Accounting, Week 2 Notes
Accounting, Week 2 Notes
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Danny King, 2013
Accounting, Week 2 Notes Revenues & Expenses
The key difference in Accrual Accounting is that income is different from cash flow.
E.g. if you provide a service for a customer and issue them an invoice with the amount to be paid and a time period to pay it, you have earned the revenue because you have provided the goods/service and it has also been realized (even though they haven’t paid yet) because you have something that can be converted into cash (the invoice). So you can book revenue before you receive the cash; you put it in Accounts Receivables. 50% of FCC enforcement actions are for violations of the two revenue criteria. 1. You earned and realized it so all. 2. You presumably already claimed the reenue in October, so nothing extra to record as revenue. You are just collecting cash in Accounts Receivable. 3. You have only earned 1 month although you have realized both, so only $10k.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes
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Page 2 of 14
Danny King, 2013
4. Only an order has been placed: no goods/services have been delivered so no revenue (not earned). 5. It was earned (the money was loaned) and realized – it was actually realized in December because the legal obligation to pay back was there. 6. Revenue never comes from selling shares, only from delivering goods or services.
Another way to think about the conservatism principle is the ‘anti-human-nature principle’
1. $0 because the engines are product costs and so not expensed until you actually sell the cars made with the engines. So at this point there is no expense. 2. Still $0 for the same reason – they aren’t expenses until you actually sell the cars. (Very specifically: expense only refers to something that shows up on the income statement. An expense is not equivalent to a cost, which can be used more loosely) 3. The (total) cost of the cars can finally be labelled as an expense once they are sold.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes
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Page 3 of 14
Danny King, 2013
4. This is a period cost (marketing salaries) and we recognise it immediately; we assume that the marketing employees’ activities are helping to sell cars this period, so their salaries get expensed this period. 5. Can only recognise half of this (because we are in December) as an expense – we only want to recognise the work paid for in December as an expense in December because we want to recognise the expenses based on business activities not based on cash flow. The already paid $25k for the other month that hasn’t yet been expensed will go into a pre-paid auditor account. 6. Dividends are never considered a business expense.
Examples & Case Study
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Accounting, Week 2 Notes
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Danny King, 2013
This only deals with the revenue part… the inventory part is dealt with separately:
This is the product cost that we recognise as an expense when we make a sale. Any time you sell goods or inventory you have to make two entries, one to record the revenue and cash we are going to collect at the selling price (18) and one to record the reduction in inventory and the CoGS expense i.e. the product cost at the original cost.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes
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Page 6 of 14
Danny King, 2013
Adjusting Entries
Adjusting entries are internal transactions (i.e. not doing business with outsiders) that update account balances in accordance with accrual accounting before the preparation of financial statements. There are two major categories of adjusting entries:
Deferred revenues & expenses: update an existing account balance to reflect an current accounting values. i.e. paid or received cash in the past and didn’t record revenue or expense at the time, and need to do it now. Accrued revenues & expenses: create a new account balance to reflect unrecorded assets or liabilities i.e. need to record a revenue/expense now even though the cash flow will occur in the future.
Note: no new cash is being paid or coming in at this point; all these transactions are after the books have closed. It’s all internal transactions. There are some categories that fit into this: Deferred expenses: are there any assets that should have been used up this period and should be expensed? E.g. prepaid rent, prepaid advertising, depreciation, amortization.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes
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Page 7 of 14
Danny King, 2013
Deferred revenues: are there any liabilities that should have been fulfilled by delivery of goods/services that should be recognised as revenue? I.e. getting cash in advance of providing a good/service e.g. unearned rental revenue, deferred subscription revenue. Accrued expenses: have any expenses accumulated during the period that have not yet been recorded? I.e. you have incurred an expense but haven’t paid for it in cash yet. E.g. Income taxes Payable, Interest Payable, Salaries & Wages Payable. Accrued revenues: have any revenues accumulated during the period that have not yet been recorded? E.g. Interest Receivable, Rent Receivable. E.g. if you have rented out space but haven’t been paid yet and you are owed. Note: these revenues are earned over time as opposed to delivering specific goods/services and so they may not have been accounted for previously, but they will need to be included when you prepare financial statements e.g. at the end of a quarter. It may simply be easier to do it at the end of the quarter than e.g. every month for rent.
