LEGL-180 Lecture Notes - Lecture 4: Accounts Payable, Accrual, Accounts Receivable

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23 Feb 2017

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Recognizes revenues when we make a sale or render a service. Revenue is assigned to the accounting period in which we earn it, regardless of when we receive it. Recognized expenses when they incurred, regardless of when paid. Accrual accounting: recognizes revenue when earned and expenses when incurred. With accrual accounting, revenue is matched against the expenses that helped earn it. Cash accounting - recognizes revenue and expenses only when revenue is received and expenses are paid (with cash) With accrual accounting, adjustments need to be made at the end of the accounting period to record any missing information or to alter any existing information to ensure expenses are properly matched to that period. An adjusting entry is a journal entry. Recorded & unrecorded: pre-paid expense [asset]- insurance, rent, property tax, business tax (pg 84-94) An expense paid in advance of it"s use.

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SECTION II: MATCHING (10 possible points)
Please match the numbered terms with their definitions by placingthe letter that identifies the best definition in the blank spacenext to the term. The value of each correct answer is 1point.

____ 1. Accrual Basis

____ 2. Cost Principle

____ 3. Credit

____ 4. Debit

____ 5. Generally Accepted Accounting Principles(GAAP)

____ 6. General Ledger

____ 7. Journal

____ 8. Liquidity

____ 9. Matching Principle

____ 10. Materiality

A. The various methods, rules, practices, and other proceduresthat have evolved over time in response to the need
to regulate the preparation offinancial statements.
B. The magnitude of an omission or misstatement in accountinginformation that will affect the judgment of
someone relying on theinformation.

C. A book, file, hard drive, or other devices containing all ofa companyâs accounts.

D. An entry on the left side of an account.

E. An entry on the right side of an account.

F. A chronological record of transactions, also known as thebook of original entry.

G. The association of revenue ofa period with all of the costs necessary to generate thatrevenue.

H. Assets are recorded at the cost to acquire them.

I. The ability of a company to pay the debts as they comedue.

J. A system of accounting in which revenues are recognized whenearned and expenses are recognized when
incurred.

SECTION III. SHORT ANSWER

1. Explain the difference between internal andexternal users of a corporationâs financial information. Give twoexamples of
internal users and two ofexternal users.

2. How do financial accounting andmanagement accounting differ?

3. What does relevance mean with regard to theuse of accounting information?

4. Briefly explain the purpose of a TrialBalance.

5. Explain briefly the Revenue RecognitionPrinciple. When should a publisher of magazines recognizerevenue?

1. Which of the following identifies the proper order of theaccounting cycle?

A. Analyze, Journalize, Unadjusted Trial Balance

B. Analyze, Post, Unadjusted Trial Balance

C. Journalize, Post, Adjusted Trial Balance

D. Unadjusted Trial Balance, Adjusted Trial Balance, Close

E. Adjusted Trial Balance, Adjustments, Financial Statements

2. Interim financial statements refer to financial reports:

A. That cover less than one year, usually spanning one, three orsix-month periods

B. That are prepared before any adjustments have beenrecorded

C. That show the assets above the liabilities and theliabilities above the equity

D. Where revenues are reported on the income statement when cashis received and expenses are reported when cash is paid

E. Where the adjustment process is used to assign revenues tothe periods in which they are earned and to match expenses withrevenues

3. The accounting principle that requires revenue to be reportedwhen earned is the:

A. Matching principle

B. Revenue recognition principle

C. Time period principle

D. Accrual reporting principle

E. Going-concern principle

4. Adjusting entries:

A. Affect only income statement accounts

B. Affect only balance sheet accounts

C. Affect both income statement and balance sheet accounts

D. Affect only cash flow statement accounts

E. Affect only equity accounts

5. The system of preparing financial statements based onrecognizing revenues when the cash is received and reportingexpenses when the cash is paid is called:

A. Accrual basis accounting

B. Operating cycle accounting

C. Cash basis accounting

D. Revenue recognition accounting

E. Current basis accounting

6. If throughout an accounting period the fees for legalservices paid in advance by clients are recorded in an accountcalled Unearned Legal Fees, the end-of-period adjusting entry torecord the portion of those fees that has been earned is:

A. Debit Cash and credit Legal Fees Earned

B. Debit Cash and credit Unearned Legal Fees

C. Debit Unearned Legal Fees and credit Legal Fees Earned

D. Debit Legal Fees Earned and credit Unearned Legal Fees

E. Debit Unearned Legal Fees and credit Accounts Receivable

7. A company had no office supplies available at the beginningof the year. During the year, the company purchased $250 worth ofoffice supplies. On December 31, $75 worth of office suppliesremained. How much should the company report as office suppliesexpense for the year? A. $75 B. $125 C. $175 D. $250 E. $325 8. OnJanuary 1 a company purchased a five-year insurance policy for$1,800 with coverage starting immediately. If the purchase wasrecorded in the Prepaid Insurance account and the company recordsadjustments only at year-end, the adjusting entry at the end of thefirst year is:

