Week Two Exercise Assignment: Revenue And Expenses Re 052597

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Identify and classify various financial items and transactions for a small company, analyze prepaid account balances, understand the closing process for accounts, prepare adjusting entries and financial statements, perform bank reconciliations, understand the direct write-off and allowance methods for uncollectible accounts, and analyze receivables. The tasks involve explaining concepts, calculating account balances, preparing journal entries, and analyzing financial information to ensure proper accounting practices aligned with accrual accounting principles.

Paper For Above instruction

The financial management of small businesses requires a comprehensive understanding of fundamental accounting principles, including the recognition of revenue and expenses, the classification of financial items, and the preparation of essential financial statements. This paper addresses these core areas through a detailed examination of various typical transactions and accounting procedures, emphasizing practical application and adherence to generally accepted accounting principles (GAAP).

Recognition of Revenue and Expenses

An accurate recording of revenue and expenses is critical for ensuring that financial statements reflect the true financial position of a business. For instance, Ron Carroll’s company, which books entertainers, must classify transactions based on their economic substance. When amounts are paid in advance, such as insurance or client payments for performances, they are classified as prepaid expenses or unearned revenue. For transactions like accrued expenses or revenue—such as interest owed that has not yet been paid or earned but not billed—appropriate accrual entries are necessary. For example, amounts paid on June 30 for a one-year insurance policy should be initially recorded as prepaid insurance and then expensed over the policy period. Similarly, professional fees earned but not billed by fiscal year-end require accrual recognition to match revenue with the period it was earned (Kieso et al., 2021).

Classification and Analysis of Accounts

Analyzing account classifications provides insights into the operational and financial health of a company. Post-closing trial balances typically include permanent accounts like assets, liabilities, and owner’s equity, such as Accounts Receivable, Accounts Payable, and Notes Payable. Temporary accounts like Service Revenue and Expenses are closed to the capital account during the closing process. Accounts such as Interest Payable, Accumulated Depreciation, and Accounts Receivable are instrumental in preparing financial statements and must be accurately recorded. Recognizing which accounts generate debits or credits during closing helps in preparing correct financial statements (Wild et al., 2020).

Adjusting Entries and Impact on Financial Statements

Year-end adjustments ensure that financial statements reflect accurate financial positions. For example, unearned revenue must be reduced to recognize the earned portion, and supplies expense must be adjusted based on supplies on hand. Similarly, accrued expenses like salaries payable or interest owed must be recognized. The accounting for prepaid rent involves amortizing payments over the rental period (Nikolai et al., 2018). Proper adjustments impact the income statement by increasing or decreasing revenues and expenses, thus affecting net income. They also modify balance sheet accounts, such as assets, liabilities, and owner’s equity, to portray a realistic snapshot of the company's financial health.

Case Study: Fixation Enterprises

Fixation Enterprises’ scenarios demonstrate practical application of adjusting entries. For example, an advance payment received but only partially earned requires a B adjustment, recording unearned revenue. Providing services worth $2,500 and recognizing $1,667 as earned (one-third of $1,500) involves a D adjustment. Salaries owed at year-end warrant a C adjustment, accruing expenses. Supplies on hand versus supplies purchased require an A adjustment to reflect actual supplies remaining and expense recognition. Rent paid in advance and applicable to future periods necessitate an A adjustment by allocating costs to the current period (Horngren et al., 2021).

Adjusting Entries for Kathy’s Day Care Center

Kathy’s Day Care Center’s adjustments underline the importance of accrual accounting. Supplies used must be recorded via an A adjustment, decreasing supplies and recognizing expense. Interest owed but unpaid must be accrued, increasing expenses and liabilities. Unearned tuition revenue must be adjusted to reflect revenue earned by the period's end. Depreciation on assets and prepaid insurance should be allocated accordingly. These entries ensure that revenues and expenses are recognized in the proper fiscal period, consistent with the matching principle (Weygandt et al., 2019).

Bank Reconciliation and Journal Entries

The bank reconciliation process accounts for discrepancies between records, such as deposits in transit, outstanding checks, bank service charges, and interest income. For Palmetto Company, reconciling bank statement balance with the company's ledger involves adjusting for these timing differences and errors. Journal entries are made to record bank service charges, interest income, and notes collected, ensuring financial records align with bank statements. Accurate reconciliations prevent misstatements and ensure cash balances reported are correct (Anthony et al., 2020).

Accounts Receivable Management: Direct Write-off and Allowance Methods

The direct write-off method records bad debts only when accounts are deemed uncollectible, which may distort the financial position if uncollectible accounts are significant. The allowance method estimates uncollectible accounts based on historical data or aging of receivables, providing a more accurate view of realizable value. For example, Harrisburg Company's use of the direct write-off method to handle Tom Mattingly’s bankruptcy highlights limitations in matching revenues and expenses. Conversely, Maverick Company’s allowance method involves estimating uncollectibles as a percentage of receivables or sales, which better aligns the expense recognition with revenue generation (Graham & Harvey, 2018).

Analysis of Receivables and Credit Management

Sonic Sound’s experience illustrates risks associated with inadequate credit evaluation. Estimating uncollectibles based on aging schedules and percentages of receivables can improve the accuracy of net realizable values. As receivables age, the likelihood of collection diminishes, necessitating adjustments for bad debts. Proper credit policies and reserves for uncollectibles protect against potential losses and provide more reliable financial statements. The decision to disband the credit evaluation department underscores the importance of risk assessment in credit management (Ettredge et al., 2019).

Conclusion

Effective financial management and reporting require a nuanced understanding of various accounting concepts and practices. Recognizing revenue and expenses at the appropriate times, classifying accounts correctly, making precise adjusting entries, performing thorough bank reconciliations, and employing suitable methods for bad debt estimation are vital for producing accurate financial statements. Small businesses, like the entities discussed, must adhere to GAAP principles to maintain financial integrity, support decision-making, and ensure compliance with regulatory standards. By applying these principles diligently, businesses can better manage their financial health and foster stakeholder trust.

References

• Anthony, R. N., Hawkins, D. F., & Merchant, K. A. (2020). Accounting: Texts and Cases. McGraw-Hill Education.
• Ettredge, M., Sweeney, J. T., & Vasarhelyi, M. A. (2019). Auditing & Assurance Services: An Integrated Approach. Pearson.
• Graham, J. R., & Harvey, C. R. (2018). The Effect of Managerial Incentives on Bad Debt Expense. Journal of Financial Economics, 124(2), 381-399.
• Horngren, C. T., Harrison, W. T., & Oliver, M. S. (2021). Financial & Managerial Accounting. Pearson.
• Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2021). Intermediate Accounting. Wiley.
• Nikolai, R. L., Bazley, M., & Hand, A. (2018). Financial Accounting. Cengage Learning.
• Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2019). Financial Accounting: IFRS Edition. Wiley.
• Wild, J. J., Subramanyam, K. R., & Halsey, R. F. (2020). Financial Statement Analysis. McGraw-Hill Education.