Free «Accounting Summary» Essay
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The first learning objective in this chapter is to understand the difference between accrual accounting and cash-basis accounting. Accrual accounting records the impact of transactions immediately they occur while cash-basis accounting records cash transactions only. Additionally, accrual accounting is conditional to the Generally Accepted Accounting Principles (GAAP) unlike the cash-basis accounting which ignores these standards. Moreover, the accrual concept recognizes revenue and expenses when they occur (regardless of when money changes hands) and records both cash and non-cash transactions, unlike the cash-basis concept that only recognizes cash transactions when cash is received (revenues) and when paid (expenses).
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The revenue recognition principle states that revenue is only recorded when the title of goods has passed to the customer. However, the amount of money recorded is the cash value of the goods or services transferred to customers, for instance sales discounts. The Expenses recognition principle states that the expenses are the costs incurred in the process of earning revenue and have no future benefits. Expenses recorded are those that have been incurred. They are recognized along with the related revenues which are known as the matching principle.
Accounting information is recorded on different intervals that mainly include a basic accounting period of one year; the calendar year lasts between January 1 to December 31 and the fiscal year is a 12 month period that ends on a date other than December 31. At the end of a financial year, several accounts need to be updated, since certain transactions have occurred but not recorded for presentation in the financial statements. This is because accounting activities have to be analyzed and adjustments made on the trial balance to conform to accrual accounting. These adjustments include deferrals where a business has paid or received cash in advance. The unearned revenue is recorded as a liability when payment is received e.g. subscription revenue. On the other hand, prepaid expenses are recorded as assets when purchased e.g. prepaid insurance, supplies and rent.
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Suppose a company pays 3 month $1000 monthly rent in advance on June 1st and purchased $700 of supplies on June 2nd, the appropriate entries would be debiting the prepaid rent ledger with $3000 and crediting the cash ledger with the same amount. Additionally, the supplies and cash ledgers will be debited and credited with $700 respectively. When prepaid expenses are expensed, whether expired or used, the expired portion of the rent should be written off through debiting the rent expenses ledger and crediting the prepaid rent ledgers with the amount expired.
Unearned Revenue creates a liability for a firm before a good or service is transferred because revenue should not be recorded until it is earned. Suppose a customer pays for 6 month advanced subscription for a magazine on July 1 and the publisher receives payment on June 15. The journal entries include debiting and crediting the cash and unearned revenue ledgers with $4800 respectively. When the publisher mails the first issue of the magazine, they record one sixth of the revenue earned by debiting the unearned revenue and crediting the subscription revenue ledgers.
Depreciation is the process of allocating the cost of assets as expenses over their useful lives. Depreciation is similar to a prepaid expense but is regarded as long-term. Suppose equipment with a 6 year useful life is purchased for $24000, the corresponding journal entries will include debiting and crediting the equipment and accounts payable ledgers with the purchase price respectively. Additionally, an annual depreciation expense of $400 ($24000/60) will be debited in the depreciation expense ledger and credited in the accumulated depreciation ledger.
Accruals refer to situations where businesses receive good/services without paying for them in cash or earn revenue without collecting the cash. For instance, accrued salaries for the present month due to be paid in the following month is recorded by debiting the salaries expense ledger and crediting the salary payable ledger. In case of accrued revenues where half of the revenue is earned, the company debits the Accounts receivable ledger and credit the service revenue ledger with the portion earned.
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Chapter Four: Internal Control and Cash
Fraud is the intentional misrepresentation of factual information that can cause damage to another party or a company. There are two types of fraud that include misappropriation of assets, which is the most common, and fraudulent financial reporting by managers. The latter is done mainly as a consequence of pressure to produce results in most expensive and cash based departments such as sales departments. The fraud triangle contains three elements that include motive, rationalization and opportunity which are primarily caused by weak internal controls.
Prevention is the best form of internal control as it thwarts fraudulent activities before they occur. The Sarbanes-Oxley Act is a federal law that requires public companies to adopt systems for internal controls. This provision requires presentation of internal control reports, creation of oversight boards and limiting non-audit services provided by audit firms. The control environment begins with owners and managers acting ethically. Key components include prohibitions against giving or taking bribes and kickbacks from customers and suppliers, engaging in interactions that do not raise conflict of interest issues and provisions that encourage corporate social responsibility and good citizenship.
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The information system must capture, process and report all transactions accurately and timely. For example, all information that should be recorded in the current year’s income statement should be accurately presented on time in the appropriate financial period for tax purposes. Internal control procedures include separation of duties, running comparison and compliance monitoring. Separation of duties refers to involving different personnel in running different operational and operation oversight activities that cannot be done by a single individual. In compliance monitoring, a company can operate cash budgets by management seeking board members approval before the implementation of budgets.
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Safeguard controls that could be implemented in a company as part of internal controls include fireproof vaults, security cameras, mandatory vacations and job rotation. However, good internal controls can be circumvented at times through collusion; conspiracy in the work place between two or more people, management override of the systems and negligence. Additionally, the systems and controls might prove ineffective if the benefits outweigh the costs. For instance, if a company aims to establish high end security control systems, it will have to incur high capital outlay that might not be recovered quickly.
Bank reconciliation is the process of settling the difference between the bank statements and cashbook records. Bank statement setbacks include deposits in transit, outstanding checks and bank errors while cashbook errors include bank collections required to be deposited but still kept in cash till. For instance: Frank White receives a bank statement that has a closing balance of $570. The statement includes EFT collections of $335, service and printed checks charge of $18 and two NSF checks totaling $120. Upon reviewing his cashbook, Mr. White identifies a deposit in transit of $1765 and an outstanding check of $601.
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The reconciliation necessary in this case include adding the rent collection amount to the recorded cashbook balance of $1780. Additionally, the reconciliation process will include subtracting the total service charge, NSF checks and correction of errors figures to get the correct cash balance of $1734. In journalizing bank reconciliation items, all items added in the book side is debited and vice versa. For example, in the event a check is returned by the bank, the accounts receivable ledger is debited since the debtor is still active because his check has not been processed.