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ACCOUNTING FUNDAMENTALS FOR MANAGERS

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1 ACCOUNTING FUNDAMENTALS FOR MANAGERS
University of Management and Technology 1901 North Fort Myer Drive Arlington, VA 22209 Voice: (703) Fax: (703) Website:

2 Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

3 The Accrual Basis of Accounting
Chapter 3 The Accrual Basis of Accounting

4 After studying this chapter, you should be able to:
Learning Objectives After studying this chapter, you should be able to: Describe the accrual basis of accounting. Use the accrual basis of accounting to analyze, record, and summarize transactions. Describe and illustrate the end-of-the-period adjustment process. Prepare accrual-basis financial statements, including a classified balance sheet. Continued

5 Learning Objectives Describe how the accrual basis of accounting enhances the interpretation of financial statements. Describe the accounting cycle for the accrual basis of accounting. Describe and illustrate how common-sized financial statements can be used to analyze and evaluate a company’s performance.

6 Learning Objective 1 Describe the accrual basis of accounting.

7 Under the cash basis, the matching concept is not emphasized.
Under accrual accounting, revenue is normally recognized when it is earned. Under the accrual accounting basis, transactions are recorded even though cash is not received or paid unit a later point. Under the cash basis, the receipt or payment of cash governs the recording process. The cash basis does not work well for large businesses.

8 Learning Objective 2 Use the accrual basis of accounting to analyze, record, and summarize transactions.

9 a. On November 1, received $1,800 from H. S
a. On November 1, received $1,800 from H.S. Company as rent for the use of Family Health Care’s land as a temporary parking lot from November 2003 through March 2004.

10 Left Side of the Accounting Equation
Assets Cash + Land Bal. 7,320 12,000 a. 1,800 Bal. 9,120 12,000

11 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Unearned Revenue Capital Stock Retained Earnings + + Bal. 10,000 6,000 3,320 a. 1,800 Bal. 10,000 1,800 6,000 3,320

12 b. On November 1, paid $2,400 for an insurance premium on a two-year, general business policy.

13 Left Side of the Accounting Equation
Assets Prepaid Cash + Insurance + Land Prepaid Insurance Bal. 9, ,000 b. –2,400 2,400 Bal. 6,720 2,400 12,000 No effect on right side

14 c. On November 1, paid $6,000 for an insurance premium on a six-month medical malpractice insurance policy.

15 Left Side of the Accounting Equation
Assets Prepaid Cash + Insurance + Land Bal. 6,720 2,400 12,000 c. –6,000 6,000 Bal ,400 12,000 No effect on right side

16 d. Dr. Landry invested an additional $5,000 in the business in exchange for capital stock.

17 Left Side of the Accounting Equation
Assets Prepaid Cash + Insurance + Land Bal ,400 12,000 d. 5,000 Bal. 5,720 8,400 12,000

18 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Unearn. Rev. Retained Earnings Capital Stock + + + Bal. 10,000 1,800 6,000 3,320 d. 5,000 Bal. 10,000 1,800 11,000 3,320

19 e. Purchased supplies for $240 on account.

20 Left Side of the Accounting Equation
Assets Prepaid Cash + Insurance Land Supplies Bal. 5,720 8, ,000 e Bal. 5,720 8, ,000

21 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Accts. Pay. Unearn. Rev. Capital Stock Retained Earnings + + + + Bal. 10,000 1,800 11,000 3,320 e. 240 Bal. 10, ,800 11,000 3,320

22 f. Purchased $8,500 of office equipment
f. Purchased $8,500 of office equipment. Paid $1,700 cash as a down payment with the remainder due in five monthly installments of $1,360 beginning December 1.

23 Left Side of the Accounting Equation
Assets Prepaid Cash + Insurance Land OfficeEquip. Supplies + Bal. 5,720 8, ,000 f. -1, ,500 Bal. 4,020 8, ,500 12,000

24 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Accts. Pay. Unearn. Rev. Capital Stock Retained Earnings + + + + Bal. 10, ,800 11,000 3,320 f. 6,800 Bal. 16, ,800 11,000 3,320

25 g. Provided services of $6,100 to patients on account.

