Posts Tagged ‘Definition’

Accounting Information System (AIS): Definition and Benefits

Written by admin. Posted in A, Financial Terms Dictionary

Accounting Information System (AIS): Definition and Benefits

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What is an Accounting Information System (AIS)?

An accounting information system (AIS) involves the collection, storage, and processing of financial and accounting data used by internal users to report information to investors, creditors, and tax authorities. It is generally a computer-based method for tracking accounting activity in conjunction with information technology resources. An AIS combines traditional accounting practices, such as the use of Generally Accepted Accounting Principles (GAAP), with modern information technology resources.

How an Accounting Information Systems (AIS) is Used

An accounting information system contains various elements important in the accounting cycle. Although the information contained in a system varies among industries and business sizes, a typical AIS includes data relating to revenue, expenses, customer information, employee information, and tax information. Specific data includes sales orders and analysis reports, purchase requisitions, invoices, check registers, inventory, payroll, ledger, trial balance, and financial statement information.

An accounting information system must have a database structure to store information. This database structure is typically programmed with query language that allows for table and data manipulation. An AIS has numerous fields to input data as well as to edit previously stored data. In addition, accounting information systems are often highly secured platforms with preventative measures taken against viruses, hackers, and other external sources attempting to collect information. Cybersecurity is increasingly important as more and more companies store their data electronically.

The various outputs of an accounting information system exemplify the versatility of its data manipulation capabilities. An AIS produces reports including accounts receivable aging reports based on customer information, depreciation schedules for fixed assets, and trial balances for financial reporting. Customer lists, taxation calculations, and inventory levels may also be reproduced. However, correspondences, memos, or presentations are not included in the AIS because these items are not directly related to a company’s financial reporting or bookkeeping.

Benefits of Accounting Information Systems

Interdepartmental Interfacing

An accounting information system strives to interface across multiple departments. Within the system, the sales department can upload the sales budget. This information is used by the inventory management team to conduct inventory counts and purchase materials. Upon the purchase of inventory, the system can notify the accounts payable department of the new invoice. An AIS can also share information about a new order so that the manufacturing, shipping, and customer service departments are aware of the sale.

Internal Controls

An integral part of accounting information systems relates to internal controls. Policies and procedures can be placed within the system to ensure that sensitive customer, vendor, and business information is maintained within a company. Through the use of physical access approvals, login requirements, access logs, authorizations, and segregation of duties, users can be limited to only the relevant information necessary to perform their business function.

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Average Inventory: Definition, Calculation Formula, Example

Written by admin. Posted in A, Financial Terms Dictionary

Average Inventory: Definition, Calculation Formula, Example

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What Is Average Inventory?

Average inventory is a calculation that estimates the value or number of a particular good or set of goods during two or more specified time periods. Average inventory is the mean value of inventory within a certain time period, which may vary from the median value of the same data set, and is computed by averaging the starting and ending inventory values over a specified period.

Key Takeaways

  • Average inventory is a calculation that estimates the value or number of a particular good or set of goods during two or more specified time periods.
  • Average inventory is the mean value of an inventory within a certain time period, which may vary from the median value of the same data set.
  • Average inventory figures can be used as a point of comparison when looking at overall sales volume, allowing a business to track inventory losses.
  • Moving average inventory allows a company to track inventory from the last purchase made.
  • Inventory management is a key success factor for companies as it allows them to better manage their costs, sales, and business relationships.

Understanding Average Inventory

Inventory is the value of all the goods ready for sale or all of the raw materials to create those goods that are stored by a company. Successful inventory management is a key focal point for companies as it allows them to better manage their overall business in terms of sales, costs, and relationships with their suppliers.

Since two points do not always accurately represent changes in inventory over different time periods, average inventory is frequently calculated by using the number of points needed to more accurately reflect activities across a certain amount of time.

For instance, if a business was attempting to calculate the average inventory over the course of a fiscal year, it may be more accurate to use the inventory count from the end of each month, including the base month. The values associated with each point are added together and divided by the number of points, in this case, 13, to determine the average inventory.

The average inventory figures can be used as a point of comparison when looking at overall sales volume, allowing a business to track inventory losses that may have occurred due to theft or shrinkage, or due to damaged goods caused by mishandling. It also accounts for any perishable inventory that has expired.

The formula for average inventory can be expressed as follows:

Average Inventory = (Current Inventory + Previous Inventory) / Number of Periods

Average inventory is used often in ratio analysis; for instance, in calculating inventory turnover.

Moving Average Inventory

A company may choose to use a moving average inventory when it’s possible to maintain a perpetual inventory tracking system. This allows the business to adjust the values of the inventory items based on information from the last purchase.

