chapter 2 accounting for accruals and deferrals copyright © 2013 by the mcgraw-hill companies, inc....

Chapter 2

Accounting for Accruals and

Deferrals

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reservedMcGraw-Hill/Irwin

2-2

Cash Basis vs. Accrual Accounting

Recognition Realization

Formally recording an economic

item or event in thefinancial statements

Collecting cash, generally from the sale of products or

services

2-3

SECTION 1: SHOW HOW ACCRUALS AFFECT FINANCIAL STATEMENTS

Show how receivables

affect financial statements.

LO 1:

2-4

Event 1: Cato Consultants was started on January 1, 2013, when it acquired $5,000 cash by issuing common stock.

= Liab. +

Cash + Supplies = + Common

Stock + Retained Earnings Revenue - Expenses =

Net Income

5,000 + n/a = n/a + 5,000 + n/a n/a - n/a = n/a 5,000 FA

Assets Stockholders' Equity

Cash Flow

Asset Source

Transaction

1. Increase assets (Cash).

2. Increase stockholders’ equity (Common Stock).

2-5

Event 2: During 2013, Cato Consultants provided $84,000 of consulting services to its clients but no cash has been collected.

1. Increase assets (accounts receivable).

2. Increase stockholders’ equity (retained earnings).

Asset Source

Transaction

= Liab. +

Cash + Accounts

Receivable = Salaries Payable +

Common Stock +

Retained Earnings Revenue - Expenses = Net Income

n/a + 84,000 = n/a + n/a + 84,000 84,000 - n/a = 84,000 n/a


Cash Flow

2-6

Event 3: Cato collected $60,000 cash from customers in partial settlement of its accounts receivable.

1. Increase assets (cash).

2. Decrease assets (accounts receivable).

Asset Exchange

Transaction

= Liab. +

Cash + Accounts


Common Stock +

Retained Earnings Revenue - Expenses =

Net Income

60,000 + (60,000) = n/a + n/a + n/a n/a - n/a = n/a 60,000 OA


Cash Flow

2-7

Event 4: Cato paid the instructor $10,000 cash for teaching training courses (salary expense).

1. Decrease cash (assets).

2. Decrease stockholders’ equity (retained earnings).

Asset Use Transaction

= Liab. +

Cash + Accounts

Receivable = + Common

Stock + Retained Earnings Revenue - Expenses = Net Income

(10,000) + n/a = n/a + n/a + (10,000) n/a - 10,000 = (10,000) (10,000) OA


Cash Flow

2-8

Event 5: Cato paid $2,000 for advertising costs. The advertisements appeared in 2013.

1. Decrease assets (cash).



= Liab. +

Cash + Accounts



(2,000) + n/a = n/a + n/a + (2,000) n/a - 2,000 = (2,000) (2,000) OA


Cash Flow

2-9

Event 6: Cato signed contracts for $42,000 of consulting services to be performed in 2014.

= Liab. +

Cash + Prepaid

Rent = + Common


n/a + n/a = n/a + n/a + n/a n/a - n/a = n/a n/a


Cash Flow

Not recognized in

the 2013 financial

statements

2-10

SECTION 1: SHOW HOW ACCRUALS AFFECT FINANCIAL STATEMENTS

Show how payables

affect financial

statements.

LO 2

2-11

Event 7: At the end of 2013, Cato recorded accrued salary expense of $6,000 (the salary expense is for courses the instructor taught in 2013 that Cato will pay cash for in 2014).

1. Increase liabilities (salaries payable).


Claims Exchange

Transaction

Assets = Liab. +

Cash = Salaries Payable +

Common Stock +


n/a = 6,000 + n/a + (6,000) n/a - 6,000 = (6,000) n/a

Stockholders' Equity

Cash Flow

122-

Vertical Statements Model

132-

Comparing Cash Flow from Operating Activities with Net Income

2-14

The Closing Process

Transfers net income (or loss) and dividends to Retained Earnings.

Establishes zero balances in all

revenue, expense, and dividend accounts.

2-15

Temporary accounts track financial

results for a limited period of time.

Temporary accounts track financial

results for a limited period of time.

