Chapter 2

docx

School

George Mason University *

*We aren’t endorsed by this school

Course

200

Subject

Accounting

Date

Apr 3, 2024

Type

docx

Pages

Uploaded by DukeFlamingo4178

Accounting for Accruals and Deferrals Introduction: Professional Headhunters, Inc. (PHI), a job placement company, operates in the northeastern United States. During 2019, the company earned $145,000 in revenue by providing services to customers. However, it collected only $120,000 of the revenue in cash. PHI expected to collect the remaining $25,000 in 2020. In addition, PHI incurred $80,000 of expenses. However, by the end of 2019, PHI had paid only $75,000 of the cash owed for expenses because it had not yet paid $5,000 to employees who had worked during 2019 but had not been paid by the end of the year. PHI expected to pay the $5,000 in cash to the employees during 2020. Based on this information alone, determine the amount of net income PHI should report on its 2019 financial statements. You will see in this chapter that while the exchange of cash will effect balance sheet elements (assets, liabilities, revenue, expenses, etc.) of the financial statements, but when calculating net income only amounts earned (whether or not the company has collected the cash) can be considered revenue and only expenses that have occurred (whether or not the company has paid cash for them) can be recorded as expenses. Accrual Accounting vs. Cash Accounting: 1. The exchange of cash can occur before (accrual) or after (deferral) a transaction is recorded that may affect revenues and expenses. 2. Under the rules of accrual accounting (required by GAAP): a. Revenues are recorded when they’re earned regardless of when the cash is collected.  Revenue occurs when another party has received a benefit from your company. b. Expenses are recorded when they’re incurred (they occur).  Expenses occur when your company has received a benefit. New Balance Sheet Accounts introduced in chapter 2: Account Name What does the balance represent? What type of account? Normal balance? Accounts receivable Amount owed from customers for goods or services already provided Asset Debit Prepaid rent or prepaid insurance Amount paid in advance of occupancy of space (prepaid rent) or insurance coverage (prepaid insurance) Asset Debit Unearned revenue Amount received in advance from customers for goods or services to be provided later Liability Credit Accounts payable Amount due to vendors Liability Credit Salaries payable Amount due to employees for services provided Liability Credit 1

Practice Problem #1 CATO CONSULTANTS 2019 TRANSACTIONS: EVENT 1 - Cato Consultants was started on January 1, 2019, when it acquired $5,000 cash by issuing common stock. EVENT 2 - During 2019, Cato Consultants provided $84,000 of consulting services to its clients. The business has completed the work and sent bills to the clients, but not yet collected any cash. This type of transaction is frequently described as providing services on account. EVENT 3 - Cato collected $60,000 cash from customers in partial settlement of its accounts receivable. EVENT 4 - Cato paid the instructor $10,000 cash for teaching training courses (salary expense). EVENT 5 - Cato paid $2,000 cash for advertising costs. The advertisements appeared in 2019. EVENT 6 - Cato signed contracts for $42,000 of consulting services to be performed in 2020. EVENT 7 - ADJ 1 - At the end of 2019, Cato recorded accrued salary expense of $6,000 (the salary expense is for courses the instructor taught in 2019 that Cato will pay cash for in 2020). Regarding Adjustments – an entry required to update an account balance is called an adjusting entry.  Adjustments ______________ effect the cash account. o Adjustments occur because the cash exchange happened at a different time then when the revenue was earned or the expense was incurred so the cash account was either already effected or will be effected at a point in the future. o Expenses that are recognized before cash is paid are called accrued expenses.  Adjustments ______________ effect stockholders’ equity. o The reason for making adjustments is to ensure that for the year the financial statements are being prepared for includes all revenues earned and expenses incurred  Either recording an expense that has occurred (causing equity to ______) or recording revenue earned (causing equity to ______). Required: 1. Record all transactions and any necessary adjustments. 2. Prepare the company’s income statement and statement of changes in equity for 2019. 3. Prepare the company’s balance sheet at 12/31/19. 4. Calculate the net cash flows from operating, investing, and financing activities for 2019 . 2

