Weygandt Financial Accounting 6th Ed

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Weygandt Financial Accounting 6th Ed Powered By Docstoc
					              SHS 297


          CASH VERSUS
          ACCRUAL BASIS
            CONCEPTS
Chapter
  3-1
                   Study Unit Objectives

     1.   Explain the time period assumption.
     2. Explain the accrual basis of accounting.
     3. Explain the reasons for adjusting entries.
     4. Identify the major types of adjusting entries.
     5. Prepare adjusting entries for deferrals.
     6. Prepare adjusting entries for accruals.
     7. Special rules for non-profit organizations




Chapter
  3-2
                         Adjusting the Accounts



                                             The Basics of
          Timing Issues
                                            Adjusting Entries



          Time period                        Types of adjusting
          assumption                         entries
          Fiscal and                         Adjusting entries
          calendar years                     for deferrals
          Accrual- vs. cash-                 Adjusting entries
          basis accounting                   for accruals
          Recognizing                        Summary of
          revenues and                       journalizing and
          expenses                           posting

Chapter
  3-3
    Timing Issues

      Accountants divide the economic life of a
      business into artificial time periods
      (Time Period Assumption).
                                        .....
          Jan.   Feb.   Mar.    Apr.             Dec.




             Generally a month, a quarter, or a year.
             Fiscal year vs. calendar year
             Also known as the “Periodicity Assumption”
Chapter
  3-4
    Timing Issues

     Review
     The time period assumption states that:
       a. revenue should be recognized in the accounting
           period in which it is earned.
          b. expenses should be matched with revenues.
          c.   the economic life of a business can be divided
               into artificial time periods.
          d. the fiscal year should correspond with the
             calendar year.


Chapter
  3-5
    Timing Issues

      Accrual- vs. Cash-Basis Accounting
      Accrual-Basis Accounting
          Transactions recorded in the periods in which
          the events occur
          Revenues are recognized when earned, rather
          than when cash is received.
          Expenses are recognized when incurred, rather
          than when paid.


Chapter
  3-6
    Timing Issues

      Accrual- vs. Cash-Basis Accounting
      Cash-Basis Accounting
          Revenues are recognized when cash is received.
          Expenses are recognized when cash is paid.
          Cash-basis accounting is not in accordance with
          generally accepted accounting principles (GAAP).




Chapter
  3-7
    Timing Issues

      Recognizing Revenues and Expenses
          Revenue Recognition Principle
          Companies recognize
          revenue in the accounting
          period in which it is
          earned.
          In a service enterprise,
          revenue is considered to
          be earned at the time the
          service is performed.
Chapter
  3-8
    Timing Issues

      Recognizing Revenues and Expenses
          Matching Principle
          Match expenses with
          revenues in the period
          when the company makes
          efforts to generate
          those revenues.

          “Let the expenses follow
          the revenues.”

Chapter
  3-9
    Timing Issues

  GAAP relationships
  in revenue and
  expense recognition




Chapter
 3-10
    Timing Issues

     Review
          One of the following statements about the accrual basis
          of accounting is false. That statement is:
           a. Events that change a company’s financial
              statements are recorded in the periods in which
              the events occur.
           b. Revenue is recognized in the period in which it is
              earned.
           c. The accrual basis is in accord with generally
              accepted accounting principles.
           d. Revenue is recorded only when cash is received, and
              expense is recorded only when cash is paid.
Chapter
 3-11
    The Basics of Adjusting Entries

          Adjusting entries make it possible to report
          correct amounts on the balance sheet
          (statement of financial position) and on the
          income statement (statement of activities).

          A company must make adjusting entries
          every time it prepares financial statements.




Chapter
 3-12
    The Basics of Adjusting Entries

          Revenues - recorded in the period in which
          they are earned.
          Expenses - recognized in the period in which
          they are incurred.
          Adjusting entries - needed to ensure that the
          revenue recognition and matching principles
          are followed.



Chapter
 3-13
    Timing Issues

     Review
          Adjusting entries are made to ensure that:
          a. expenses are recognized in the period in which
             they are incurred.
          b. revenues are recorded in the period in which
             they are earned.
          c. balance sheet and income statement accounts
             have correct balances at the end of an
             accounting period.
          d. all of the above.

