Exercises: Unit 2 Financial Accounting

Today, the larger corporations with many shareholders are likely to use electronic records instead of issuing the paper stock certificates. Liabilities also include amounts received in advance for a future sale or for a future service to be performed. You should consider our materials to be an introduction to selected accounting and bookkeeping topics (with complexities likely omitted). We focus on financial statement reporting and do not discuss how that differs from income tax reporting. Therefore, you should always consult with accounting and tax professionals for assistance with your specific circumstances.

What does a healthy balance sheet look like?

If the company is required to pay the $6,000 in advance at the end of December, the expense needs to be deferred so that $1,000 will appear on each of the monthly income statements for January through June. Under the accrual method of accounting, the expenses should be reported in the same accounting period as the related revenues. If that is not certain, then an expense should be reported in the accounting period in which its cost expires or is used up.

Rules of Debits & Credits for the Balance Sheet & Income Statement

Among the many required reports is the Annual Report to the SEC, Form 10-K. Some corporations may be required to have their external financial statements audited. Under the indirect method, the first amount shown is the corporation’s net income (or net earnings) from the income statement. Assuming the net income was $100,000 it is listed first and is followed by many adjustments to convert the net income (computed under the accrual method of accounting) to the approximate amount of cash. Hence, if a florist receives $2,000 for its old delivery van and the accounting records show that the van has a carrying value of $1,500 the income statement will report a gain on sale of assets of $500.

► Income or Revenue

Accounts payable form the largest portion of the current liability section on the company’s financial statements. Liabilities refer to a company’s financial responsibilities, and any change in liabilities also affects equity. Accounts payable, short-term and long-term debt, inventory costs and other line items affect shareholder equity. An increase in money owed to suppliers, interest rates or inventory costs causes total liabilities to rise and, if assets stay constant, decreases shareholder equity.

Balance Sheet Accounts

If $3,000 has been earned, the Service Revenues account must include $3,000. The remaining $1,000 that has not been earned will be deferred to the following accounting period. The deferral will be evidenced by a credit of $1,000 in a liability account such as Deferred Revenues or Unearned Revenues. The accounting software’s vendor files also allow a company to prepare purchase orders, receiving tickets and to pay the vendors’ invoices. Allowance for Doubtful AccountsThe Allowance for Doubtful Accounts is a contra-asset account since its balance is intended to be a credit balance (or a zero balance). When the balance in this account is combined with the balance in Accounts Receivable, the resulting amount is known as the net realizable value of the receivables.

Corporations routinely need cash in order to replace inventory and other assets whose costs have increased or to expand the business. As a result, corporations rarely distribute all of their net income to stockholders. A contra revenue account that reports the discounts allowed by the seller if the customer pays the amount owed within a specified time period. For example, terms of “1/10, n/30” indicates that the buyer can deduct 1% of the amount owed if the customer pays the amount owed within 10 days.

Expenses decrease stockholders’ equity (which is on the right side of the accounting equation).Therefore expense accounts will have their balances on the left side. Revenues increase stockholders’ equity (which is on the right side of the accounting equation).Therefore the balances in the revenue accounts will be on the right side. Bookkeeping (and accounting) involves the recording of a company’s financial transactions. The transactions will have to be identified, approved, sorted and stored in a manner so they can be retrieved and presented in the company’s financial statements and other reports. The adjusting entries will require a person to determine the amounts and the accounts.

It’s calculated by dividing a firm’s total liabilities by total shareholders’ equity. All the statistics required to compute shareholders’ equity is available on a company’sbalance sheet. Long-term assets are assets that cannot be converted to cash or consumed within a year (e.g. investments; property, plant, and equipment; and intangibles, such as patents). Corporations with net accumulated losses may refer to negative shareholders’ equity as positive shareholders’ deficit. A report of the movements in retained earnings are presented along with other comprehensive income and changes in share capital in the statement of changes in equity. “Temporary accounts” (or “nominal accounts”) include all of the revenue accounts, expense accounts, the owner’s drawing account, and the income summary account.

A corporation is a form of business that is a separate legal entity from its owners. The people and/or organizations who own a corporation are called stockholders. Stockholders (owners) receive shares of stock as receipts for theirinvestments in the business. This form of business offers limited liability to stockholders—the owners can only lose what they invested in the business. Their other assets cannot be taken to satisfy the obligations of the company they invest in.

When its articles of incorporation are prepared, a business will often request authorization to issue a larger number of shares than what is immediately needed. Stockholders’ equity is the value of a company’s assets accounts payable stockholders equity left for shareholders after the company pays all of its liabilities. Our Stockholders’ Equity Cheat Sheet explains some of the terminology found on a corporation’s balance sheet. The systematic allocation of an intangible asset to expense over a certain period of time.

• In some accounting software, the chart of accounts is also used to designate where an account will be reported in the financial statements.
• A decrease in the value of a long term asset to an amount that is less than the amount shown under the cost principle.
• A liability, in general, is an obligation to, or something that you owe somebody else.
• We will use the accounting equation to explain why we sometimes debit an account and at other times we credit an account.

This one-year period of time (or time interval) is referred to as a calendar year. A calendar year corporation will have quarterly accounting periods that end on March 31, June 30, September 30, and December 31. The annual financial statements should also include notes to the financial statements. The notes (which are to be referenced on each financial statement) disclose important information regarding the amounts appearing or not appearing on the financial statements.

When inventory items are acquired or produced at varying costs, the company will need to make an assumption on how to flow the changing costs. A stock split, such as a 2-for-1, means that every stockholder will have twice as many shares as was held previously. Accordingly, the market price per share after the split should be one-half of the market price existing prior to the stock split.

• Some refer to the journal as the book of original entry, since the entries are first recorded in a journal.
• This figure is subtracted from a company’s total equity, as it represents a smaller number of shares that are available to investors.
• Assets are on the left side of the accounting equation.Asset account balances should be on the left side of the accounts.
• When the vendor’s invoice is processed in January, it can be debited to Repairs Expenses (as would normally happen).
• Current liabilities are one of two-part of liabilities and hence, accounts payable are liabilities.

We will assume that as of December 3 the equipment has not been placed into service. Therefore, there is no expense (or revenue) to be reported on the income statement for the period of December 1-3. It will become part of depreciation expense only after it is placed into service. The purchased service, which is an expense, reduces stockholders’ equity and therefore is classified as a debit. On the other hand, the accounts payable which increases the liabilities account is considered a credit. This preferred stock feature assures the owner that any omitted dividends on this stock will be made up before the common stockholders will receive a dividend.

Likewise, any decrease in the amount of money that a company needs to pay out increases shareholder equity. The totals show us that the corporation had assets of $17,200 with $7,120 provided by the creditors and $10,080 provided by the stockholders. The accounting equation also reveals that the corporation’s creditors had a claim of $7,120 and the stockholders had a residual claim for the remaining $10,080. The purchase of a corporation’s own stock will never result in an amount to be reported on the income statement. Therefore, there is no transaction involving the income statement for the two-day period of December 1 through December 2. Since ASI has not yet earned any revenues nor incurred any expenses, there are no amounts to be reported on an income statement.