Accounting for Lawyers OUTLINE
Schenk; Fall 2011
Professional Income – all expenses = net income
– Increase in an expense is a debit
– Decrease to an expense is a credit
– Increase to income is a credit
– Decrease to income is a debit
– Income statements need to be closed out before the income is added to the balance sheet
– Process:
o Do journal entries for all expenses and sales/service income
o Make individual T-charts for each account
o Take totals from the T chart, which are recorded on the Income Sheet and close out to Profit and Loss T chart
§ Do new journal entries for each account:
Debit to Profit and Loss
Credit to Rent expense
Debit to Income
Credit to Profit and Loss
o Then close out Profit and Loss total to Proprietorship/Partner Equity/etc.
Profit and Loss
– Close out Profit and Loss to Equity Portion of Balance Sheet with journal entries
Debit to Profit and Loss
Credit to Propreitorship/Partner Equity, etc.
– Record final income to appropriate account under Equity on the Balance Sheet
o NEVER carry over income from one balance sheet to another
o Always close out with an income and profit/loss statement
Accrual and Deferral
– Accrual: need to accrue to a different period; income has already been received/cash not yet paid
o Income: did the services or sales but did not yet get paid
Debit to accrued revenue/sales $2000 (ASSET)
Credit to Revenue/sales of $2000
o Expense: have an expense that has been accrued but did not pay yet
Debit to expense acct
Credit to accrued expense acct (LIABILITY)
– Defferal: need to defer to a future period (cash has moved)
o Income: if you received the cash but have not yet done the service/sale
§ Ex: a client prepays you for work that will be done in the next period
§ Create a deferred sales for amount (LIABILITY) and credit it for the amount
o Expense: pre pay an expense that will not all be used in the current period
§ Ex: co. pays for a 3 year insurance policy upfront
Debit to Insurance expense $3000
Credit to cash $3000
· At end of period would have to adjust to show that 2000 of the insurance expense was for future periods so.
· Create a deferred interest account/pre paid expense (ASSET) and…
Debit pre-paid expense $2000
Credit Insurance expense $2000
– Can’t put these all in the current period because there would be a disparity
– Interest on loans (have to accrue in following periods)
Principles:
– Historic Cost: record assets at historic/original cost
– Objective: accounting principles have to be objective; everyone does the same
– Revenue Recognition: only recognize revenue when 1) an exchange has occurred and 2) the acctg entity has completed the earnings process
– Matching: Must match expenses and revenue in same acctg period
– Consistency: stay consistent each year
– Full Disclosure: have to disclose anything relevant
– Emerging Fair Value/Relevance Principle: things are changing
Modifying Conventions:
– Materiality:
o Quantitative: depends on size of the company and what the error is to determine if actually material
§ Rule of thumb, if more than 5% of total assets, is material
§ Also look to ratios for liquidity
o Qualitative; if money is paid for illegal reasons always material
– Conservatism: be conservative
– Industry Practices: what are the practices of that industry
Depreciation:
– Bought a machine to produce goods and paid a specific amount
o Bought machine in cash, so need to debit the cash account for amount
o And is an asset to machinery for that amount
o BUT the machine will actually be used for 5 years, so can’t put all the amount in the machine asset account
o Have to create a deferred asset account “depreciation of machinery” and credit it with how much will be used in later years
o So debit machinery for amount and credit an accumulated depreciation account for that year.
–
he problems (ex: internal controls)
§ Companies do not like this; does not look good
– U.S. has GAAP, but internationally there are different accounting standards
o Problematic for companies that work internationally
o SEC is supposed to write opinion about convergence by end of year
– Bily v Arthur Young & Company
o Company goes out of business; investors lost all money; bring lawsuit against auditing firm Arthur Young and claim liabilities were misstated on the balance sheet and audit gave clean opinion (see notes pg. 15-16)
o Court said different standards of imposing liability
o General Negligence
§ Court relied on the decision from the Ultramares case out of NY
§ Have to look at privity, came from Ultramares case in New York:
· In order for an auditor to be liable under general negligence there has to be privity
o Privity: direct relationship
· Has to be direct contractual relationship- auditor and client; so client could sue, but not these investors
· This was also confirmed in Credit Alliance case
· Ultramares said that general negligence only is ok for the client
§ So first the court looked to this case, but went on
§ There is another way to base a lawsuit under general liability
§ Foreseeability Standard under RESTATEMENT 2d of TORTS, section 552
· This is an easier standard to prove, need less of a connection
· Only liable if there is a causal link; the auditor should have foreseen that the third party would have relied on this report
· Have to have justifiable reliance on the information
· But here this auditor did not prepare for any particular third party