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Financial Accounting notes 3

Financial Accounting notes 3 - IQ-JTGE RS INTRODUCTION TO...

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Unformatted text preview: IQ-JTGE RS INTRODUCTION TO FINANCIAL ACCOUNTING . 33:01o:272. SECTIONS 08 81 09 |FALL 2011 Rutgers Busmess School Newark and New Brunswick PROFESSOR JULIAN YEO Class Notes 03: Journal Entries for Our Business Simulation Game This document contains most of the journal entries that we will come across during the business simulation game. Below is an index of accounts (by alphabetical order) you will find: Accrued Consultin_ Revenue m Accumulated De . reciation Advances from Customers Buildings Consultin; Revenue Consultin_ Revenue Receivable Contributed Ca . ital De reciation Ex ense Gains/losses on Sales of Pro erties Income Tax Refimd Receivable Insurance Ex ense Interest Expense Interest Pa able Loan Miscellaneous Expenses Miscellaneous Revenues Pre aid Income Tax Pre . aid Insurance Properties Rental Ex o ense Rental Receivable Rental Revenue Rental Pa able Re air and Maintenance Ex ense Write-off Ex ense Templates of unadjusted/adjusted Trial Balance can also be found on page 10 of this document. Upon completion of this topic, you should able to: I J oumalize all transactions that take place in a simulated business environment I Make all the necessary adjusting entries I Prepare financial statements based on transactions take place is a simulated business environment Copyright © 2011 1 You may only share these materials with current term students. Before we start playing... 0 Owners’ contribution to the business Month Accounts Debit Credit 01 Properties xx Contributed Capital/PIC xx Both teams already own properties and both teams are using their properties as their capital contribution. We assume that the prices on the board are the fair values of the properties. CAR’s properties are worth $2,510 and HAT’s properties are worth $3,180. Question: Does HAT have an advantage over CAR? Note that the performance measure we focus on is ROE (Return on owners ’ equity). 0 (Initial) Loan Month Accounts Debit Credit 01 Cash $1, 500 Loan $1,500 You need cash as part of the business’ operating activities. As a result of this transaction, you have an increase in asset (cash — debit) and an increase in liabilities (loan — credit). While we are playing... Common Revenues Revenues are inflows of assets or settlements of liabilities, or both, during a period as a result of the delivery or production of goods, the rendering of services, or other earnings activities that constitute an entity’s typical day-to-day activities. Some possible revenues that you will come across in the simulation game include: 0 Rental Revenue 0 Consulting Revenue 0 Miscellaneous Revenue Rental Revenue When another team visits one of your properties, even though they do not pay the rent in the same month of their visit (they pay in the following month), you have performed your services and earned the revenue. Therefore, you can recognize rental revenue in the month when another team stays at one of your properties. Copyright © 2011 2 You may only share these materials with current term students. 0 Rental Revenue Month Accounts Debit Credit Xx Rental Receivable xx Rental Revenue xx Here, you have an increase in asset (rental receivable — debit) and an increase in revenue (rental revenue- credit). When you receive the cash in the following month... Month Accounts Debit Credit Xx Cash xx Rental Receivable xx Consulting Revenue Each time when you pass ‘go’, you collect $200 cash from the bank for consulting work that you have performed. 0 Consulting Revenue Month Accounts Debit Credit xx Cash xx Consulting Revenue xx Miscellaneous Revenue Apart from rental and consulting revenue, you may have earned revenue outside of the 2 main services you provide. For example, you may have earned revenue as a result of landing on ‘free parking’ when there is cash available. You may have earned revenue because of a chance/community chest card that you draw. Given that it is not unusual that you receive miscellaneous revenue throughout the game, they are clearly part of your core operating revenue. Month Accounts Debit Credit xx Cash xx Misc. Revenue xx Common Expenses Expenses are outflows of assets or incurrence of liabilities, or both, during a period as a result of the delivery or production of goods, the rendering of services, or other earnings activities that constitute an entity’s typical, day-to-day activities. Some possible expenses that you will incur: 0 Rental Expenses 0 Repair and Maintenance Expenses 0 Miscellaneous Expenses Copyright © 2011 3 You may only share these materials with current term students. Rental Expense When you land on another team’s properties, you incur a rental expense in the month of your visit, even though you don’t have to pay for it till the following month. This is part of the expenses that you have to incur in order to generate revenue coming in (i.e., in order to generate consulting revenue, you have to move around the board). 