26 Left Side of the Accounting Equation
Assets Prep Office Cash Insur. + Supp. + Equip. + Land Ac. Rec. Bal. 4,020 8, ,500 12,000 g. 6,100 Bal. 4,020 6,100 8, ,500 12,000

27 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Accts. Pay. Unearn. Rev. Capital Stock Retained Earnings + + + + Bal. 16, ,800 11,000 3,320 Fees Earned g ,100 Bal. 16, ,800 11,000 9,420

28 h. Received $5,500 for services provided to patients who paid cash.

29 Left Side of the Accounting Equation
Assets Prep Office Cash Insur. + Supp. + Equip. + Land Ac. Rec. Bal. 4,020 6,100 8, ,500 12,000 h. 5,500 Bal. 9,520 6,100 8, ,500 12,000

30 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Accts. Pay. Capital Stock Unearn. Rev. Retained Earnings + + + + Bal. 16, ,800 11,000 9,420 Fees Earned h ,500 Bal. 16, ,800 11, ,920

31 i. Received $4,200 from insurance companies, which paid on patients’ accounts for services that have been rendered.

32 Left Side of the Accounting Equation
Assets Prep Office Cash Insur. + Supp. + Equip. + Land Ac. Rec. Bal. 9,520 6,100 8, ,500 12,000 i. 4,200 –4,200 Bal. 13,720 1,900 8, ,500 12,000 No effect on right side

33 j. Paid $100 on account for supplies that had been purchased.

34 Left Side of the Accounting Equation
Assets Prep Office Cash Insur. + Supp. + Equip. + Land Ac. Rec. Bal. 13,720 1,900 8, ,500 12,000 j. –100 Bal. 13,620 1,900 8, ,500 12,000

35 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Accts. Pay. Unearn. Rev. Capital Stock Retained Earnings + + + + Bal. 16, ,800 11,000 14,920 j. –100 Bal. 16, ,800 11, ,920

36 k. Expenses paid during November were as follows: wages, $2,790; rent, $800; utilities, $580; interest, $100; miscellaneous, $420.

37 Left Side of the Accounting Equation
Assets Prep Office Cash Insur. + Supp. + Equip. + Land Ac. Rec. Bal. 13,620 1,900 8, ,500 12,000 k. –4,690 Bal. 8,930 1,900 8, ,500 12,000

38 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Accts. Pay. Unearn. Rev. Capital Stock Retained Earnings + + + + Bal. 16, ,800 11,000 14,920 k. –2,790 –800 –580 –100 –420 Wages Exp. Rent Exp. Utilities Exp. Interest Exp. Miscellaneous Exp. Bal. 16, ,800 11, ,230

39 l. Paid dividends of $1,200 to stockholder (Dr. Landry).

40 Left Side of the Accounting Equation
Assets Prep Office Cash Insur. + Supp. + Equip. + Land Ac. Rec. Bal. 8,930 1,900 8, ,500 12,000 l. –1,200 Bal. 7,730 1,900 8, ,500 12,000

41 Right Side of the Accounting Equation
Stockholders’ Equity Liabilities Notes Payable Accts. Pay. Unearn. Rev. Capital Stock Retained Earnings + + + + Bal. 16, ,800 11,000 10,230 Dividends l. –1,200 Bal. 16, ,800 11,000 9,030

42 3 Describe and illustrate the end-of-the-period adjustment process.
Learning Objective 3 Describe and illustrate the end-of-the-period adjustment process.

43 The accrual basis of accounting requires the accounting records to be updated prior to preparing financial statements.

44 This updating process is called the adjustment process.

45 Deferrals and Accruals
Deferrals are created by recording a transaction in a way that delays or defers the recognition of an expense or a revenue Accruals are created when a revenue or expense has not been recorded at the end of the accounting period.

46

47 Deferrals and Accruals
a1. Earlier Family Health Care prepaid two policies—a general business policy for $2,400 and a malpractice policy for $6,000. The general business policy expires at a rate of $100 ($2,400 ÷ 24) per month and the malpractice policy expires at a rate of $1,000 ($6,000 ÷ 6) per month.

