Review of a Company’s Accounting System C hapter 3

2 Accounting Equation Assets = + Liabilities Stockholder’s Equity Stockholder’s Equity

3 Assets Accounting Equation Assets are the corporation’s economic resources and have future value.

4 Liabilities Accounting Equation Liabilities are obligations ordebts. A liability is a present obligation for a future sacrifice as a result of a past transaction.

5 Stockholders’ Equity Accounting Equation Stockholders’ equity is the residual interest in assets or net worth, which is assets minus liabilities.

6 Assets = Liabilities + Stockholders’ Equity Stockholders’ Equity = Contributed Capital + Retained Earnings Retained Earnings = Beginning Retained Earnings + Net Income – Dividends Net Income = Revenues – Expenses Interrelated Accounting Equations

7 Revenues Revenues are charges to customers for goods or services provided.

8 Expenses Expenses are assets that have expired, been consumed, or become cost of goods sold and have no future value.

9 Permanent (Real) Accounts Assets = Liabilities + Stockholders’ Equity Asset Accounts (debit) (credit) Increase Decrease Liability Accounts (debit) (credit) Decrease Increase Capital Stock Accounts (debit) (credit) Decrease Increase Retained Earnings (debit) (credit) Decrease Increase Accounts The debits must equal the credits

10 Temporary (Nominal) Accounts Revenue Accounts (debit) (credit) Decrease Increase Expense Accounts (debit) (credit) Increase Decrease Retained Earnings (debit) (credit) Decrease Increase Dividend Accounts (debit) (credit) Increase Decrease Accounts

11 1.Income Statement— Summarizes the results of a company’s income-producing activities for the accounting period. 2.Balance Sheet— Summarizes the amounts of a company’s assets, liabilities, and stockholders’ equity at the end of the accounting period. 3.Statement of Cash Flows— Summarizes a company’s cash receipts and cash payments during the accounting period. Financial Statements

12 1.Record the daily transactions in a journal 2.Post the journal entries to the accounts in the ledger 3.Prepare and post adjusting entries 4.Prepare the financial statements 5.Prepare and post closing entries for revenue, expense, and dividend accounts The Accounting Cycle

13 Comprehensive Illustration for Dapple Corporation Step 1: Journalizing: Recording in the General Journal

14 GENERAL JOURNAL On January 1, 2010, various stockholders invest in Dapple by purchasing 2,000 shares of no-par stock at $10 per share. Date Account Titles and Explanations Debit Credit 2010 Jan. 1Cash20,000 Capital Stock20,000 Issued 2,000 shares of no-par stock at $10 per share.

15 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit 2010 Jan. 1Cash20,000 Capital Stock20,000 Issued 2,000 shares of no-par stock at $10 per share. On January 16, Dapple purchases two acres of land as a building site, paying $1,500 an acre. 16Land3,000 Cash3,000 Purchased 2 acres of land at $1,500 per acre.

16 Comprehensive Illustration for Dapple Corporation Step 2: Posting to the Ledger

17 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit 2010 Jan. 1Cash20,000 Capital Stock20,000 Issued 2,000 shares of no-par stock at $10 per share. 16Land3,000 Cash3,000 Purchased 2 acres of land at $1,500 per acre. Cash 1/1 20,000 Capital Stock 1/1 20,000

18 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit 2010 Jan. 1Cash20,000 Capital Stock20,000 Issued 2,000 shares of no-par stock at $10 per share. 16Land3,000 Cash3,000 Purchased 2 acres of land at $1,500 per acre. Cash 1/1 20,000 1/16 3,000 Land 1/16 3,000

19 After the journal entries are posted for the accounting period, a trial balance is often prepared.

20 The trial balance is used to verify that the total of the debit balances is equal to the total of the credit balances. Debits Credits

21 Comprehensive Illustration for Dapple Corporation Step 3: Preparation of Adjusting Entries

22 Adjusting Entries 1.The purpose of adjusting entries is to record revenues and expenses in the correct period 2.Dated the last day of the accounting period

23 On March 30, Dapple Corporation purchased a one- year comprehensive insurance policy. Prepaid Expense

24 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit 2010 Jan. 1Cash20,000 Capital Stock20,000 Issued 2,000 shares of no-par stock at $10 per share. Mar. 30Prepaid Insurance360 Cash360 Purchased a 1-year comprehensive insurance policy. On March 30, Dapple Corporation purchased a one- year comprehensive insurance policy.