0 Rental Expense Month Accounts Debit Credit xx Rental Expense xx Rental Payable xx Here, you have an increase in expense (rental expense — debit) and an increase in liability to be paid in the following month (rental payable- credit). When you make the cash payment in the following month... Month Accounts Debit Credit xx Rental Payable xx Cash xx Repair and Maintenance Expenses These are expenses that you have to incur in order to generate rental revenue. Given that these expenses are often period-specific (i.e., you have to incur them periodically), and the amount is often trivial, rather than capitalizing them as assets and depreciate them overtime, you will recognize these expenses in the period which you incur them. Month Accounts Debit Credit xx Repair and Maintenance Expense xx Cash xx Miscellaneous Expenses Just like miscellaneous revenues, you may incur expenses throughout the game that are difficult to aggregate into a specific category. You may also incur expenses that you do not like to disclose explicitly to your users. For example, when you land on ‘go to jail’; rather than having a separate category for “billing out of jail expense” on your financial statements, I think you will be more comfortable putting those expenses as part of ‘miscellaneous’. Given that you will incur miscellaneous revenue frequently throughout the game, they are part of your core operating expenses. Month Accounts Debit Credit xx Misc. Exp xx Cash xx Copyright © 2011 4 You may only share these materials with current term students. Other transactions 0 Building houses and hotels Hotel is considered as the 5th house in this simulation game. When building a house (an increase in asset- debit), you record the following entry: Month Accounts Debit Credit xx Building xx Cash xx 0 Gains/losses on Sales of Properties In this simulation, properties are held to generate future rental revenues. Properties are not held primarily for trading purposes. This does not preclude the possibility that you may sell/exchange some of your properties. Given that these are not part of your peripheral operating activities, when a profit/loss is made when properties are sold/exchanged, a gain/loss is recognized. For example, when a team sells a property to another team for cash, the difference between the cash amount received and the book value of the property gives rise to a gain/loss on sale of property. For example, another team pays $100 cash for Baltic Avenue that has a book value of $60. The journal entry is: Month Accounts Debit Credit xx Cash $1 00 Properties - Baltic $60 Gain on sale ofproperty $40 If the property is sold with building, don’t forget to depreciate the building up to the point of sale. See unrecorded expenses for more on depreciation. Let’s now consider case where there is an exchange of property between the two teams. E.g., CAR gave up Oriental Avenue (book value of $100) for HAT’s New York Avenue (book value of $200). In CAR’s book... Month Accounts Debit Credit xx Properties — New York Ave $200 Properties — Oriental Ave $100 Gain on exchange of property $100 Copyright © 2011 5 You may only share these materials with current term students. In HAT’s book... HAT can bring in the new property at purchase price, which is the book value of New York Ave that HAT gave up. Month Accounts Debit Credit xx Properties — Oriental Ave $200 Properties — New York Ave $200 Question: Should HAT recognize a loss instead? Question: Does it matter if CAR and HAT have diflerent treatments for the same transaction ? 0 Loss of Properties in a Storm Unfortunately, some of your properties are in areas that are prone to natural disaster. It is not uncommon that you will loose some of your buildings in the storm. When it happens, you will record an expense for your loss of building. It can also happen to your properties, it may be the case that the cost of getting the land into a condition that is rentable outweighs the costs of the construction, therefore it is cheaper for you to write off the property as an expense. When it happens, don’t forget to bring the depreciation expense up to date. Using the example of a building, after accounting for depreciation, you will record the following: Month Accounts Debit Credit xx Write—Ofl Expense — Buildings xx Accumulated Dep — Buildings xx Buildings xx After we