Financial Accounting II and Adjustments Lecture Notes

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Midterm 2

The Accounting Cycle

Event happens, interpret event, enter into journal, post to ledger, unadjusted trial balance, adjusting entries, adjusted trial balance, close temporary accounts, post-closing trial balances, prepare statements

Accounts to Debit

Assets: Cash, merchandise inventory, A/R, prepaid rent, equipment, (accum. depr.)
Owner's Equity: expenses, losses, dividends, COGS, depreciation expense

Accounts to Credit

Liabilities: A/P, unearned revenue, dividends payable, wages payable
Owner's Equity: Common stock (investments by owners/owner's contributions), retained earnings, revenue, gains

Balance of debits and credits

Beware: balances only means total of debits and credits are equal, so...
1) If you miss a transaction
2) Wrong amounts to correct accounts
3) Right amounts to wrong accounts
4) Wrong amounts to wrong accounts...
...it will still balance!

Purpose of adjusting entries

Adjusting entries are made at the end of every reporting period to ensure:
1) Revenue is recognized when it is earned, realized or realizable
2) Expenses (losses) are recognized in the period in which they contribute to the production of revenue -matching
3) Certain accounts are valued at their market value rather than original cost (later)-investments, inventories, and receivables

Investments

At market value rather than original cost (adjust historical cost to MV)

Inventories

At lower cost or market rather than original cost

Receivables

At net realizable value rather than face value

Accrual adjusting entries

Asset or liability increases (builds up) as time passes, e.g. interest receivables from bank or interest payable related to loan

Common aspects of all adjusting entries

1) Involves at least one balance sheet and one income statement
2) Doesn't involve cash account (except when reconciling cash itself)

Deferral adjusting entries

Asset or liability decreases as time passes

Capitalization

Item was initially recorded in a balance sheet account when acquired/received

Adjusting entry needed when:

At the end of the period, we still have all of the asset or owe all of the liability, or we used it all up/earned all of it

Expense

A verb meaning initially put it on the income statement

Capitalizing and Expensing

Whether you capitalize or expense, in the long-run it will be the same, but in the short-run in will be different.

Temporary Accounts

Revenues, expenses, gains, losses, dividends (will show a zero balance on post-closing trial balance)

Permanent Accounts

Have a balance on the post-closing trial balance

Criteria for recognizing economic events in accounting records:

1) Relevant
2) Objectively measurable

Equipment is...

Capitalized when it is first acquired

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