Fundamentals of Financial Accounting

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1 Fundamentals of Financial Accounting CHAPTER I Accounting in action. What is accounting? Accounting is the recording of financial transactions plus storing, sorting, retrieving, summarizing, and presenting the information in various reports and analyses. Accounting is also a profession consisting of individuals having the formal education to carry out these tasks. Accounting consist of 3 basics activity Identifies Records Communicates The building boxes of accounting Effective financial reporting depends on sound ethical behavior. To sensitize you to ethical situation in business and to give you practice at solving ethical dilemmas, we address ethics in a number of ways in this book: Ethics in Financial Reporting A number of the Feature Stories discuss the central importance of ethical behavior to financial reporting Ethics insight boxes and marginal Ethics Notes highlight ethics situations and issues in actual business settings Many of the People, Planet, and Profit Insight boxes focus on ethical issues that companies face in measuring and reporting social and environmental issues Ethics case simulates a business situation and asks you to put yourself in the position of a decision-maker in that case. Accounting Standards International Accounting Standards Board (IASB) Financial Accounting Standard Board (FASB) Measurement Principles Historical Cost Principle Fair Value Principle Assumptions Monetary Unit Assumption Economic Entity Assumption Proprietorship Partnership Corporation

2 The Basic Accounting Equation Assets = Liabilities + Equity Asset Liabilities Equity Equipment, Land, Supplies, Cash Interest payable, Salaries payable, Accounts payable, Notes payable Salaries expense, Services expense, Retained earnings, Share Capital-Ordinary Increases Investments by shareholders Decreases Dividends to shareholders Equity Revenue Expenses Transaction Analysis Transaction Analysis is the process of reconciling the differences made to each side of the equation with each financial transaction occurs. Let s look at some sample transactions to get a better understanding of how the analysis and equation work. 1. A transaction that decreases total assets must also decrease total liabilities or equity. 2. A transaction that increases total assets must also increase total liabilities or equity. 3. Some transactions may increase one account and decrease another on the same side of the equation i.e. one asset increases and another decreases. Assets = Liabilities + Equity and - Assets = Liabilities + Equity Share Capital-Ordinary + Retained Earnings Revenues - Expenses - Dividends

3 The accounting equation for a brand new company will look like this: Assets = Liabilities + Equity $0 $0 $0 Transaction 1: The owner deposits $5000 in the checking account to begin operations Assets = Liabilities + Equity +$5000 $0 + $5000 The asset Cash is increased by $5000 and the Owner s Equity is increased $5000. The business owes the owner $5000. Transaction 2: The business purchases a computer, on credit, for $2500. Assets = Liabilities + Equity +$2500 +$2500 $ The asset Computers is increased by $2500 and the liability is also increased $2500 because the business now owns the store $2500. Transaction 3: The business purchases office supplies using $550 cash. Assets = Liabilities + Equity +$550 -$550 The asset Office Supplies is increased $550 and the asset Cash is decreased $550. Transaction 4: A business purchases a building for $100,000 with a $25,000 cash down-payment and a loan for the $75,000 outstanding. Assets = Liabilities + Owner s Equity +$100, ,000 -$25,000 Transaction 5: The business sells goods for $1,200 cash. Assets = Liabilities + Owner s Equity +$1200 +$1200 (Revenue) The asset Cash is increased $1200 and the revenue increases Owner s Equity $1200. Transaction 6: The business pays its rent monthly rent of $950 using a company check. Assets = Liabilities + Owner s Equity -$950 -$950 (Expense) The asset Cash is decreased $950 and the expense decreases Owner s Equity $950. Transaction 7: The business owner withdraws $2,000 for his personal use.

4 Assets = Liabilities + Owner s Equity -$1200 -$1200 (Revenue) The asset Cash is decreased $2000 and the drawing decreases Owner s Equity $2000. Financial Statements Income Statement Retained Earnings Statement Statement of Financial Position Statement of Cash Flows

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6 CHAPTER II The Recording Process The Account Debits and Credits Account Name Debit/Dr. Credit/Cr. T-account form If debit amounts are greater than Credit amounts, the account will have a debit balance Account Name Debit/Dr. Credit/Cr. $10,000 8,000 $3,000 balance $15,000 If debit amounts are less than Credit amounts, the account will have a credit balance Account Name Debit/Dr. Credit/Cr. $10,000 $3,000 8,000 balance $1,000 Assets Debits should exceed credits Liabilities Credits should exceed debits Normal balance is on the increase side Share capital and revenues increase equity (credit) Dividends and expenses decrease equity (debit) Step in the Recording Process 1. Analyze each transaction for its effects on the accounts. 2. Enter the transaction information in a journal. 3. Transfer the journal information to appropriate accounts in ledger. The Journal General Journal J1 Date Account Titles and Explanation Ref. Debit Credit 2015 Jan. 1 Cash 2 15, Share Capital-Ordinary 15,000 (Issues shares for cash) 4 Equipment 7,000 Cash 7,000 (Purchased equipment for cash)