have finished playing... Entries that require adjustment at the end of the period Prepaid Expenses Prepaid expenses are transactions in which services that the firm receives are paid for in advance. Adjusting entries are required at the end of the period to recognize the portion of the prepaid expenses that has already been used up (therefore, allocate to an expense account). Prepaid Insurance In this simulation, insurances are valid for 24 months. When you pay the entire amount upfront, you are paying for something with economic benefits that is going to last longer than the current year. When you make the cash payment, we will treat it as an asset, and make the adjustment at the end of the year to recognize the insurance coverage that we have used up for the current year. Copyright © 2011 6 You may only share these materials with current term students. At the time when you make the payment... Month Accounts Debit Credit xx Prepaid Insurance xx Cash xx At the end of the year, you will recognize the coverage that you have used up for the current year. Month Accounts Debit Credit 12 Insurance Expense xx Prepaid Insurance xx Prepaid Income Tax Throughout the game, when you land on squares on the board that require tax payments, all tax payments are assumed to be prepaid income tax (even though the board says luxury tax). When you make prepaid income tax payments... Month Accounts Debit Credit xx Prepaid Income tax xx Cash xx For your simulation, you are not liable for any income tax for your first year of operations (however, prepaid income tax will tie up your cash flows). At the end of the year, you will recognize that you can get a cash refimds for all the income taxes that you have prepaid. Month Accounts Debit Credit 12 Income Tax Refund Receivable xx Prepaid Income Tax xx Uneamed Revenue Uneamed revenues are obligations to deliver goods or services that result from receiving assets (e.g., cash) before providing the goods or services. An adjusting entry is required at the end of the year to recognize the portion of unearned revenue that is earned. In our simulation, some customers pay their rent in advance. When that happens, given that you haven’t performed the services to earn that revenue, we have to recognize that the business still owes the customers the rental amount received in advance. As a result of the transaction, you have an increase in Cash (asset— debit) and an increase in Advances from Customers (liability — credit). Copyright © 2011 7 You may only share these materials with current term students. At the time when you receive cash from customers in advance... Month Accounts Debit Credit xx Cash xx Advances from Customers xx At the end of the year, if you have performed part of the services, you have to recognize that part of the liability is no longer owed and revenue is earned. Month Accounts Debit Credit 12 Advances from Customers xx Rental Revenue xx Accrued Revenue Accrued revenues are revenues that you have earned but have not collected the cash yet. As part of the simulation, each time you pass ‘go’, you receive consulting revenue of $200. Depending on where you are at the end of the game, you may have performed part of the consulting services. For example, if you finish at three spaces before passing ‘go’, you should accrues 75% of the consulting revenue (you have completed 3% of the consulting work). Month Accounts Debit Credit 12 Consulting Revenue Receivable $150 Consulting Revenue $150 When cash is received in the following year, you will then record the following entry: Month Accounts Debit Credit 01 Cash $200 (YR 2) Consulting Revenue Receivable $150 Consulting Revenue $50 Accrued expenses Accrued expenses are expenses that you have incurred but have not paid. One example is interest expense on loans/mortgages. For the initial loan that you take up in month 1, you have to accrue 12 months’ worth of interests. For subsequent loans/mortgages that you take up, you can assume that the transaction take place at the end of the month. For example, if you take up a mortgage in month 8, you can assume that it happens at the end of month 8, therefore you only need to accrue interests for months 9-12 (4 months). Copyright © 2011 8 You may only share these materials with current term students. At the end of the year, you should record the following entry: Month Accounts Debit Credit 12 Interest Exp xx Interest Payable xx Unrecorded expenses Depreciation Some assets provide economic benefits over several accounting periods. At the end of the year, we need to recognize the extent to which we have ‘used up’ some of the benefits. One example is the houses/hotels you built as part of the simulation. Here, depreciation is calculated