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1、A.Measuring Business Income a.explain why financial statements are prepared at the end of the regular accounting period.Major Financial Statements:The balance sheet:provides a snapshot of the firms financial condition.The income statement:reports on the performance of the firm.The statement of cash
2、flows:reports the cash receipts and cash outflows classified according to operating,investment and financing activities.The statement of stockholders equity:reports the amounts and sources of changes in equity from transactions with owners.The footnotes of the financial statements:allow uses to impr
3、ove assessment of the amount,timing and uncertainty of the estimates reported in the financial statements.The most accurate way to measure the results of enterprise activity would be to measure them at the time of the enterprises eventual liquidation.Business,government,investors,and various other u
4、ser groups,however,cannot wait indefinitely for such information.If accountants did not provide financial information periodically,someone else would.The periodicity or time period assumption simply implies that the economic activities of an enterprise can be divided into artificial time periods.The
5、se time periods vary,but the most common are monthly,quarterly,and yearly.The information must be reliable and relevant.This requires that information must be consistent and comparable over time and also be provided on a timely basis.The shorter the time period,the more difficult it becomes to deter
6、mine the proper net income for the period.A months results are usually less reliable than a quarters results,and a quarters results are likely to be less reliable than a years results.Investors desire and demand that information be quickly processed and disseminated;yet the quicker the information i
7、s released,the more it is subject to error.This phenomenon provides an interesting example of the trade-off between relevance and reliability in preparing financial data.In practice,financial reporting is done at the end of the accounting period.Accounting periods can be any length in time.Firms typ
8、ically use the year as the primary accounting period.The 12-month accounting period is referred to as the fiscal year.Firms also report for periods less than a year(e.g.quarterly)on an interim basis.Accounting period must be of equal length.Financial statements are prepared at the end of the regular
9、 accounting period to allow comparison across time.User Comments Posted by Jeanette 2003-10-25 14:15:45.same period-allow comparision basic assumption in preparing financial statements is-the firm will continue in operation,-going concern,assigning revenue-expenses-base on matching principle Posted
10、by GiGi 2004-01-29 06:25:01.remember that there are 4 types of financial statements b.explain why the accounts must be adjusted at the end of each period.Why?Most external transactions are recorded when they occur.The employment of an accrual system means that numerous adjustments are necessary befo
11、re financial statements are prepared because certain accounts are not accurately stated.Some external transactions might not even seem like transactions and are recognized only at the end of the accounting period.Examples include unrecorded revenues and credit purchase.Some economic activities do no
12、t occur as the result of external transactions.Examples include depreciation and the expiration of prepaid expenses.Timing:Often a transaction affects the revenue or expenses of two or more accounting periods.The related cash inflow or outflow does not always coincide with the period in which these
13、revenue or expense items are recorded.Thus,the need for adjusting entries results from timing differences between the receipt or disbursement of cash and the recording of revenue or expenses.For example,if we handle transactions on a cash basis,only cash transactions during the year are recorded.Con
14、sequently,if a companys employees are paid every two weeks and the end of an accounting period occurs in the middle of these two weeks,neither liability nor expense has been recorded for the last week.To bring the accounts up to date for the preparation of financial statements,both the wage expense
15、and the wage liability accounts need to be increased.A necessary step in the accounting process,then,is the adjustment of all accounts to an accrual basis and their subsequent posting to the general ledger.Adjusting entries are therefore necessary to achieve a proper matching of revenues and expense
16、s in the determination of net income for the current period and to achieve an accurate statement of the assets and equities existing at the end of the period.Adjustment principles The revenue recognition principle The matching principle What to adjust?Each adjusting entry affects both a real account
17、(assets,liability,or owners equity)and a nominal or income statement account(revenue or expense).The four basic types of adjusting entries are:1.deferred expenses that benefits more than one period:for example,prepaid expenses(e.g.prepaid insurance,rent)are expenses paid in advance and recorded as a