Chapter
 3-14
    Types of Adjusting Entries

     Deferrals

     1. Prepaid Expenses. Expenses paid in cash and recorded as
        assets before they are used or consumed.
     2. Unearned Revenues. Cash received and recorded as
        liabilities before revenue is earned.

     Accruals

     1. Accrued Revenues. Revenues earned but not yet received in
        cash or recorded.
     2. Accrued Expenses. Expenses incurred but not yet paid in
        cash or recorded.
Chapter
 3-15
            Adjusting Entries for Deferrals

      Deferrals are either:
          Prepaid expenses or

          Unearned revenues.




Chapter
 3-16
    Adjusting Entries for “Prepaid Expenses”

      Payment of cash, that is recorded as an asset because
      service or benefit will be received in the future.

          Cash Payment     BEFORE     Expense Recorded


      Prepayments often occur in regard to:
           insurance                    building
           supplies                     purchases
           Advertising                  equipment
           rent                         purchases

Chapter
 3-17
    Adjusting Entries for “Prepaid Expenses”

      Prepaid Expenses
          Costs that expire either with the passage of time
          or through use.

          Adjusting entries

          (1) to record the expenses that apply to the
              current accounting period, and

          (2) to show the unexpired costs in the asset
              accounts.

Chapter
 3-18
    Adjusting Entries for “Prepaid Expenses”

          Illustration
          Adjusting entries for prepaid expenses




            Increases (debits) an expense account and
            Decreases (credits) an asset account.

Chapter
 3-19
    Adjusting Entries for “Prepaid Expenses”
     Example (Insurance): On Oct. 4th, Pioneer Advertising
     paid $600 for a one-year fire insurance policy. Show the
     journal entry to record the payment on Oct 4th.

          Oct. 4      Prepaid insurance           600
                         Cash                                     600


               Prepaid Insurance                  Cash
              Debit        Credit         Debit          Credit
                   600                                       600




Chapter
 3-20
    Adjusting Entries for “Prepaid Expenses”
     Example (Insurance): On Oct. 4th, Pioneer Advertising paid
     $600 for a one-year fire insurance policy. Show the adjusting
     journal entry required at Oct. 31st.

          Oct. 31      Insurance expense               50
                          Prepaid insurance                       50


               Prepaid Insurance              Insurance Expense
               Debit        Credit            Debit     Credit
                    600              50           50


                    550
Chapter
 3-21
  Adjusting Entries for “Unearned Revenues”

      Receipt of cash that is recorded as a liability because
      the revenue has not been earned.

          Cash Receipt      BEFORE     Revenue Recorded


      Unearned revenues often occur in regard to:
           rent                          sale of airline tickets
           magazine subscriptions        school tuition
           customer deposits for
           future service


Chapter
 3-22
  Adjusting Entries for “Unearned Revenues”

      Unearned Revenues
          Company makes an adjusting entry to record the
          revenue that has been earned and to show the
          liability that remains.

          The adjusting entry for unearned revenues results
          in a decrease (a debit) to a liability account and an
          increase (a credit) to a revenue account.




Chapter
 3-23
  Adjusting Entries for “Unearned Revenues”

          Illustration
          Adjusting entries for unearned revenues




            Decrease (a debit) to a liability account and
            Increase (a credit) to a revenue account.
Chapter
 3-24
  Adjusting Entries for “Unearned Revenues”
     Example: On Oct. 2nd, Pioneer Advertising received $1,200
     from R. Knox for services to be completed by December 31.
     Show the journal entry to record the receipt on Oct 2nd.

          Oct. 2      Cash                             1,200
                           Unearned Revenue                     1,200


                       Cash                   Unearned Rent Revenue
              Debit           Credit           Debit       Credit
                   1,200                                       1,200




Chapter
 3-25
  Adjusting Entries for “Unearned Revenues”
     Example: On Oct. 2nd, Pioneer Advertising received $1,200
     from R. Knox for services to be completed by December 31.
     Show the adjusting journal entry required on Oct. 31st.

          Oct. 31      Unearned Revenue              400
                          Service Revenue                       400


                Service Revenue             Unearned Revenue
               Debit        Credit          Debit      Credit
                                400            400         1,200


                                                            800
Chapter
 3-26
            Adjusting Entries for Accruals

      Made to record:
          Revenues earned and

          Expenses incurred

      in the current accounting period that have not
      been recognized through daily entries.