A. Debit Prepaid Insurance, $1,800; credit Cash, $1,800

B. Debit Prepaid Insurance, $1,440; credit Insurance Expense,$1,440

C. Debit Prepaid Insurance, $360; credit Insurance Expense,$360

D. Debit Insurance Expense, $360; credit Prepaid Insurance,$360

E. Debit Insurance Expense, $360; credit Prepaid Insurance,$1,440

9. Unearned revenue is reported on the financial statementsas:

A. A revenue on the balance sheet

B. A liability on the balance sheet

C. An unearned revenue on the income statement

D. An asset on the balance sheet

E. An operating activity on the statement of cash flows

10. Which of the following assets is not depreciated?

A. Store fixtures

B. Computers

C. Land

D. Buildings

E. Vehicles

11. On April 30, 2011, a three-year insurance policy waspurchased for $18,000 with coverage to begin immediately. What isthe amount of insurance expense that would appear on the company'sincome statement for the year ended December 31, 2011? A. $500 B.$4,000 C. $6,000 D. $14,000 E. $18,000 12. Expenses incurred butunpaid that are recorded during the adjusting process with a debitto an expense and a credit to a liability are:

A. Intangible expenses

B. Prepaid expenses

C. Unearned expenses

D. Net expenses

E. Accrued expenses

13 The difference between the cost of an asset and theaccumulated depreciation for that asset is called

A. Depreciation Expense

B. Unearned Depreciation

C. Prepaid Depreciation

D. Depreciation Value

E. Book Value

14. A company purchased a new truck at a cost of $42,000 on July1, 2011. The truck is estimated to have a useful life of 6 yearsand a salvage value of $3,000. How much depreciation expense willbe recorded for the truck for the year ended December 31, 2011?

A. $3,250

B. $3,500

C. $4,000

D. $6,500

E. $7,000

15. A company's Office Supplies account shows a beginningbalance of $600 and an ending balance of $400. If office suppliesexpense for the year is $3,100, what amount of office supplies waspurchased during the period?

A. $2,700

B. $2,900

C. $3,300

D. $3,500

E. $3,700

chocolatereindeer731

I am unsure of what is unclear. The instructions are:

1. Set up a worksheet for the solvency ratios--currentratio and the quick ratio.

2. Compute these ratios for Doctors Smith and Brown. Todo so, you will need one additional piece of information that isnot present on the doctorsâstatements: their maximum annual debt service is$22,200.

Practice Exercise 11âII: Solvency Ratios

Refer to Doctors Smith and Brownâs financial statementspresented in the preceding Chapter 10.

Required

1. Set up a worksheet for the solvency ratios. current ratio and the quick ratio.

The requested information is below:

Exhibit 10-1 Westside Clinic Balance Sheet

Assets	December 31, 20x2		December 31, 20x1

Current Assets
Cash and cash equivalents		$190,000		$145,000
Accounts receivable (net)		250,000		300,000
Inventories		25,000		20,000
Prepaid Insurance		5,000		3,000
Total Current Assets		$470,000		$468,000
Property, Plant, and Equipment
Land	$100,000		$100,000
Buildings (net)	0		0
Equipment (net)	260,000		300,000
Net Property, Plant, and Equipment		360,000		400,000
Other Assets
Investments	$133,000		$32,000
Total Other Assets		133,000		32,000
Total Assets		$963,000		$900,000
Liabilities and Fund Balance
Current Liabilities
Current maturities of long-term debt	$52,000		$48,000
Accounts payable and accruedexpenses	293,000		302,000
Total Current Liabilities		$345,000		$350,000
Long-Term Debt	$252,000		$300,000
Less Current Maturities of Long-Term Debt	?52,000		?48,000
Net Long-Term Debt		200,000		252,000
Total Liabilities		$545,000		$602,000
Fund Balances
Unrestricted fund balance	$418,000		$298,000
Restricted fund balance	0		0
Total Fund Balances		418,000		298,000
Total Liabilities		$963,000		$900,000

Exhibit 10-2 sets out the result of operations for two years,with the most current period in the left column. If the balancesheet is a snapshot, then the statement of revenue and expenses isa diary because it is a record of transactions over the period of ayear. Operating revenues and operating expenses are set out first,with the result being income from operations of $115,000($2,000,000 less $1,885,000). Then other transactions are reported;in this case, interest income of $5,000 under the headingâNonoperating Gains (Losses).â The total of $120,000 ($115,000 plus$5,000) is reported as an increase in fund balance. This figurecarries forward to the next major report, known as the statement ofchanges in fund balance.