18、ssets before they are used or consumed.When these assets are consumed,expenses should be recognized:a debit to an expense account and a credit to an asset account.Another example is depreciation.The cost of a long-term asset is allocated as an expense over its useful life.At the end of each period d
19、epreciation expense is recorded through an adjusting entry:a debit to a depreciation expense account and a credit to an accumulated depreciation account(a contra account used to total the past depreciation expenses on specific long-term assets).2.accrued expenses that incurred but not yet paid or re
20、corded:examples are employee salaries and interest on borrowed money.At the end of the accounting period,the accrued expense is recorded through an adjusting entry:a debit to an expense account(i.e.Salaries Expense)and a credit to a liability account(i.e.Salaries Payable).3.accrued revenues that ear
21、ned but not yet received or recorded:also called unrecorded revenues.Examples include interest revenues,rent revenues,etc.Such revenues accumulate with the passing of time,but the firm may have not received the payment or billed the client.An adjusting entry should be:a debit to an asset account(i.e
22、.Accounts Receivable)and a credit to a revenue account(i.e.Interest Revenue).4.unearned revenues that are revenues received in cash before delivery of goods/services:examples are magazine subscription fees,customer deposits for services.These revenues are not earned yet and thus should be recorded a
23、s liabilities.An adjusting entry should be:a debit to a liability account(i.e.Unearned Revenue)and a credit to a revenue account(i.e.Revenue).User Comments Posted by GiGi 2004-01-29 06:26:22.accrual system!definition Posted by Gina 2004-02-03 22:17:33.accrual based accounting recognizes the impact o
24、f a business event as it occurs,regardless of whether transaction affected cash Posted by Gina 2004-02-03 22:20:20.Revenue Principle:basis for recording revenues(ie tells when to record revenue and the amounts).Matching Principle:basis for recording expensis(ie direction to ID all expenses during th
25、e period,measure them,and match them against the revenues earned in that period).c.explain why the accrual basis of accounting produces more useful income statements and balance sheets than the cash basis.Revenue is something earned through the sale of goods or services.Not all cash receipts are rev
26、enues;for example,cash received through a loan is not revenue.Expenses are the cost of goods or services used to generate revenues.Not all cash payments are expenses;for example,cash dividends paid to stockholders are not expenses.Net income is the difference between revenues and expenses.It is repo
27、rted on the income statement,and is the focus in evaluating a firms profitability.Most companies use the accrual basis accounting,recognizing revenue when it is earned(the goods are sold or the services performed)and recognizing expenses in the period incurred,without regard to the time of receipt o
28、r payment of cash.Net income is revenue earned minus expenses incurred.Under the strict cash basis accounting,revenue is recorded only when the cash is received and expenses are recorded only when the cash is paid.Net income is cash revenue minus cash expenses.The matching principle is ignored here,
29、resulting inconformity with generally accepted accounting principles.Todays economy is considerably more lubricated by credit than by cash.And the accrual basis,not the cash basis,recognizes all aspects of the credit phenomenon.Investors,creditors,and other decision makers seek timely information ab
30、out an enterprises future cash flows.Accrual basis accounting provides this information by reporting the cash inflows and outflows associated with earnings activities as soon as these cash flows can be estimated with an acceptable degree of certainty.Receivables and payables are forecasters of futur
31、e cash inflows and outflows.In other words,accrual basis accounting aids in predicting future cash flows by reporting transactions and other events with cash consequences at the time the transactions and events occur,rather than when the cash is received and paid.Accrual accounting generally provide
32、s a better indication of performance than cash basis of accounting since it increases the comparability of income statements and balance sheets across periods.B.Financial Reporting and Analysis a.define each asset and liability category on the balance sheet and prepare a classified balance sheet.Thi
33、nk of the balance sheet as a photo of the business at a specific point in time.It presents the assets,liabilities,and the equity ownership of a business entity as of a specific date.Assets are the economic resources controlled by the firm.Liabilities are the financial obligations that the firm must