Chapter
 3-27
    Adjusting Entries for “Accrued Revenues”

      Revenues earned but not yet received in cash or
      recorded.

      Adjusting entry results in:

          Revenue Recorded       BEFORE   Cash Receipt

      Accrued revenues often occur in regard to:
            interest
            rent
            services performed

Chapter
 3-28
    Adjusting Entries for “Accrued Revenues”

      Accrued Revenues
      An adjusting entry serves two purposes:

          (1) It shows the receivable that exists, and

          (2) It records the revenues earned.




Chapter
 3-29
    Adjusting Entries for “Accrued Revenues”

          Illustration
          Adjusting entries for accrued revenues




            Increases (debits) an asset account and
            Increases (credits) a revenue account.
Chapter
 3-30
    Adjusting Entries for “Accrued Revenues”
     Example:      October Pioneer Advertising earned $200 for
                    In
     advertising services that have not been recorded. Show the
     journal entry to record the accrued revenues in October.

          Oct. 31      Accounts Receivable           200
                          Service Revenue                       200


              Accounts Receivable             Service Revenue
               Debit        Credit           Debit         Credit
                    200                                        200




Chapter
 3-31
    Adjusting Entries for “Accrued Expenses”

      Expenses incurred but not yet paid in cash or
      recorded.

      Adjusting entry results in:

          Expense Recorded     BEFORE          Cash Payment


      Accrued expenses often occur in regard to:
            interest                taxes
            rent                    salaries


Chapter
 3-32
    Adjusting Entries for “Accrued Expenses”

      Accrued Expenses
      An adjusting entry serves two purposes:

          (1) It records the obligations, and

          (2) It recognizes the expenses.




Chapter
 3-33
    Adjusting Entries for “Accrued Expenses”

          Illustration
          Adjusting entries for accrued expenses




            Increases (debits) an expense account and
            Increases (credits) a liability account.
Chapter
 3-34
    Adjusting Entries for “Accrued Expenses”
    Example: On Oct 1st, Pioneer Advertising signed a $,5000, 3-
    month note payable at a rate of 12% per year. The total
    interest due on the note at its due date is $150 ($5,000 X
    12% X 3/12). Show the journal entry to record the borrowing
    on Oct. 1st.
       Oct. 1    Cash                           5,000
                     Notes payable                    5,000

                   Cash                   Notes Payable
           Debit          Credit        Debit      Credit
             5,000                                    5,000




Chapter
 3-35
    Adjusting Entries for “Accrued Expenses”
    Example: On Oct 1st, Pioneer Advertising signed a $,5000, 3-
    month note payable at a rate of 12% per year. The total
    interest due on the note at its due date is $150 ([$5,000 x
    12%] / 12 months). Show the adjusting journal entry required
    on Oct. 31st.
          Oct. 31      Interest expense              50
                          Interest payable                         50

               Interest Expense               Interest Payable
               Debit        Credit           Debit        Credit
                    50                                             50




Chapter
 3-36
    Adjusting Entries for “Accrued Expenses”

      Accrued Expenses
      An adjusting entry serves two purposes:

          (1) It records the obligations, and

          (2) it recognizes the expenses.




Chapter
 3-37
    Not-for-Profit Expense Categories

      Program Expenses
          Activities directly related to the purpose(s) for
          which the organization was established.

          Example:

          If a food bank was formed to distribute groceries
          to disadvantaged populations, then those costs
          incurred directly related to the distribution would
          be accounted for here.


Chapter
 3-38
    Not-for-Profit Expense Categories

      Management and General Expenses
          Those expenses associated with the overall
          direction and management of the organization.

          Examples:

          Record-keeping, general legal fees, annual
          reporting, etc.




Chapter
 3-39
    Not-for-Profit Expense Categories

      Fund-raising Expenses
          Expenses associated with solicitation of money,
          materials for which individual(s) or organization(s)
          receive no direct economic benefit.

          Examples include: printing, personnel, cost of
          maintaining mailing list, cost of gifts sent to
          prospective contributors/donors.




