asset Use Transaction Event 5: Conner paid $10,000 to the instructor in partial settlement of salaries payable. New Event

  9. Decrease assets (cash). • Decrease stockholders’ equity (retained earnings). Asset Use Transaction Event 6: Conner paid $2,000 for advertising costs. The advertisements appeared in 2008. Advertising Expense

  10. Event 7: Conner signed contracts for $42,000 of Consultants services to be performed in 2009.

  11. Organize general ledger accounts under an accounting equation. LO 2

  12. Summary of Transactions Now, let’s prepare the financial statements for Conner Consultants using the data presented above.

  13. Prepare financial statements based on accrual accounting. LO 3

  14. Preparing Financial Statements Earned--not all received Incurred not paid

  15. Preparing Financial Statements

  16. Preparing Financial Statements

  17. Describe the matching concept, the accounting cycle and the closing process. LO 4

  18. The Closing Process Transfers net income (or loss) and dividends to Retained Earnings. Temporary Accounts Permanent Account Establishes zero balances in all revenue, expense, and dividend accounts.

  19. Revenues Assets TemporaryAccounts Permanent Accounts Equity Liabilities Dividends Expenses Permanent accounts track financial results from year to year. Temporary and Permanent Accounts Temporary accounts track financial results for a limited period of time.

  20. General Ledger Accounts Here are the general ledger accounts for Conner Consultants after closing the temporary accounts. Closing Entries: Cl. 1: Transfers balance in revenue to retained earnings Cl. 2 & 3: Transfer balances in expenses to retained earnings

  21. Matching Concept Cash basis accounting can distort the measurement of net income because it sometimes fails to properly match revenues with expenses. The problem is that cash is not always received or paid in the period when the revenue is earned or when the expense is incurred. The objective of accrual accounting is to improve matching of revenues with expenses.

  22. Record business events involving interest-bearing receivables and payables in a horizontal financial statements model. LO 5

  23. Second Accounting Cycle Assume the following events apply to Conner Consultants during 2009. Since you are familiar with these types of events, let’s look at the summary of the general ledger accounts for Conner Consultants. Now, let’s move on to events 7 & 8.

  24. Decrease assets (cash). • Increase assets (certificate of deposit). Asset Exchange Transaction Event 7: On March 1, 2009, Conner invested $60,000 in a certificate of deposit (CD). Investing Activity

  25. Increase assets (interest receivable). • Increase stockholders’ equity (retained earnings). Asset Source Transaction Event 8: On December 31, 2009, Conner adjusted the books to recognize interest revenue earned to date on the CD. The CD had a 6 percent annual rate of interest and a one-year term to maturity. Interest is due in cash on the maturity date, March 1, 2010. Interest Revenue

  26. Adjusting Entries Update account balances Prior to preparing financial statements

  27. Summary of General Ledger Accounts Here is a summary of the general ledger accounts for Conner Consultants at December 31, 2009. Now, let’s prepare the 2009 financial statements for Conner Consultants using the data presented above.

  28. Preparing Financial Statements

  29. equal Preparing Financial Statements

  30. Preparing Financial Statements

  31. Close Nominal Accounts Adjust Accounts Prepare Statements Steps in an Accounting Cycle 1. Record Transactions 4. 2. Now, let’s look at some more transactions for Conner Consultants. 3.

  32. Asset Source Transaction • Increase assets (cash). • Increase liabilities (notes payable). On September 1, 2010, Conner borrowed $90,000 cash from First City Bank by issuing a 1 year note at 9% interest. 4/12 for interest would be calculated in 2010 Financing Activity

  33. Increase liabilities (interest payable). • Decrease stockholders’ equity (retained earnings). Claims Exchange Transaction On August 31, 2011, the maturity date of the note, three events are recognized. First, $5,400 of interest expense has accrued since January 1, 2011. Interest Expense

  34. Asset Use Transaction • Decrease assets (cash). • Decrease liabilities (interest payable). On August 31, 2011, the maturity date of the note, three events are recognized. Second, cash is paid for $8,100, the total amount of interest due on the note.

  35. Asset Use Transaction • Decrease assets (cash). • Decrease liabilities (notes payable). On August 31, 2011, the maturity date of the note, three events are recognized. Third, Conner must recognize the repayment of the $90,000 principal of the note.

  36. Prepare a vertical financial statements model. Explain how business events affect financial statements over multiple accounting cycles LO 6 & 7

  37. Vertical Financial Statements Changes in Stockholders’ Equity Statement

  38. Vertical Financial Statements

  39. Vertical Financial Statements

  40. Discuss the primary components of corporate governance. LO 8

  41. Corporate Governance Corporate governance is the set of relationships between the board of directors, management, shareholders, auditors, and other stakeholders that determines how a company is operated.

  42. Importance of Ethics • The accountant’s role requires trust and credibility. • Accounting information is worthless if the accountant is not trustworthy. • Therefore, the accounting profession requires high ethical standards.

  43. AICPA Code of Professional Ethics Includes articles requiring CPAs to • Exercise sensitive professional and moral judgments. • Act in a way to serve the public interest. • Perform with the highest sense of integrity. • Be objective and independent, in fact and appearance. • Exercise due care.

  44. Sarbanes-Oxley Act • Prompted by the audit failures of Enron, WorldCom, and others • Key provisions: • Created the Public Company Accounting Oversight Board (PCAOB) • Requires management to certify financial statements • Imposes harsh penalties on management for violations

  45. The Fraud Triangle Opportunity Key to protecting yourself and your company: personal integrity. Pressure Rationalization

  46. Classify accounting events into one of four categories. LO 9

  47. Recap: Types of Transactions The described transactions can be classified into one of four categories: Asset source Asset use Asset exchange Claimsexchange Increase assets, increase claims on assets Decrease assets, decrease claims on assets Increase one asset, decrease another asset Increase one claims account, decrease another.

  48. Appendix: Describe the auditor’s role in financial reporting. LO 10

  49. CPAs Certified Public Accountants The Financial Analyst How can a financial analyst know that a company really did follow GAAP? Audits

  50. Materiality and Financial Audits Auditors do not guarantee that financial statements are absolutely correct—only that they are materially correct. Material Item An error, or other reporting problem, that would influence the decision of an average prudent investor.

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