48 Deferrals and Accruals
Assets Stockholder’ Equity Prepaid Insurance Retained Earnings Balance 8, ,030 a1 –1,100 Insurance Exp. –1,100 Balance 7,300 7,930

49 Deferrals and Accruals
a2. For November, $150 of the supplies were used, leaving $90 of supplies for use during the coming months. Assets Stockholder’ Equity Retained Earnings Supplies Balance ,930 a2 –150 Supplies Exp. –150 Balance ,780

50 Deferrals and Accruals
Fixed assets such as drilling equipment lose their ability to provide service over time. This reduction in ability is called depreciation.

51 Deferrals and Accruals
The fixed asset account is not reduced directly by depreciation. Instead, an offsetting account, called Accumulated Depreciation, is used.

52 Deferrals and Accruals
a3. Assume that the amount of depreciation for November is $160. Assets Stockholder’ Equity Office Equipment Accumulated – Depreciation Retained Earnings Balance 8,500 7,930 a3 Depreciation Exp. 160 –160 Balance 8, ,620

53 Deferrals and Accruals
a4. Of the $1,800 received for five-months’ rent, $360 ($1,800 ÷ 5) has been earned. Liabilities Stockholder’ Equity Unearned Rent Retained Earnings Balance 1,800 7,620 a4 –360 Rental Rev. 360 Balance 1,440 7,980

54 Deferrals and Accruals
a5. As of November 30, employees are owed $220 for accrued wages. Liabilities Stockholder’ Equity Wages Payable Retained Earnings Balance ,980 a5 220 Wages Exp. –220 Balance ,760

55 Deferrals and Accruals
a6. Family Health Care provided $750 in services to patients that have not yet been billed. Assets Stockholder’ Equity Accounts Receivable Retained Earnings Balance 1,900 7,760 a6 750 Fees Earned 750 Balance 2,650 8,510

56 Learning Objective 4 Prepare accrual-basis financial statements, including a classified balance sheet.

57 For the Month Ended November 30, 2003
Family Health Care, P.C. Income Statement For the Month Ended November 30, 2003 Fees earned $12,350 Operating expenses: Wages expense $3,010 Insurance expense 1,100 Rent expense 800 Utilities expense 580 Depreciation expense 160 Supplies expense 150 Interest expense 100 Miscellaneous expense Total operating expenses ,320 Operating income: $ 6,030 Other income: Rent revenue Net income $ 6,390

58 Retained Earnings Statement For the Month Ended November 30, 2003
Family Health Care, P.C. Retained Earnings Statement For the Month Ended November 30, 2003 Retained earnings, November 1, $3,320 Net income for November $6,390 Less dividends 1, ,190 Retained earning, November 30, $8,510 From the income statement (Slide 3-55)

59 Family Health Care, P.C. Continued Balance Sheet Assets
November 30, 2003 Assets Current assets: Cash $ 7,730 Accounts receivable 2,650 Prepaid insurance 7,300 Supplies Total current assets $17,770 Fixed assets: Office equipment $8,500 Less accumulated depreciation $ 8,340 Land 12,000 Total fixed assets ,340 Total assets $38,110 Continued

60 From the retained earnings statement
Liabilities Current liabilities: Accounts payable $ Wages payable 220 Notes payable 6,800 Unearned revenue 1,440 Total current liabilities $ 8,600 Long-term liabilities: Notes payable 10,000 Total liabilities $18,600 Stockholders’ equity Capital stock $11,000 Retained earnings 8, ,510 Total liabilities and stockholders’ equity $38,110 From the retained earnings statement

61 Statement of Cash Flows For the Month Ended November 30, 2003
Family Health Care, P.C. Statement of Cash Flows For the Month Ended November 30, 2003 Cash flows from operating activities: Cash received from patients $ 9,700 Cash received from rental of land 1,800 $11,500 Deduct cash payments for expenses: Insurance premiums $(8,400) Supplies (100) Wages (2,790) Rent (800) Utilities (580) Interest (100) Miscellaneous expense (420) (13,190) Net cash flow used in operating activities $ (1,690) Continued