Chapter
 3-40
    Not-for-Profit Expense Guidelines

      Better Business Bureau Expense Guidelines
             Spend at least 65% of total expenses on program
              activities.
             Spend no more than 35% of related contributions
              on fundraising. (related contributions include
              donations, legacies and other gifts received
              resulting from fund-raising efforts.
             Unrestricted net assets should not exceed three
              times previous year’s expenses or current budget,
              whichever is higher.


Chapter
 3-41
    Contributions Other than Services and Collections

          Contributions – an unconditional transfer of
          cash or other assets from one entity to
          another (General Rule)
             Reported as revenue or gains in period received
             Reported as assets, liability decreases, or
              expenses, depending on form of benefit
             Measured at fair value of contribution received
             Reported as restricted or unrestricted




Chapter
 3-42
    Entries for Not-for-Profit Organization
    Example: In response to a fund raising campaign, pledges
    were received promising $2 million in 2008. The NFPO
    believes 80% will be realized. What, if any, are the journal
    entries to be made in 2008?

      2008       Contributions Receivable     2,000,000
                    Allowance for uncollectible        400,000
                    contributions

                    Unrestricted support -            1,600,000
                    contributions




Chapter
 3-43
    Entries for Not-for-Profit Organization
    Example: Subsequently in 2008, the NFPO collects the
    expected pledged amounts plus an additional $20,000. What,
    if any, are the journal entries to be made in 2008?


      2008      Cash                          1,620,000
               Allowance for uncollectible     400,000
               contributions

                   Contributions receivable           2,000,000
                   Unrestricted support -                 20,000
                   contributions



Chapter
 3-44
    Contributions Other than Services and Collections

          Unrestricted Contribution – a contribution
          received without a donor imposed restriction.
             Reported as an unrestricted revenue or gains in
              period received
             Reported as an increase to unrestricted to net
              assets




Chapter
 3-45
    Contributions Other than Services and Collections

          Restricted Contribution – a contribution
          received with a donor imposed restriction.
             Reported as a restricted revenue or gains in
              period received
             Reported as an increase to restricted net
              assets
             Maybe classified as temporarily or permanently
              restricted




Chapter
 3-46
    Entries for Not-for-Profit Organization
    Example: A donor gave a NFPO a $20,000 cash gift. The
    donor told the organization the gift could not be used until
    next year. What, if any, are the journal entries to be made
    this year?
                   Cash                         20,000
                      Temp restricted support            20,000
                      - contributions
                                       Temp restricted support
                    Cash                   - contributions
           Debit           Credit        Debit       Credit
            20,000                                       20,000




Chapter
 3-47
    Contributions Other than Services and Collections

          Temporarily versus Permanently Restricted
          Contribution
             Temporarily restrictions
                 Purpose-type – may be satisfied by
                  completion of project
                 Time restrictions – may be satisfied by
                  the passage of time
             Permanent restrictions – must be maintained
              in perpetuity


Chapter
 3-48
    Entries for Not-for-Profit Organization
    Example: A donor gave a NFPO investments worth $100,000.
    The donor stipulated that the gift must be held in perpetuity,
    but the income could be used as trustees deemed appropriate.
    What, if any, are the journal entries to be made?
                   Investments                    100,000
                      Permanently restricted                100,000
                      support - contributions
                                         Permanently restricted
              Investments                support - contributions
           Debit        Credit             Debit       Credit
           100,000                                      100,000




Chapter
 3-49
    Contributions - Promises to Give
          Unconditional versus Conditional Promises to
          Give
             Unconditional - depend only on the passage of
              time or demand of the receiver of the
              promise
                 Recognized
             Conditional – bind donor on the occurrence of
              a “future and uncertain” event.
                 Not recognized until such event has
                  substantially occurred

Chapter
 3-50
    Entries for Not-for-Profit Organization
    Example: Another donor gave the NFPO a $115,000 cash
    gift, telling the organization the gift could be used anytime.
    What, if any, are the journal entries to be made?

                   Cash                        115,000
                      Unrestricted support -             115,000
                      contributions
                                         Unrestricted support -
                    Cash                     contributions
           Debit           Credit         Debit       Credit
            115,000                                      115,000




Chapter
 3-51
    Contributed Services
          Accounting is more limited than General Rule.
          Must be recorded at fair value provided:
             Services received create or enhance
              nonfinancial assets or
             Require specialized skills and are provided by
              individuals that possess those skills and would
              typically need to be purchased had those
              skills not been donated.