7 The date of the transaction. The debit account title is entered first. The credit account title is indented and entered on next line. A brief explanation of transaction appears on the line below the credit account title. The column titled Reference is left blank when the journal entry is made. The ledger General Journal J1 Date Account Titles and Explanation Ref. Debit Credit 2015 Jan. 1 Cash Share Capital-Ordinary (Issues shares for cash) ,000 15,000 General Ledger No.101 Date Explanation Ref. Debit Credit Balance 2015 Jan. 1 J1 15,000 15,000 Trial balance

8 Prepaid expense Chapter III Adjusting the accounts Ex. On Oct1, 2013, paid $12,000 for one year rent. Accounting period is one year Journal Entry: Oct1 : Prepaid Rent 12,000 Cash 12,000 On Dec31, 3 months expenses have been incurred. Therefore, Adjusting Entry: Dec31 : Rent expense 3,000 12,000/12 *3 Prepaid Rent 3,000 Unearned Revenue Ex. On Nov1, 2013, Received $3,000 in advance for one year from a customer for services to be rendered in the future. Accounting period is one year,2013 Journal Entry Nov1 : Cash 3,000 Unearned Revenue 3,000 On Dec31, 2months revenues have been earned. Therefore, Adjusting Entry: Dec 31: Unearned Revenue 500 Service Revenue 500 A liability-revenue account relationship exists with unearned revenues. Accrued Revenue (note receivable) interest. Ex. On Nov1, 2013, Sun Co rendered services for $3,000 to a customer and received a 12%, 3month note. Journal Entry: Nov1: Notes Receivable 3,000 Service Revenue 3,000 2 months interest (Nov&Dec) is accrued revenue (2 months because 2 month is another year) Adjusting Entry: Dec 31: Interest Receivable 60 3,000*(12/100)*(2/12) Interest Revenue 60 Summary of the adjusting entries Debit Credit 1. Prepaid Expense 2. Supplies Expense Prepaid Expense 3. Unearned Revenue Supplies Expense Supplies

9 4. Accrued Revenue 5. Accrued Expense Unearned Revenue Service Revenue Accrued Receivable Service Revenue Expense Payable 6. Depreciation Expense Accumulated Depreciation Equipment 7. Interest on a Notes receivable Interest Receivable Interest Revenue 8. Interest on a Notes Payable Interest Expense Interest Payable Ex. The Ledger of Villa Rental Agency on March 31 of the current year includes the selected accounts, shown below, before adjusting entries have been prepared. Analysis of the accounts shows the following. 1. The equipment depreciates $300 per month. : answer is depreciation expense 2. One-third of the unearned rent revenue was recognized during the quarter. 3. Interest of $500 is accrued on the notes payable. 4. Supplies on hand total $ Insurance expires at the rate of $200 per month.: expired = using up

10 **Explanation of 1. Have to multiple by 3 because in the first month of year 2013 is January February and in the end of March so have to multiple by , have to multiple by 13 because of the word quarter because $200 is per month but this problem is 3 months.

11 Chapter IV Completing the accounting Cycle This chapter is about how to make worksheet, income statement, retained earnings statement, statement of financial position and closing entries. This have the fixed pattern as follow Worksheet Name of company Worksheet For the.... Ended Retained Earnings Statement Income Statement

12 Statement of Financial Position

13 Correction Entry If the question give your debit and credit if it wrong you have to put it in opposite side such as wrong is debit when you do the correct you should put it on credit. Ex. Joshua Company discovered the following errors made in Jan A payment of salaries and wages expense of $700 was debited to equipment and credited to cash, both for $700 Correct

14 Ex. The trial balance of Midas Company at December 31, the end of the company s fiscal year is shown on the work sheet: Adjustment data: 1. Depreciation is $10,000 on buildings and $9,000 on equipment 2. Interest of $5,000 is due and unpaid on notes payable at December Journalize the closing entries. Instructions: 1. Complete the worksheet. 2. Prepare a multiple-step income statement, a retained earnings statement and state of financial position at December31. ********** The Work Sheet Answer in another file*********

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17 Journal Entries for the Buyer: Chapter V Accounting for Merchandising Operations Journal Entries for the Seller: ***Note: FOB Shipping Point = Buyer have to pay FOB Destination = Seller have to pay

18 Ex. The trial balance of Midas Company at December 31, the end of the company s fiscal year is shown on the work sheet: Adjustment data: 1.Depreciation is $10,000 on buildings and $9,000 on equipment 2. Interest of $5,000 is due and unpaid on notes payable at December 3.Journalize the closing entries. Instructions: 3. Complete the worksheet. 4. Prepare a multiple-step income statement, a retained earnings statement and state of financial position at December31. **Interpret the adjustment data 1. Depreciation exp-build 10,000 Accumulated dep-build 10,000 Depreciation exp-equipment 9,000 Accumulated dep-equipment 9, Interest expense 5, Ending balance = 88,900 Interest payable 5,000 = 90,000 Cost of goods sold 1,100