Practice Problem #1 Continued CATO CONSULTANTS 2020 TRANSACTIONS: EVENT 1 - Cato paid $6,000 to the instructor to settle the salaries payable obligation. EVENT 2 - Cato purchased $800 of supplies on account. EVENT 3 - On March 1, 2020, Cato signed a one-year lease agreement and paid $12,000 cash in advance to rent office space. The one-year lease term began on March 1. EVENT 4 - Cato received $18,000 cash in advance from Westberry Company for consulting services Cato agreed to perform over a one-year period beginning June 1, 2020. EVENT 5 - Cato provided $96,400 of consulting services on account. EVENT 6 - Cato collected $105,000 cash from customers as partial settlement of accounts receivable. EVENT 7 - Cato paid $32,000 cash for salary expense. EVENT 8 - Cato incurred $21,000 of other operating expenses on account. EVENT 9 - Cato paid $18,200 in partial settlement of accounts payable. EVENT 10 - Cato paid $79,500 to purchase land it planned to use in the future as a building site for its home office. EVENT 11 - Cato paid $21,000 in cash dividends to its stockholders. EVENT 12 - Cato acquired $2,000 cash from issuing additional shares of common stock. 3

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

Practice Problem #1 Adjustments ADJ 1 (Supplies adjustment) - After determining through a physical count that it had $150 of unused supplies on hand as of December 31, Cato recognized supplies expense. Beginning supplies balance $ 0 Plus: Supplies purchased $ 800 Less: Supplies remaining $ (150) = Supplies expense $ 650 1. How is the supplies expense recorded? What elements of the financial statements are affected by this transaction? 2. How is the ending balance of supplies recorded? How does this ending balance effect the financial statements? ADJ 2 (Rent adjustment) - Cato recognized rent expense for the office space used during the accounting period. Amount prepaid $ 12,000 Divided by: # of months / 12 months = Expense per month = $1,000 Multiplied by # of months occupied X 10 months = Rent expense = $ 10,000 1. How does the rent expense recorded? What elements of the financial statements are affected by this transaction? 2. How is the ending balance in the prepaid rent account recorded? How does this ending balance effect the financial statements? 4

ADJ 3 ( Unearned revenue adjustment) - Cato recognized the portion of the unearned revenue it earned during the accounting period. Amount Collected $ 18,000 Divided by: # of months / 12 months Earnings per month $ 1,500 Multiplied by # of months provided X 7 months = Revenue earned that year = $ 10,500 1. How is the revenue earned in the year recorded? What elements of the financial statements are affected by this transaction? 2. How is the ending balance of unearned revenue recorded? How does this ending balance effect the financial statements? ADJ 4 (Accrued salary adjustment) - Cato recognized $4,000 of accrued salary expense (the salary expense is for courses the instructor taught in 2020 that Cato will pay cash for in 2021). 1. How is the salary expense recorded? What elements of the financial statements are affected by this transaction? Required: 1. Record all transactions and any necessary adjustments. 2. Prepare the company’s income statement and statement of changes in equity for 2020. 3. Prepare the company’s balance sheet at 12/31/20. 4. Calculate the net cash flows from operating, investing, and financing activities for 2020 . 5