The goal of depreciation and amortization is to allocate the original cost of a long-lived asset over the course of its useful life. I.e. instead of recognizing the cost of an asset purchase in just one period we spread that cost over the period we use to generate revenue (matching princinples). We do this to match the total expense (i.e. original cost) of the asset to the revenues it generates over its period of use. E.g. spreading the cost of a truck over 48 months, which is the length of time it is used in the business (i.e. generating revenue for it).
When we record account depreciation (e.g. on a truck) it’s not deducted from the truck account. Instead you create a Contra Asset (XA) Account called Accumulated Depreciation. XA accounts have a credit balance (i.e. goes up with credits & down with debits), which is the opposite of usual asset balances (hence contra). Whatever you accumulate in the Accumulated Depreciation account is subtracted from the Property, Plant & Equipment account in order to get the net book value. On the other hand, amortization is usually deducted directly from the intangible asset account. Almost all companies use straight-line depreciation to recognize this depreciation expense in their financial statements.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Accounting, Week 2 Notes Danny King, 2013
Financial Statements
Danny King [email protected] www.dannyking.eu
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Page 12 of 14
Accounting, Week 2 Notes Danny King, 2013
Closing Entries
Danny King [email protected] www.dannyking.eu
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Accounting, Week 2 Notes Danny King, 2013
And now you can start the next fiscal period.
Danny King [email protected] www.dannyking.eu
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Danny King, 2013
Accounting, Week 2 Notes Revenues & Expenses
The key difference in Accrual Accounting is that income is different from cash flow.
E.g. if you provide a service for a customer and issue them an invoice with the amount to be paid and a time period to pay it, you have earned the revenue because you have provided the goods/service and it has also been realized (even though they haven’t paid yet) because you have something that can be converted into cash (the invoice). So you can book revenue before you receive the cash; you put it in Accounts Receivables. 50% of FCC enforcement actions are for violations of the two revenue criteria. 1. You earned and realized it so all. 2. You presumably already claimed the reenue in October, so nothing extra to record as revenue. You are just collecting cash in Accounts Receivable. 3. You have only earned 1 month although you have realized both, so only $10k.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes
0
Page 2 of 14
Danny King, 2013
4. Only an order has been placed: no goods/services have been delivered so no revenue (not earned). 5. It was earned (the money was loaned) and realized – it was actually realized in December because the legal obligation to pay back was there. 6. Revenue never comes from selling shares, only from delivering goods or services.
Another way to think about the conservatism principle is the ‘anti-human-nature principle’
1. $0 because the engines are product costs and so not expensed until you actually sell the cars made with the engines. So at this point there is no expense. 2. Still $0 for the same reason – they aren’t expenses until you actually sell the cars. (Very specifically: expense only refers to something that shows up on the income statement. An expense is not equivalent to a cost, which can be used more loosely) 3. The (total) cost of the cars can finally be labelled as an expense once they are sold.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes
0
Page 3 of 14
Danny King, 2013
4. This is a period cost (marketing salaries) and we recognise it immediately; we assume that the marketing employees’ activities are helping to sell cars this period, so their salaries get expensed this period. 5. Can only recognise half of this (because we are in December) as an expense – we only want to recognise the work paid for in December as an expense in December because we want to recognise the expenses based on business activities not based on cash flow. The already paid $25k for the other month that hasn’t yet been expensed will go into a pre-paid auditor account. 6. Dividends are never considered a business expense.
