Accounts Payable 10, CR. Naturally, journal entries need to be made for income statement transactions as well. For the most part, when making a journal entry to a revenue account, we use a credit, and when making an entry to an expense account, we use a debit.
We need to decrease Cash and increase Rent Expense. Rent Expense 4, CR. Cash 10, CR. Sales 10, Sometimes a transaction will require two journal entries. Cash 1, CR. Sales 1, DR.
Cost of Goods Sold CR. Of course, hardly anybody uses an actual paper document for a general ledger anymore. T-Accounts In many situations, it can be useful to look at all the activity that has occurred in a single account over a given time period. The Trial Balance A trial balance is simply a list indicating the balances of every single general ledger account at a given point in time. The trial balance is typically prepared at the end of a period, prior to preparing the primary financial statements.
The purpose of the trial balance is to check that debits—in total—are equal to the total amount of credits. If debits do not equal credits, you know that an erroneous journal entry must have been posted. The purpose of a trial balance is to check that total debits equal total credits.
Her lease requires her to prepay her rent for the next 3 months at the beginning of every quarter. For example, in April, she is required to pay her rent for April, May, and June. If Pam uses the cash method of accounting, her net income in April will be substantially lower than her net income in May or June, even if her sales and other expenses are exactly the same from month to month. This is, of course, a distortion of the reality. The Accrual Method Under the accrual method of accounting, revenue is recorded as soon as services are provided or goods are delivered, regardless of when cash is received.
Note: This is why we use an Accounts Receivable account. Similarly, under the accrual method of accounting, expenses are recognized as soon as the company receives goods or services, regardless of when it actually pays for them. Accounts Payable is used to record these as-yet-unpaid obligations. The goal of the accrual method is to fix the major shortcoming of the cash method: Distortions of economic reality due to the frequent time lag between a service being performed and the service being paid for.
On the 5th of every month, he pays his sales reps their commissions for sales made in the prior month. First, because Mario uses the accrual method, the expense is recorded when the services are performed, regardless of when they are paid for.
This ensures that any financial statements for the month of August reflect the appropriate amount of Commissions Expense for sales made during the month. Second, after both entries have been made, the net effect is a debit to the relevant expense account and a credit to Cash. Last point of note: Commissions Payable will have no net change after both entries have been made. Its only purpose is to make sure that financial statements prepared at the end of August would reflect that—at that particular moment—an amount is owed to the sales reps.
Because Lindsey uses the accrual method, she must record the interest expense over the life of the loan, rather than recording it all at the end when she pays it off. Naturally, there are occasions in which the opposite situation arises. Again, the goal of the accrual method is to record the revenues or expenses in the period during which the real economic transaction occurs as opposed to the period in which cash is exchanged.
Of course, the process will start all over again on July 1st when Pam prepays her rent for the third quarter of the year. Then, they will record the revenue month by month.
This seems obvious, but there are times in which it would appear reasonable for a company to report an asset at a value other than the amount paid for it. For example, if a company has owned a piece of real estate for several decades, reporting the piece of land at its historical cost may very significantly understate the value of the land. However, if GAAP allowed companies to use any other valuation method—current market value for instance—it would introduce a great deal of subjectivity into the process.
To use the example of real estate again: Depending upon what method you use or who you ask, you could find several different answers for the fair market value of a piece of real estate.
The reason for using such a flawed assumption is that the benefit gained from adjusting the value of assets on a regular basis to reflect inflation would be far outweighed by the cost in both time and money of requiring companies to do so. Matching Principle According to GAAP, the matching principle dictates that expenses must be matched to the revenues that they help generate, and recorded in the same period in which the revenues are recorded.
This concept goes hand-in-hand with the concept of accrual accounting. Similarly, it is the matching principle that dictates that if a company purchases an asset that is expected to provide benefit to the company for multiple accounting periods a desk, for instance , the cost of the asset must be spread out over the period for which it is expected to provide benefits.
However, due to its objective nature, historical cost is generally used when reporting the value of assets under GAAP. This is known as the monetary unit assumption. This is known as the entity concept or entity assumption. Rather, the cost is spread out over several years through a process known as depreciation. Straight-Line Depreciation The most basic form of depreciation is known as straight-line depreciation. Using this method, the cost of the asset is spread out evenly over the expected life of the asset.
He expects the equipment to last for 5 years, by which point it will likely be of no substantial value. When Daniel first purchases the equipment, he would make the following journal entry: DR.
Equipment 5, CR. In this case, Accumulated Depreciation is used to offset Equipment. We make the credit entries to Accumulated Depreciation rather than directly to Equipment so that we: 1. Have a record of how much depreciation has been charged against the asset already. When Daniel disposes of the asset, he will make the following entry: Accumulated Depreciation 5, Equipment 5, After making this entry, there will no longer be any balance in Equipment or Accumulated Depreciation.
Salvage Value What if a business plans to use an asset for a few years, and then sell it before it becomes entirely worthless? If, however, the asset is sold for less than its net book value, a loss must be recorded. Determining whether to make a gain entry or a loss entry is never too difficult: Just figure out whether an additional debit or credit is needed to make the journal entry balance.
For example, the double declining balance method consists of multiplying the remaining net book value by a given percentage every year. The percentage used is equal to double the percentage that would be used in the first year of straight-line depreciation. Another GAAP-accepted method of depreciation is the units of production method. Under the units of production method, the rate at which an asset is depreciated is not a function of time, but rather a function of how much the asset is used.
Given the fact that a wastebasket is almost certain to last for greater than one year, it should, theoretically, be depreciated over its expected useful life. The benefit of the additional accounting accuracy is far outweighed by the hassle involved in making insignificant depreciation journal entries year after year.
As a result, assets of this nature are generally expensed immediately upon purchase rather than depreciated over multiple years. Such a purchase would ordinarily be recorded as follows: Office Administrative Expense Common intangible assets include patents, copyrights, and trademarks. The patent will expire in As such, Kurt will amortize the patent over what he projects to be its useful life: four years.
Perpetual Method of Inventory Any business that keeps real-time information on inventory levels and that tracks inventory on an item-by-item basis is using the perpetual method. For example, retail locations that use barcodes and point-of-sale scanners are utilizing the perpetual inventory method. There are two main advantages to using the perpetual inventory system. First, it allows a business to see exactly how much inventory they have on hand at any given moment, thereby making it easier to know when to order more.
CoGS will be calculated, quite simply, as the sum of the costs of all of the particular items sold over the period. The primary disadvantage to using the perpetual method is the cost of implementation. Periodic Method of Inventory The periodic method of inventory is a system in which inventory is counted at regular intervals at month-end, for instance. More on these assumptions later. Beginning inventory, plus the amount of inventory purchased over the period gives you the total amount of inventory that could have been sold sometimes known, understandably, as Cost of Goods Available for Sale.
Any stolen items will accidentally get bundled up into CoGS, because: 1. For example, if a business is dealing with changing per-unit inventory costs, assumptions have to be made as to which ones were sold the cheaper units or the more expensive units.
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