Effectively, this helps compare inventory averages across multiple time periods by converting all pricing to the current market standard. This makes it similar to adjusting historical data based on the rate of inflation for more stable market items. It allows simpler comparisons on items that experience high levels of volatility.

Example of Average Inventory

A shoe company is interested in better managing its inventory. The current inventory in its warehouse is equal to $10,000. This is in line with the inventory for the three previous months, which were valued at $9,000, $8,500, and $12,000.

When calculating a three-month inventory average, the shoe company achieves the average by adding the current inventory of $10,000 to the previous three months of inventory, recorded as $9,000, $8,500 and $12,000, and dividing it by the number of data points, as follows:

Average Inventory = ($10,000 + $9,000 + $8,500 + $12,000) / 4

This results in an average inventory of $9,875 over the time period being examined.

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Accrued Revenue: Definition, Examples, and How To Record It

Written by admin. Posted in A, Financial Terms Dictionary

Accrued Revenue: Definition, Examples, and How To Record It

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What Is Accrued Revenue?

Accrued revenue is revenue that has been earned by providing a good or service, but for which no cash has been received. Accrued revenues are recorded as receivables on the balance sheet to reflect the amount of money that customers owe the business for the goods or services they purchased.

Accrued revenue may be contrasted with realized or recognized revenue, and compared with accrued expenses.

Key Takeaways

  • Accrued revenue is used in accrual accounting where revenue is recorded at the time of sale, even if payment is not yet received.
  • This follows the revenue recognition principle, which requires that revenue be recorded in the period in which it is earned.
  • Accrued revenue is recorded with an adjusting journal entry that recognizes items that would otherwise not appear in the financial statements at the end of the period.
  • It is commonly used in the service industry, where contracts for services may extend across many accounting periods.

Understanding Accrued Revenue

Accrued revenue is the product of accrual accounting and the revenue recognition and matching principles. The revenue recognition principle requires that revenue transactions be recorded in the same accounting period in which they are earned, rather than when the cash payment for the product or service is received. The matching principle is an accounting concept that seeks to tie revenue generated in an accounting period to the expenses incurred to generate that revenue. Under generally accepted accounting principles (GAAP), accrued revenue is recognized when the performing party satisfies a performance obligation. For example, revenue is recognized when a sales transaction is made and the customer takes possession of a good, regardless of whether the customer paid cash or credit at that time.

Accrued revenue often appears in the financial statements of businesses in the service industry, because revenue recognition would otherwise be delayed until the work or service was finished, which might last several months—in contrast to manufacturing, where invoices are issued as soon as products are shipped. Without using accrued revenue, revenues and profit would be reported in a lumpy fashion, giving a murky and not useful impression of the business’s true value.

For example, a construction company will work on one project for many months. It needs to recognize a portion of the revenue for the contract in each month as services are rendered, rather than waiting until the end of the contract to recognize the full revenue.

In 2014, the Financial Accounting Standards Board and the International Accounting Standards Board introduced a joint Accounting Standards Code Topic 606 Revenue From Contracts With Customers. This was to provide an industry-neutral revenue recognition model to increase financial statement comparability across companies and industries. Public companies had to apply the new revenue recognition rules for annual reporting periods beginning after December 15, 2017.

Recording Accrued Revenue

Accrued revenue is recorded in the financial statements by way of an adjusting journal entry. The accountant debits an asset account for accrued revenue which is reversed with the amount of revenue collected, crediting accrued revenue.

Accrued revenue covers items that would not otherwise appear in the general ledger at the end of the period. When one company records accrued revenues, the other company will record the transaction as an accrued expense, which is a liability on the balance sheet.

When accrued revenue is first recorded, the amount is recognized on the income statement through a credit to revenue. An associated accrued revenue account on the company’s balance sheet is debited by the same amount in the form of accounts receivable.

When a customer makes a payment for the goods or services received, the accountant makes a journal entry for the amount of cash received by debiting the cash account on the balance sheet, and then crediting the same amount to the accrued revenue account or accounts receivable account.

Examples of Accrued Revenue

Accrued revenue is often recorded by companies engaged in long-term projects like construction or large engineering projects. Similar to the example of the construction company above, companies in the aerospace and defense sectors might accrue revenue as each piece of military hardware is delivered, even if they only bill the U.S. government once a year.

Landlords may book accrued revenue if they record a tenant’s rent payment at the first of the month but receive the rent at the end of the month.

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Adjusting Journal Entry Definition: Purpose, Types, and Example

Written by admin. Posted in A, Financial Terms Dictionary

Adjusting Journal Entry Definition: Purpose, Types, and Example

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What Is an Adjusting Journal Entry?