19 Classifying Inventory Merchandising Company Inventory Manufacturing Company Raw Materials Work in Process Finished Goods Determining Inventory Quantities Perpetual System Periodic System Taking a Physical Inventory Determining Ownership of Goods Chapter VI Inventory Purchased goods not yet received Sold goods not yet delivered Inventory Costing Specific Identification First-In, First-Out (FIFO) Average-cost How to compute the cost of goods sold? Example Use the following information to calculate the value of inventory on hand on Mar 31 and cost of goods sold during March in FIFO periodic inventory system and under FIFO perpetual inventory system. Mar 1 Beginning Inventory 68 $15.00 per unit 5 Purchase 140 $15.50 per unit 9 Sale 94 $19.00 per unit 11 Purchase 40 $16.00 per unit 16 Purchase 78 $16.50 per unit 20 Sale 116 $19.50 per unit 29 Sale 62 $21.00 per unit Cost Flow Assumptions Cost of goods sold = Beginning Inventory + Purchases Ending Inventory Average Unit cos = Cost of beginning inventory + Cost of purchases Units in beginning inventory + Units purchased

20 Solution FIFO Periodic Units Available for Sale = = 326 Units Sold = = 272 Units in Ending Inventory = = 54 Cost of Goods Sold Units Unit Cost Total Sales From Mar 1 Inventory 68 $15.00 $1,020 Sales From Mar 5 Purchase 140 $15.50 $2,170 Sales From Mar 11 Purchase 40 $16.00 $640 Sales From Mar 16 Purchase 24 $16.50 $ $4,226 Ending Inventory Units Unit Cost Total Inventory From Mar 16 Purchase 54 $16.50 $891 FIFO Perpetual Purchases Sales Balance Date Units Unit Cost Total Units Unit Cost Total Units Unit Cost Total Mar 1 68 $15.00 $1, $15.50 $2, $15.00 $1, $15.50 $2, $15.00 $1, $15.50 $1, $15.50 $ $16.00 $ $15.50 $1, $16.00 $640

21 16 78 $16.50 $1, $15.50 $1, $16.00 $ $16.50 $1, $15.50 $1, $16.00 $608 2 $16.00 $32 78 $16.50 $1, $16.00 $ $16.50 $ $16.50 $396 Lower-of-Cost-or-Net Realizable Value Lower-of-Cost-or- Cost Net Realizable Value Net Realizable Value Flat-screen TVs $60,000 $55,000 $55,000 Satellite radios 45,000 52,000 45,000 DVD recorders 48,000 45,000 45,000 DVDs 15,000 14,000 14,000 Total inventory $159,000

22 Chapter IV Fraud, Internal Control and Cash Fraud Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. Internal Control o Methods and measures adopted to: Safeguard assets. Enhance accuracy and reliability of accounting records. Increase efficiency of operations. Ensure compliance with laws and regulations. Principles of Internal Control Activities Physical Controls

23 Independent Internal Verification Cash Receipts Controls Over-the-Counter Receipts Mail Receipts

24 Example : Permitting only designated personnel to handle cash receipts is an application of the principle of: a. segregation of duties. b. establishment of responsibility. c. independent check. d. other controls Cash Disbursements Controls Voucher system Petty cash fund Example: Assume that on March 15 Zhu s petty cash custodian requests a check for NT$2,610. The fund contains NT$390 cash and petty cash receipts for postage NT$1,320, freight-out NT$1,140, and miscellaneous expenses NT$150. The general journal entry to record the check is: Mar. 15 Postage expense 1,320 Freight-out expense 1,140 Miscellaneous expense 150 Bank Code Numbers Control Features: Use of a Bank Use of a Bank (Deposits) Cash 2,610 Front Side Reverse Side

25 Use of a Bank (Checks) Maker Payee Payer Debit Memorandum Bank service charge. NSF (not sufficient funds). Credit Memorandum Collect notes receivable. Interest earned Bank Statements

26 Reconciliation Procedures + Deposit in Transit - Outstanding Checks +/- Bank Errors + Notes collected by bank (CM) - NSF (bounced) checks (DM) - Check printing or other service charges (DM) +/- Book Errors CORRECT BALANCE CORRECT BALANCE Example : The bank statement for Laird Company, in Illustration 7-10, shows a balance per bank of 15, on April 30, On this date the balance of cash per books is 11, Using the four reconciliation steps, Laird determines the following reconciling items. Step 1. Deposits in transit: April 30 deposit (received by bank on May 1). 2, Step 2. Outstanding checks: No. 453, 3,000.00; no. 457, 1,401.30; no. 460, 1, , Step 3. Errors: Laird wrote check no. 443 for 1, and the bank correctly paid that amount. However, Laird recorded the check as 1, Step 4. Bank memoranda: a. Debit NSF check from J. R. Baron for b. Debit Charge for printing company checks c. Credit Collection of note receivable for 1,000 plus interest earned 50, less bank collection fee ,035.00

27 Prepare a bank reconciliation at April 30. Cash balance per bank statement 15, Add: Deposit in transit 2, Less: Outstanding checks (5,904.00) Adjusted cash balance per bank 12, Cash balance per books 11, Add: Error in check No Less: NSF check (425.60) Less: Bank service charge (30.00) Add: Collection of notes receivable 1, Adjusted cash balance per books 12,204.85

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