financial+Chapter 6

financial+Chapter 6 - Chapter 6 Analyzing Accounts Learning...

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Chapter 6 - Analyzing Accounts Learning Objectives: After studying Chapter 6, you should Understand how accounts receivable is used and what makes it go up and what makes it go down. Understand the inventory and cost of goods sold accounts. Know what causes the inventory account to increase and decrease. Understand prepaid accounts and what causes them to increase and decrease. Understand long-term assets and how these accounts are impacted by sales and purchases. Understand the accounts payable account and how it relates to inventory. Know what causes increases and decreases in both of these accounts. Understand the notes payable account and the interest payable account and how they are increased and decreased. Understand some of the other common payable accounts and how they are impacted by transactions of the business. Understand the common stock account and what increases it. Know how to prepare a Statement of Retained Earnings and understand how it fits into the accounting cycle. Know the possible causes of increases and decreases in the retained earnings account. To understand financial accounting, it is important to think about how the accounts are impacted by transactions. For example, when the “cash” account increases, it is because cash has been received. When it decreases, it is because cash has been paid out. Accounts Receivable: When the account “accounts receivable” increases, it is because a sale has been made for which the cash has not yet been collected. The entry is to increase the Income Statement account revenue (or sales) and to increase the Balance Sheet account accounts receivable. At the time of the sale, the Income Statement account and the Balance Sheet are both impacted. When this account decreases, it is because all or part of the amount due has been collected. When the cash is collected, accounts receivable is reduced and cash is increased. When the cash is collected, the transaction is just an exchange of one asset, the receivable, for another asset, cash, and only the Balance Sheet is impacted. Inventory: When the asset account “inventory” increases, it is because inventory has been purchased. Recall that the term “inventory” is only used when referring to the product the company is in business to sell. Typically inventory will be purchased “ on account ”, which means that it is usually not paid for at the time of receipt but is paid later when an invoice is submitted by the selling company. Companies are often allowed to purchase on account because they may purchase many products from the same suppliers and could receive shipments as often as daily. A purchase of inventory on account is recorded by increasing the asset account inventory and increasing the liability account accounts payable. The company has increased what it owns, but it has also increased what it owes. This transaction increases the totals at the bottom of the Balance Sheet. If the inventory had been
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