Temporary and Permanent Accounts

Revenues

Exp

ense

s Divid

end

s

TemporaryAccounts

Permanent Accounts

Assets

Lia

bili

ties E

qu

ity

Permanent accounts track financial

results from year to year.

Permanent accounts track financial

results from year to year.

2-16

Steps in an Accounting Cycle

Record Transaction

s

Adjust Accounts

Prepare Statements

Close Nominal Accounts

2-17

Matching Concept

The objective of accrual accounting is to improve matching of revenues with expenses.

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 Conservatism Principle

2-18

When faced with a recognition dilemma, conservatism guides

accountants to select the alternative that produces the

lowest amount of net income.

2-19

Event 1: Cato paid $6,000 to the instructor to settle the salaries payable obligation.


2. Decrease liabilities (salaries payable).


= Liab. +

Cash + Accounts


Common Stock +


(6,000) + n/a = (6,000) + n/a + n/a n/a - n/a = n/a (6,000) OA


Cash Flow

2-20

SECTION 2: SHOW HOW DEFERRALS AFFECT FINANCIAL STATEMENTS

Show how supplies affect

financial statements.

LO 3

2-21

Event 2: Cato purchased $800 of supplies on account.

1. Increase assets (supplies).

2. Increase liabilities (accounts payable).

Asset Source

Transaction

= Liab. +

Cash + Supplies = Accounts Payable +

Common Stock +


n/a + 800 = 800 + n/a + n/a n/a - n/a = n/a n/a


Cash Flow

2-22


Show how prepaid items

affectfinancial

statements.

LO 4

2-23

Event 3: On March 1, 2014, Cato signed a one-year lease agreement and paid $12,000 cash in advance to rent office space. The one-year lease term begins March 1.


2. Increase assets (prepaid rent).

Asset Exchange

Transaction

= Liab. +

Cash + Prepaid

Rent = + Common


(12,000) + 12,000 = n/a + n/a + n/a n/a - n/a = n/a (12,000) OA


Cash Flow

2-24


Show how unearned revenues

affect financial statements.

LO 5

2-25

Event 4: Cato received $18,000 cash in advance from Westberry Company for consulting services to be performed over a one-year period beginning June 1, 2014.


2. Increase liabilities (unearned revenue).

Asset Source

Transaction

Assets = Liab. +

Cash = Unearned Revenue +

Common Stock +


18,000 = 18,000 + n/a + n/a n/a - n/a = n/a 18,000 OA


Cash Flow

2-26

Event 5: Cato provided $96,400 of consulting services on account.

1. Increase assets (accounts receivable).


Asset Source

Transaction

= Liab. +

Cash + Accounts


Common Stock +


n/a + 96,400 = n/a + n/a + 96,400 96,400 - n/a = 96,400 n/a


Cash Flow

2-27

Event 6: Cato collected $105,000 cash from customers in partial settlement of its accounts receivable.


2. Decrease assets (accounts receivable).

Asset Exchange

Transaction

= Liab. +

Cash + Accounts


Common Stock +

Retained Earnings Revenue - Expenses =

Net Income

105,000 + (105,000) = n/a + n/a + n/a n/a - n/a = n/a 105,000 OA


Cash Flow

2-28

Event 7: Cato paid $32,000 cash for salary expense.




= Liab. +

Cash + Accounts



(32,000) + n/a = n/a + n/a + (32,000) n/a - 32,000 = (32,000) (32,000) OA


Cash Flow

2-29

Event 8: Cato incurred $21,000 of other operating expenses on account.

1. Increase liabilities (accounts payable).


Claims Exchange

Transaction

Assets = Liab. +

= Accounts Payable +

Common Stock +


n/a = 21,000 + n/a + (21,000) n/a - 21,000 = (21,000) n/a


Cash Flow

2-30

Event 9: Cato paid $18,200 cash in partial settlement of accounts payable.


2. Decrease liabilities (accounts payable).


Assets = Liab. +

Cash = Accounts Payable +

Common Stock +


(18,200) = (18,200) + n/a + n/a n/a - n/a = n/a (18,200) OA


Cash Flow

2-31

Event 10: Cato paid $79,500 for land it planned to use in the future as a building site for its home office.