STATEMENT OF CHANGES IN FUND BALANCE/NET WORTH

Remember that our formula for a basic statement of revenue andexpense looked like this:

Operating Revenue â Operating Expenses = Operating Income

Exhibit 10-2 Westside Clinic Statement of Revenue andExpenses

	For the Year Ending

Revenue	December 31, 20x2		December 31, 20x1

Net patient service revenue		$2,000,000		$1,850,000
Total operating revenue		$2,000,000		$1,850,000
Operating Expenses
Medical/surgical services	$600,000		$575,000
Therapy services	860,000		806,000
Other professional services	80,000		75,000
Support services	220,000		220,000
General services	65,000		60,000
Depreciation	40,000		40,000
Interest	20,000		24,000
Total operating expenses		1,885,000		1,800,000
Income from Operations		$115,000		$50,000
Nonoperating Gains (Losses)
Interest Income	$5,000		$2,000
Net nonoperating gains		5,000		2,000
Revenue and Gains in Excess of
Expenses and Losses		$120,000		$52,000
Increase in Unrestricted Fund Balance		$120,000		$52,000

The excess of revenue over expenses flows back into equity orfund balance through the mechanism of the statement of fundbalance/net worth. Exhibit 10-3 shows a balance at the first of theyear; then it adds the excess of revenue over expenses (in theamount of $115,000) plus some interest income (in the amount of$5,000) to arrive at the balance at the end of the year.

If you refer back to the balance sheet, you will see the$418,000 balance at the end of the year appearing on it. So we canthink of the balance sheet, the statement of revenue and expenses,and the statement of changes in fund balance/net worth as lockedtogether, with the statement of changes in fund balance being themechanism that links the other two statements.

But there is one more major reportâthe statement of cashflowsâand we will examine it next.

STATEMENT OF CASH FLOWS

To perceive why a statement of cash flows is necessary, we mustfirst revisit the concept of accrual basis accounting. If cash isnot paid or received when revenues and expenses are entered on thebooksâthe usual situation in accrual accountingâwhat happens? Theother side of the entry for revenues is accounts receivable, andthe other side of the entry for expenses is accounts payable. Theseaccounts rest on the balance sheet and have not yet been turnedinto cash. Another characteristic of accrual accounting is therecognition of depreciation. A capital assetâa piece of equipment,for exampleâis purchased for $20,000. It has a usable life of fiveyears. So depreciation expense is recognized in each of the fiveyears until the $20,000 is used up, or depreciated. (Land is anexception to this rule: it is never depreciated.) Depreciation isrecognized within each year as an expense, but it does notrepresent a cash expense. This is a concept that now enters intothe statement of cash flows.

Exhibit 10-4 presents the current period cash flow. In effect,this statement takes the accrual basis statements and converts themto a cash flow for the period through a series of reconcilingadjustments that account for the noncash amounts.

Understanding the cash/noncash concept makes sense of thisstatement. The starting point is the income from operations, thesubtotal from the statement of revenue and expense. Depreciationand interest are added back, and changes in asset and liabilityac-counts, both positive and negative, are recognized. Theseadjustments account for operating activities. Next, capital andrelated financing activities are addressed; then investingactivities are adjusted. The result is a net increase in cash andcash equivalents of $45,000 in our example. This figure is added tothe cash balance at the beginning of the year ($145,000) to arriveat the cash balance at the end of the year ($190,000). Now referback to the balance sheet, and you will find the cash balance isindeed $190,000. So the fourth major reportâthe statement of cashflowsâinterlocks with the other three major reports.

Exhibit 10-3 Westside Clinic Statement of Changes in FundBalance

	For the Year Ending

Statement of Changes in Fund Balance	December 31, 20x2	December 31, 20x1

Balance First of Year	$298,000	$246,000
Revenue in Excess of Expenses	115,000	50,000
Interest Income	5,000	2,000
Balance End of Year	$418,000	$298,000

Exhibit 10-4 Westside Clinic Statement of Cash Flows

Statement of Cash Flows	For the Year Ending

	December 31, 20x2		December 31, 20x1

Operating Activities
Income from operations		$115,000		$50,000
Adjustments to reconcile income from
operations to net cash flows from
operating activities
Depreciation and amortization		40,000		40,000
Interest expense		20,000		24,000
Changes in asset and liabilityaccounts
Patient accountsreceivable		50,000		â250,000
Inventories		â5,000		â5,000
Prepaid expenses andother assets		â2,000		â1,000
Accounts payable andaccrued expenses		â9,000		185,000
Net cash flow from operating activities		$209,000		$43,000
Cash Flows from Noncapital Financing Activities		0		0
Cash Flows from Capital and Related Financing ActivitiesAcquisition of equipment	$ 0		$(300,000)
Proceeds from loan for equipment	0		300,000
Interest paid on long-term obligations	â20,000		0
Repayment of long-term obligations	â48,000		0
Net cash flows from capital and related financing activities		â68,000		0
Cash Flows from Investing Activities
Interest income received	$5,000		$2,000
Investments purchased (net)	â 101,000		0
Net cash flows from investing activities		â96,000		2,000
Net Increase (Decrease) in Cash and Cash Equivalents		$45,000		$45,000
Cash and Cash Equivalents, Beginning of Year		145,000		100,000
Cash and Cash Equivalents, End of Year		$190,000		$145,000

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LEGL-180 Lecture Notes - Lecture 4: Accounts Payable, Accrual, Accounts Receivable

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