62 Net cash flow used in operating activities $ (1,690)
Cash flows from investing activities: Purchase of office equipment (1,700) Cash flows from financing activities: Additional issuance of capital stock $ 5,000 Deduct cash dividends (1,200) Net cash flow from financing activities ,800 Net increase in cash $ November 1, 2003 cash balance ,320 November 30, 2003 cash balance $ 7,730

63 Assets Assets are resources such as physical items or rights that are owned by the business.

64 Physical assets of a long-term nature are referred to as fixed assets.
Buildings Equipment Land Fixtures

65 Rights that are long-term in nature are called intangible assets.
Patents Copyrights Trademarks Leasehold improvements

66 Assets Cash and other assets that are expected to be converted to cash or sold or used up within one year or less, through the normal operations of the business, are called current assets. Accounts receivable Notes receivable Supplies Other prepaid expenses

67 Liabilities Liabilities are amounts owed to outsiders… normally referred to as creditors.

68 A sizable number of liabilities end in the word “payable.”
Accounts payable Wages payable Interest payable Taxes payable Liabilities that will be due within a short time (usually one year or less) and that are paid out of current assets are called current liabilities. A sizable number of liabilities end in the word “payable.”

69 Liabilities Liabilities that will not be due within a short time (usually more than a year) or are not paid out of current assets are called long-term liabilities. Mortgage payable Bonds payable

70 Stockholders’ Equity Stockholders’ equity is the stockholders’ right to the assets of the business. Capital stock Retained earnings

71 Learning Goal 5 Describe how the accrual basis of accounting enhances the interpretation of financial statements.

72 Cash Basis Income Statement For the Month Ended November 30, 2003
Family Health Care, P.C. Cash Basis Income Statement For the Month Ended November 30, 2003 Note that this is a cash basis income statement Fee earned $ 9,700 Operating expenses: Wages expense $2,790 Insurance expense 8,400 Rent expense 800 Utilities expense 580 Supplies expense 100 Interest expense 100 Miscellaneous expense Total operating expenses 13,190 Operating loss $ 3,490 Rental revenue ,800 Net loss $ 1,690

73 Using the accrual basis, net income for November was $6,390
Using the accrual basis, net income for November was $6,390. However, if we followed the cash basis, the firm shows a loss of $1,690. Cash Accrual

74 6 Describe the accounting cycle for the accrual basis of accounting.
Learning Objective 6 Describe the accounting cycle for the accrual basis of accounting.

75 2. Identifying, analyzing, and recording adjustment data.
The Accounting Cycle 1. Identifying, analyzing and recording the effects of transactions on the accounting equation. 2. Identifying, analyzing, and recording adjustment data. 3. Preparing financial statements. 4. Preparing the accounting records for the next accounting period.

76 After the financial statements are prepared, the balances in the revenue, expense, and dividend accounts are closed by the closing process.

77 In this way, the revenue, expense, and dividend accounts begin each period with a zero balance, and the transactions of each period are kept separate from one another.

78 Learning Objective 7 Describe and illustrate how common-size financial statements can be used to analyze and evaluate a company’s performance.

79 Common-Size Financial Statements
Income Statements for the Year Ending December 31, 2001 Wendy’s McDonald’s Note Wendy’s higher proportion of operating expenses to revenue. Revenues % 100.0% Operating expenses % % Operating income 13.8% 18.2% Other expenses % % Income before taxes 12.9% 15.7% Income taxes % % Net income 8.1% 11.0% Which is probably the reason for Wendy’s lesser percentage of net income.

80 Common-Size Financial Statements
Balance Sheets as of December 31, 2001 Wendy’s McDonald’s Current assets: Cash 5.4% 1.9% Accounts receivable 4.0% 3.9% Inventories and other assets % % Total current assets 12.8% 8.1% Property, plant, and equipment 79.0% 76.7% Other long-term assets % % Total assets 100.0% 100.0% Continued

81 Common-Size Financial Statements
Balance Sheets as of December 31, 2001 Wendy’s McDonald’s Current liabilities: Accounts payable 5.4% 3.1% Other liabilities % % Total current liabilities 14.3% 10.0% Long-term liabilities 36.1% 47.9% Stockholders’ equity % % Total assets 100.0% 100.0%


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