Chapter
 3-52
    Entries for Not-for-Profit Organization
    Example: A psychologist donated 20 hours of her time to the
    NFPO’s counseling program. The NFPO would have paid
    $4,000 for these services. In addition a lawyer donated 10
    hours to review government contracts. The lawyer would have
    normally charged $2,000 for such services. What, if any, are
    the journal entries to be made?


    In-kind expenses – counseling services       4,000
    In-kind expenses – administration - other    2,000
            Unrestricted support – donated services      6,000




Chapter
 3-53
    Entries for Not-for-Profit Organization
    Example: A NFPO held a book sale. It raised $12,000, but it
    paid $2,000 of that amount on various expenses. Several high
    school students donated 16 hours of their time, selling
    refreshments and books for the event. The NFPO would have
    paid them $5 per hour if they time had not been donated.
    What, if any, are the journal entries to be made?


          Cash                                      10,000
          Expenses – fund raising - other            2,000
              Unrestricted gains – special events            12,000




Chapter
 3-54
    Contributions to Collections
          FASB gives not-for-profits the option of not
          recognizing donations to collections if the
          collections meet all of the following criteria:
             Are held for public exhibition, or research in
              furtherance of public service rather than financial
              gain,
             Are protected, kept unencumbered, cared for and
              preserved and
             Are subject to an organizational policy that requires
              proceeds from sale to be used for acquiring other
              items for collections.
          If criteria not met, then donation must be
Chapter
 3-55
             recognized.
    Other Accounting Matters
          Investments: Valuation, Income, Gains and
          Losses
             Investments held at cost if purchased
             Investments reported at fair market value if
              donated
             Investments carrying amounts must be
              adjusted to reflect fair value on financial
              statements (must book unrealized gains and
              losses)


Chapter
 3-56
    Other Accounting Matters

          Exchange Transaction Revenues
          An exchange is a transaction wherein each
          participant both receives and sacrifices value
          •   Accounted for similar to for-profit entities
          •   Must use accrual accounting,
          •   Accounts receivable, deferred revenue and
              allowance for bad debts accounts are utilized




Chapter
 3-57
    Other Accounting Matters

          Subscription and Membership Income
          Membership dues recognized as revenue in
          period(s) during which they provide benefits to
          members


          Nonrefundable initiation fees are generally
          reported as revenues in the period(s) the
          organization is entitled to receive them



Chapter
 3-58
    Entries for Not-for-Profit Organization
    Example: In December 2008, a NFPO held its annual
    membership fund raiser. Members donated $12,000 to help
    pay for the 2009 programming. What are the journal entries
    to be made in December 2008?


          Cash                                 12,000
              Deferred Revenue                          12,000



    What are the journal entries to be made in January 2009?
          Deferred Revenue                        1,000
             Unrestricted revenue                         1,000

Chapter
 3-59
    Other Accounting Matters

          Depreciation Expense
             Generally represents cost of long-lived asset
              over estimated useful life
             Long-lived assets and depreciation methods
              must be disclosed
             There are separate rules for works of art,
              historical treasures and collections




Chapter
 3-60
    Other Accounting Matters

          Fund-Raising Expenses
             Costs are reported separately
             Joint costs are allocated between programs
              and fund-raising activities
             To determine whether certain costs are
              allocated, the purpose, audience and contents
              of item in questions is reviewed. If any of
              the three criteria are not met, then costs are
              100% fund-raising.

Chapter
 3-61
    Entries for Not-for-Profit Organization
    Example: A NFPO mails a brochure to parents describing
    methods for counseling children and how to detect student
    drug abuse. The nature of action requested and audience
    contacted meet the three criteria. The audience was not
    limited to persons likely to contribute and the audience was
    called upon to take action related to purposes of the NFPO
    and the brochure described specific actions to be taken.
    Should the cost of the brochure be allocated (split) between
    fund-raising and programs? What, if any, are the journal
    entries to be made (assume the total was $8,000 and 25% was
    due to fund-raising)?

     Program expense – drug abuse prevention    6,000
     Fund raising expenses                      2,000
            Cash                                         8,000
Chapter
 3-62

				
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