An adjusting journal entry is an entry in a company’s general ledger that occurs at the end of an accounting period to record any unrecognized income or expenses for the period. When a transaction is started in one accounting period and ended in a later period, an adjusting journal entry is required to properly account for the transaction.

Adjusting journal entries can also refer to financial reporting that corrects a mistake made previously in the accounting period.

Key Takeaways

  • Adjusting journal entries are used to record transactions that have occurred but have not yet been appropriately recorded in accordance with the accrual method of accounting.
  • Adjusting journal entries are recorded in a company’s general ledger at the end of an accounting period to abide by the matching and revenue recognition principles.
  • The most common types of adjusting journal entries are accruals, deferrals, and estimates.
  • It is used for accrual accounting purposes when one accounting period transitions to the next.
  • Companies that use cash accounting do not need to make adjusting journal entries.

Understanding Adjusting Journal Entries

The purpose of adjusting entries is to convert cash transactions into the accrual accounting method. Accrual accounting is based on the revenue recognition principle that seeks to recognize revenue in the period in which it was earned, rather than the period in which cash is received.

As an example, assume a construction company begins construction in one period but does not invoice the customer until the work is complete in six months. The construction company will need to do an adjusting journal entry at the end of each of the months to recognize revenue for 1/6 of the amount that will be invoiced at the six-month point.

An adjusting journal entry involves an income statement account (revenue or expense) along with a balance sheet account (asset or liability). It typically relates to the balance sheet accounts for accumulated depreciation, allowance for doubtful accounts, accrued expenses, accrued income, prepaid expenses, deferred revenue, and unearned revenue.

Income statement accounts that may need to be adjusted include interest expense, insurance expense, depreciation expense, and revenue. The entries are made in accordance with the matching principle to match expenses to the related revenue in the same accounting period. The adjustments made in journal entries are carried over to the general ledger that flows through to the financial statements.

Types of Adjusting Journal Entries

In summary, adjusting journal entries are most commonly accruals, deferrals, and estimates.

Accruals

Accruals are revenues and expenses that have not been received or paid, respectively, and have not yet been recorded through a standard accounting transaction. For instance, an accrued expense may be rent that is paid at the end of the month, even though a firm is able to occupy the space at the beginning of the month that has not yet been paid.

Deferrals

Deferrals refer to revenues and expenses that have been received or paid in advance, respectively, and have been recorded, but have not yet been earned or used. Unearned revenue, for instance, accounts for money received for goods not yet delivered.

Estimates

Estimates are adjusting entries that record non-cash items, such as depreciation expense, allowance for doubtful accounts, or the inventory obsolescence reserve.

Not all journal entries recorded at the end of an accounting period are adjusting entries. For example, an entry to record a purchase of equipment on the last day of an accounting period is not an adjusting entry

Why Are Adjusting Journal Entries Important?

Because many companies operate where actual delivery of goods may be made at a different time than payment (either beforehand in the case of credit or afterward in the case of pre-payment), there are times when one accounting period will end with such a situation still pending. In such a case, the adjusting journal entries are used to reconcile these differences in the timing of payments as well as expenses. Without adjusting entries to the journal, there would remain unresolved transactions that are yet to close.

Example of an Adjusting Journal Entry

For example, a company that has a fiscal year ending December 31 takes out a loan from the bank on December 1. The terms of the loan indicate that interest payments are to be made every three months. In this case, the company’s first interest payment is to be made March 1. However, the company still needs to accrue interest expenses for the months of December, January, and February.

Since the firm is set to release its year-end financial statements in January, an adjusting entry is needed to reflect the accrued interest expense for December. To accurately report the company’s operations and profitability, the accrued interest expense must be recorded on the December income statement, and the liability for the interest payable must be reported on the December balance sheet. The adjusting entry will debit interest expense and credit interest payable for the amount of interest from December 1 to December 31.

What Is the Purpose of Adjusting Journal Entries?

Adjusting journal entries are used to reconcile transactions that have not yet closed, but which straddle accounting periods. These can be either payments or expenses whereby the payment does not occur at the same time as delivery.

What Are the Types of Adjusting Journal Entries?

The main two types are accruals and deferrals. Accruals refer to payments or expenses on credit that are still owed, while deferrals refer to prepayments where the products have not yet been delivered.

What Is the Difference Between Cash Accounting and Accrual Accounting?

The primary distinction between cash and accrual accounting is in the timing of when expenses and revenues are recognized. With cash accounting, this occurs only when money is received for goods or services. Accrual accounting instead allows for a lag between payment and product (e.g., with purchases made on credit).

Who Needs To Make Adjusting Journal Entries?

Companies that use accrual accounting and find themselves in a position where one accounting period transitions to the next must see if any open transactions exist. If so, adjusting journal entries must be made accordingly.

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