on a straight-line basis: Depreciation Expense = (Cost—Residual Value)/ Useful life The residual value is the proceeds that you can get for selling back the building (which is half the construction cost). For example, a house was built on Boardwalk (costing $200) in month 11, Year 1. At the end of year (month 12), you need to depreciate the house for 2 months (including the month of construction). Depreciation Expense per month = ($200-$100)/50 = $2 per month. When recognizing the depreciation expense (debit depreciation expense), the corresponding entry is to recognize a decrease in the value of building. Rather than crediting the asset account directly, we can credit a contra-asset account called Accumulated Depreciation. This, in turn, allows us to keep the historical cost of the assets separate from the ‘used up’ portion of the asset. Both items provide useful information. We will look into this when we discuss long-lived assets later in the course. Month Accounts Debit Credit I 2 Depreciation Expense $4 Accumulated Depreciation $4 The net book value of the building is Building — Accumulated Depreciation. The net book value is the amount that will appear on the balance sheet. Copyright © 2011 9 You may only share these materials with current term students. Trial Balance for our Business Simulation Game Unadjusted/adjusted Trial Balance as at December 31, Year 1. A trial balance lists the balances of all the accounts in the ledger on a particular date. This is prepared to ensure that the posting procedure has been carried out as such that the sum of debit account balances equal to the sum of credit account balances. A trial balance is typically prepared both before and after you make adjusting entries. The trial balance you prepare before you make adjusting entries is commonly known as an Unadjusted Trial Balance. Adjusting entries are made to ensure that net income is measured correctly at the end of the period. Given that these entries will change the balances in some of the accounts, another trial balance (known as Adjusted Trial Balance) is prepared to check the accuracy of the arithmetic in the posting procedure. Question: What types of errors are not captured by the trial balance? Attached are two templates that you can use in preparing your unadjusted and adjusted trial balances. You may not need all of the accounts listed. In some instances, you may need to add new accounts. I have also inserted a column called “Reference Number”. Each account that a company prepares is typically given a reference number. These numbers are company specific and a new reference number is generated each time a new account is created. In practice, it is not uncommon to see these reference numbers being grouped by categories. For example, asset accounts typically have reference numbers of 1000-1999, a liability account has a reference number between 2000-2999, an equity account has a reference number between 3000-3999, a revenue account has a reference number in the range of 4000-4999, and an expense account has a reference number of 5000-5999. Once your accounts are grouped by these categories, you can easily prepare your income statement and balance sheet. Copyright © 2011 10 You may only share these materials with current term students. Unadjusted/Adjusted Trial Balance for CAR/HAT as at December 31, Year 1. Ref Accounts Amounts in Accounts Amounts in Accounts with Debit Balances with Credit Balances 1001 Cash 1002 Rental Receivables 1003 Consulting Revenue Receivable 1004 Interest Receivable 1006 Pre - aid Income Tax 1007 Prepaid Insurance 1008 Properties/Lands 1009 Buildin Rental Payable Advances from Customers Contr1buted Ca 1ta1 Rental Revenue Consultin_ Revenue 4003 Miscellaneous Revenue 4004 Accrued Consultin_ Revenue 4005 Gain from Sales of Pro oerties — — — 5001 5002 5003 5004 5005 5006 5007 5008 Loss from Sales of Pro n erties Copyright © 201 1 11 You may only share these materials with current term students. Unadjusted/Adjusted Trial Balance for CAR/HAT as at December 31, Year 1. Ref Accounts Amounts in Accounts Amounts in Accounts with Debit Balances with Credit Balances 1001 Cash 1002 Rental Receivables 1003 Consulting Revenue Receivable 1004 Interest Receivable 1006 Pre - aid Income Tax 1007 Prepaid Insurance 1008 Properties/Lands 1009 Buildin Rental Payable Advances from Customers Contr1buted Ca 1ta1 Rental Revenue Consultin_ Revenue 4003 Miscellaneous Revenue 4004 Accrued Consultin_ Revenue 4005 Gain from Sales of Pro oerties — — — 5001 5002 5003 5004 5005 5006 5007 5008 Loss from Sales of Pro n erties Copyright © 2011 12 You may only share these materials with current term students. ...
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