Examples & Case Study
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
0
Page 4 of 14
Accounting, Week 2 Notes
0
Page 5 of 14
Danny King, 2013
This only deals with the revenue part… the inventory part is dealt with separately:
This is the product cost that we recognise as an expense when we make a sale. Any time you sell goods or inventory you have to make two entries, one to record the revenue and cash we are going to collect at the selling price (18) and one to record the reduction in inventory and the CoGS expense i.e. the product cost at the original cost.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes
0
Page 6 of 14
Danny King, 2013
Adjusting Entries
Adjusting entries are internal transactions (i.e. not doing business with outsiders) that update account balances in accordance with accrual accounting before the preparation of financial statements. There are two major categories of adjusting entries:
Deferred revenues & expenses: update an existing account balance to reflect an current accounting values. i.e. paid or received cash in the past and didn’t record revenue or expense at the time, and need to do it now. Accrued revenues & expenses: create a new account balance to reflect unrecorded assets or liabilities i.e. need to record a revenue/expense now even though the cash flow will occur in the future.
Note: no new cash is being paid or coming in at this point; all these transactions are after the books have closed. It’s all internal transactions. There are some categories that fit into this: Deferred expenses: are there any assets that should have been used up this period and should be expensed? E.g. prepaid rent, prepaid advertising, depreciation, amortization.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes
0
Page 7 of 14
Danny King, 2013
Deferred revenues: are there any liabilities that should have been fulfilled by delivery of goods/services that should be recognised as revenue? I.e. getting cash in advance of providing a good/service e.g. unearned rental revenue, deferred subscription revenue. Accrued expenses: have any expenses accumulated during the period that have not yet been recorded? I.e. you have incurred an expense but haven’t paid for it in cash yet. E.g. Income taxes Payable, Interest Payable, Salaries & Wages Payable. Accrued revenues: have any revenues accumulated during the period that have not yet been recorded? E.g. Interest Receivable, Rent Receivable. E.g. if you have rented out space but haven’t been paid yet and you are owed. Note: these revenues are earned over time as opposed to delivering specific goods/services and so they may not have been accounted for previously, but they will need to be included when you prepare financial statements e.g. at the end of a quarter. It may simply be easier to do it at the end of the quarter than e.g. every month for rent.
The goal of depreciation and amortization is to allocate the original cost of a long-lived asset over the course of its useful life. I.e. instead of recognizing the cost of an asset purchase in just one period we spread that cost over the period we use to generate revenue (matching princinples). We do this to match the total expense (i.e. original cost) of the asset to the revenues it generates over its period of use. E.g. spreading the cost of a truck over 48 months, which is the length of time it is used in the business (i.e. generating revenue for it).
When we record account depreciation (e.g. on a truck) it’s not deducted from the truck account. Instead you create a Contra Asset (XA) Account called Accumulated Depreciation. XA accounts have a credit balance (i.e. goes up with credits & down with debits), which is the opposite of usual asset balances (hence contra). Whatever you accumulate in the Accumulated Depreciation account is subtracted from the Property, Plant & Equipment account in order to get the net book value. On the other hand, amortization is usually deducted directly from the intangible asset account. Almost all companies use straight-line depreciation to recognize this depreciation expense in their financial statements.
Danny King [email protected] www.dannyking.eu
Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Page 8 of 14
Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Page 10 of 14
Accounting, Week 2 Notes Danny King, 2013
Danny King [email protected] www.dannyking.eu
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Page 11 of 14
Accounting, Week 2 Notes Danny King, 2013
Financial Statements
Danny King [email protected] www.dannyking.eu
0
Page 12 of 14
Accounting, Week 2 Notes Danny King, 2013
Closing Entries
Danny King [email protected] www.dannyking.eu
0
Page 13 of 14
Accounting, Week 2 Notes Danny King, 2013
And now you can start the next fiscal period.
Danny King [email protected] www.dannyking.eu
0
Page 14 of 14