34、fulfill in the future.Liabilities are typically fulfilled by payment of cash.They represent the source of financing provided to the firm by the creditors.Equity Ownership is the owners investments and the total earnings retained from the commencement of the firm.Equity represents the source of finan
35、cing provided to the firm by the owners.Balance sheet accounts are classified so that similar items are grouped together to arrive at significant subtotals.Furthermore,the material is arranged so that important relationships are shown.The table below indicates the general format of balance sheet pre
36、sentation:Balance Sheet Classifications Assets Liabilities and Owners Equity Current Assets Current liabilities Long-term investments Long-term debt Property,plan and equipment Owners equity Intangible assets Capital stock Other assets Additional paid-in capital Retained earnings Current Assets:They
37、 are cash and other assets expected to be converted into cash,sold,or consumed either in one year or in the operating cycle,whichever is longer.The operating cycle is the average time between the acquisition of materials and supplies and the realization of cash through sales of the product for which
38、 the materials and supplies were acquired.The cycle operates from cash through inventory,production,and receivables back to cash.Where there are several operating cycles within one year,the one-year period is used.If the operating cycle is more than one year,the longer period is used.Current assets
39、are presented in the balance sheet in order of liquidity.The five major items found in the current asset section are:Cash:valued at its stated value.Cash restricted for purpose other than payment of current obligations or for use in current operations should be excluded from the current asset sectio
40、n.Marketable securities:Also referred to as marketable securities.Valued at cost or lower of cost and market.Accounts receivables:amounts owed to the firm by its customers for goods and services delivered.Valued at the estimated amount collectible.Inventories:Products that will be sold in the normal
41、 course of business.Prepaid expenses:they are expenditures already made for benefits(usually services)to be received within one year or the operating cycle,whichever is longer.Typical examples are prepaid rent,advertising,taxes,insurance policy,and office or operating supplies.They are reported at t
42、he amount of un-expired or unconsumed cost.Long-Term Investments:Often referred to simply as investments,they are to be held for many years,and are not acquired with the intention of disposing of them in the near future.Investments in securities such as bonds,common stock,or long-term notes that man
43、agement does not intend to sell within one year.Investments in tangible fixed assets not currently used in operations,such as land held for speculation.Investments set aside in special funds such as a sinking fund,pension fund,or plant expansion fund.The cash surrender value of life insurance is inc
44、luded here.Investments in non-consolidated subsidiaries or affiliated companies.Property,Plant,and Equipment:They are properties of a durable nature used in the regular operations of the business.With the exception of land,most assets are either depreciable(such as building)or consumable.Intangible
45、Assets:They lack physical substance and usually have a high degree of uncertainty concerning their future benefits.They include patents,copyrights,franchises,goodwill,trademarks,trade names,secret processes,and organization costs.Generally,all of these intangibles are written off(amortized)to expens
46、e over 5 to 40 years.Other Assets:They vary widely in practice.Examples include deferred charges(long-term prepaid expenses),non-current receivables,intangible assets,assets in special funds,and advances to subsidiaries.Current Liabilities:They are obligations that are reasonably expected to be liqu
47、idated either through the use of current assets or the creation of other current liabilities within one year or within the operating cycle,whichever is longer.They are not reported in any consistent order.A typical order is:Notes payable,accounts payable,accrued items(e.g.accrued warranty costs,comp
48、ensation and benefits)income taxes payable,current maturities of long-term debt,etc.The excess of total current assets over total current liabilities is referred to as working capital.It represents the net amount of a companys relatively liquid resources;that is,it is the liquid buffer,or margin of
49、safety,available to meet the financial demands of the operating cycle.Long-Term Liabilities They are obligations that are not reasonably expected to be liquidated within the normal operating cycle but,instead,at some date beyond that time.Bonds payable,notes payable,deferred income taxes,lease oblig
50、ations,and pension obligations are the most common long-term liabilities.Generally they are of three types:Obligations arising from specific financing situations,such as issuance of bonds,long-term lease obligations,and long-term notes payable.Obligations arising from the ordinary operations of the