Matching Concept: 1. Cash basis accounting can distort reported net income because it sometimes fails to match expenses with the revenues they produced. 2. The objective of accrual accounting is to improve the matching of revenues with expenses. 3. Example: The 2019 ADJ entry #1 - The $6,000 of accrued salary expense that Cato Consultants recognized at the end of year 1. a. The instructor’s teaching produced revenue in year 1. If we wouldn’t had made the adjustment to recognize the $6,000 salary expense, then the expense would not have been matched with the revenue it generated. Practice Problem #2 The Sanders Company had the following balances at 12/31/2018: Cash $35,000 Accounts Payable $7,500 Accounts Receivable $9,000 Common Stock $40,000 Land $51,000 Retained Earnings $47,500 The following events occurred in 2019. Jan 1 Acquired $20,000 cash from the issue of common stock Feb 28 Paid $15,000 cash in advance for a one-year lease of office space. The lease begins on March 1 st . Mar 1 Paid a $2,000 cash dividend to stockholders Apr 1 Purchased additional land for $15,000 cash May 1 Made a cash payment on accounts payable of 5,500 July 31 Received $10,200 cash in advance for one year of services to be performed monthly beginning August 1 st Dec 31 Earned $58,000 of service revenue on account during the year Dec 31 Received cash collections from accounts receivable amounting to $46,000 Dec 31 Incurred other operating expenses on account during the year that amounted to $28,000 Dec 31 Accrued $6,500 of salary expense Required: 1. Record all transactions and any necessary adjustments. 2. Prepare the company’s income statement and statement of changes in equity for 2019. 3. Prepare the company’s balance sheet at 12/31/19. 4. Calculate the net cash flows from operating, investing, and financing activities for 2019 . 6

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

Practice Problem #3 1. Open the excel file named “Practice #3 Template”. For each line item describe the transaction which took place. 2. Assuming the rental lease was for 12 months, determine which month the lease for rent begins (not the month it was paid but when occupancy begins) 3. Assuming the company was to provide services over a 12-month period determine which month the company began providing services to the customers that paid in advance. 4. Prepare the financial statements for 2019. 7

Practice Problem #4 What effect do the following transactions have on net income and cash flows? Item #1 is an example of how your answers should be Event Effect on Net Income Effect on Cash Flows Effect on Balance Sheet Cash sales made during the last week of the year aren’t recorded Net income would be understated (too low) because revenue wasn’t recorded Cash flows from operating activities (therefore total cash flows) would be understated (too low) because the cash received wasn’t recorded Assets and equity would be understated (too low) because neither cash (asset) nor revenue (equity) weren’t recorded A company neglects to record the expired portion of insurance they paid in advance earlier in the year Should have reduced prepaid insurance and expense (overstated) No effect Assets are overstated, equity is overstated (expense) Services provided on account during the last week of the year aren’t recorded Revenue is understated, so net income is understated, assets are understated (accounts receivable) No effect Equity is understated, assets is understated A landlord receives cash on July 1 st for a 6 month lease and records this as unearned revenue. The landlord fails to make an adjustment at the end of the year Unearned revenue is overstated (liabilities), understated revenue (equity), net income is understated No effect Equity is understated, liability is overstated Supplies are counted at the end of the year but no adjustment is made to reflect the difference between the amount of supplies on hand earlier in the year versus the end of the year Work for a client is begun in November but won’t be completed and billed until the end of January so nothing has been recorded. 8

Practice Problem #5 1. In the year 2019 Coleman Company’s balance in accounts receivable decreased by $18,000. During the year they collected $86,000 from customers for services provided on account, how much were their sales on account during the year? Ex. Start off with 100,000 in accounts receivable Increase by blank amount End balance is 82,000 (18,000 decrease) The blank amount must be 68,000 USE REAL NUMBERS FOR THESE PURPOSELY CONFUSING QUESTIONS 2. On March 1, 2019 Huddleston Company entered into an insurance contract with Jefferson Company in which they (Huddleston) agreed to provide 12 months of insurance coverage beginning on October 1 st in exchange for $54,000 which will be paid in total on August 1 st . Record the necessary transactions for each company for the following dates: Huddleston Jefferson March 1 Contract NOTHING Contract NOTHING August 1 Increase cash 54000, increase liability 54000 (unearned revenue) Decrease cash, increase prepaid insurance October 1 Nothing, no service Nothing, no benefit December 31 Decrease liability (unearned revenue) 13500, increase revenue 13500 Decrease prepaid insurance 13500, decrease equity (insurance expense) 13500 a. What was Jefferson’s insurance expense for 2019? b. What was the balance in Jefferson’s prepaid insurance account on December 31st? c. What was Huddleston’s revenue for 2019? 9

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version