2. Increase assets (land).Asset

Exchange Transaction

= Liab. +

Cash + Land = + Common


(79,500) + 79,500 = n/a + n/a + n/a n/a - n/a = n/a (79,500) IA


Cash Flow

2-32

Event 11: Cato paid $21,000 in cash dividends to its stockholders.




Assets = Liab. +

Cash = + Common


(21,000) = n/a + n/a + (21,000) n/a - n/a = n/a (21,000) FA


Cash Flow

2-33

Event 12: Cato acquired $2,000 cash from issuing additional shares of common stock.

= Liab. +

Cash + Supplies = + Common

Stock + Retained Earnings Revenue - Expenses =

Net Income

2,000 + n/a = n/a + 2,000 + n/a n/a - n/a = n/a 2,000 FA


Cash Flow

Asset Source

Transaction

1. Increase assets (Cash).

2. Increase stockholders’ equity (Common Stock).

2-34


Explain the accounting cycle

including adjustments and

the closing process.

LO 6

2-35

Event 13: After determining through a physical count that it had $150 of unused supplies on hand as of December 31, Cato recognized supplies expense.

1. Decrease assets (supplies).



Assets = Liab. +

Supplies = + Common


(650) = n/a + n/a + (650) n/a - 650 = (650) n/a


Cash Flow

Beginning supplies balance

$0

+

Supplies purchased

$800

=

Supplies available for

use$800

-

Ending supplies balance

$150

=

Supplies used

$650

2-36

Event 14: Cato recognized rent expense for the office space used during the accounting period.

1. Decrease assets (prepaid rent).



Assets = Liab. +

Prepaid rent = + Common


(10,000) = n/a + n/a + (10,000) n/a - 10,000 = (10,000) n/a


Cash Flow

2-37

Event 15: Cato recognized the portion of the unearned revenue it earned during the accounting period.

1. Decrease liabilities (unearned revenue).


Claims Exchange

Transaction

Assets = Liab. +

= Unearned Revenue +

Common Stock +


n/a = (10,500) + n/a + 10,500 10,500 - n/a = 10,500 n/a


Cash Flow

2-38

Event 16: Cato recognized $4,000 of accrued salary expense.

1. Increase liabilities (salaries payable).


Claims Exchange

Transaction

Assets = Liab. +

= Salaries Payable +

Common Stock +


n/a = 4,000 + n/a + (4,000) n/a - 4,000 = (4,000) n/a


Cash Flow

2-39


Prepare financial

statements based

on accrual accounting.

LO 7

2-40

Preparing Financial Statements

2-41


2-42


2-43


Classify accounting events into oneof four categories:

■ Asset source■ Asset use■ Asset exchange■ Claims exchange

LO 8

2-44

Recap: Types of Transactions

The described transactions can be classified into one of four

categories:Asset

use

Increase assets,

increase claims on

assets

Increase one asset, decrease another

asset

Decrease assets,

decrease claims on

assets

Asset source

Asset exchange

Claimsexchange

Increase one claims

account, decrease another.

2-45


Discuss the primary

components of corporate governance.

LO 9

2-46

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.

2-47

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.

2-48

AICPA Code of Professional Conduct

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.

Sarbanes-Oxley (SOX) 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

2-49

2-50

The Fraud Triangle

RationalizationPressure

Opportunity

Key to protecting yourself and your company: personal integrity.

2-51

APPENDIX

Compute interest

expense and show how it

affects financial statements.

LO 11

Calculating Interest

= Liab. +

Cash + Equipment = Interest Payable +

Common Stock +


n/a + n/a = 275$ + + (275)$ n/a - 275 = (275) n/a


Cash Flow

1. Increase liabilities (Interest Payable).

2. Decrease stockholders’ equity (Retained Earnings). Claims

Exchange Event

2-52

2-53

End of Chapter Two

chapter 2 accounting for accruals and deferrals copyright © 2013 by the mcgraw-hill companies, inc....

Documents

statement of cash flows

asset exchange transaction

cato consultants

type of transaction

financial statements

iithis transaction incre

financial statementsshow

accounting cycle