25 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit Adjusting Entries Dec. 31Insurance Expense270 Prepaid Insurance270 To record expiration of 9 months of insurance coverage purchased on March 30. By December 31, nine months of the policy had expired. By December 31, nine months of the policy had expired.

26 On December 1, Dapple Corporation received $450 for three months’ rent in advance. Deferred Revenue

27 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit 2010 Jan. 1Cash20,000 Capital Stock20,000 Issued 2,000 shares of no-par stock at $10 per share. Dec. 1Cash450 Unearned Rent450 Received 3 months’ rent in advance at $150 per month. Company owes use of portion of building to Fritz Company for the 3-month period. On December 1, Dapple Corporation received $450 for three months’ rent in advance.

28 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit Adjusting Entries Dec. 31Insurance Expense270 Prepaid Insurance270 To record expiration of 9 months of insurance coverage purchased on March Unearned Rent150 Rent Revenue150 To record earning of 1 month of rent revenue from receipt collected in advance on December 1. By December 31, one month’s rent ($450 ÷ 3 = $150) has been earned.

29 On December 31, Dapple Corporation has accrued salaries of $900. Entries must be journalized before they are posted.

30 On September 1, Dapple Corporation accepted a $1,320, 15% note as payment when it sold an acre of land. Accrual of Interest Revenue

31 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit Adjusting Entries Sept. 1Notes Receivable1,320 Loss on Sale of Land180 Land1,500 Sold 1 acre of land at less than its cost, incurring a loss. Buyer issued a note due in 6 months and bearing 15% annual interest. On September 1, Dapple Corporation accepted a $1,320, 15% note as payment when it sold an acre of land.

32 Interest Receivable 12/31 Adj. 66 Interest Revenue 12/31 Adj.66 By December 31, the company has earned 4 months of interest totaling $66 ($1,320 × 0.15 × 4/12). Adjusting Entries

33 Remaining Adjusting Entries

34 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit 2010 Jan. 1Cash20,000 Capital Stock20,000 Issued 2,000 shares of no-par stock at $10 per share. Dec. 1Cash450 Rent Revenue450 31Rent Revenue300 Unearned Rent300 Adjusting entry using alternative method of recording deferred revenue. Some companies may record the receipt of revenue in advance as revenues instead of unearned revenues. At Dec. 31, some of the revenue has still not been earned and an adjusting entry must be made.

35 GENERAL JOURNAL Date Account Titles and Explanations Debit Credit 2010 Jan. 1Cash20,000 Capital Stock20,000 Issued 2,000 shares of no-par stock at $10 per share. Mar. 30Insurance Expense360 Cash360 Purchased a 1-year comprehensive insurance policy. Dec. 31Prepaid Insurance90 Insurance Expense90 Prepaid expenses may be recorded as expenses and the unused portion adjusted at year end.

36 Comprehensive Illustration for Dapple Corporation Step 4: Preparation of the Financial Statements

37 1.If necessary, recompute the balance of each account in the ledger. 2.Prepare an adjusted trial balance to verify that debits equal credits. 3.Prepare an income statement. 4.Prepare a statement of retained earnings. 5.Prepare a balance sheet. Preparation of the Financial Statements

38 Income Statement

39 Retained Earnings Statement

40 Balance Sheet

41 Comprehensive Illustration for Dapple Corporation Step 5: Preparation of Closing Entries

42 1.Close temporary accounts with credit balances to Income Summary and record the ending inventory. 2.Close temporary accounts with debit balances to Income Summary and close the beginning inventory. 3.Close Income Summary to Retained Earnings. 4.Close Dividends Distributed to Retained Earnings. Typical Order of Closing Entries

43 Closing Entries

44 1.Adjusting entries that create accrued revenues or expenses to be collected or paid in the next accounting period 2.Adjusting entries related to prepayments of costs initially recorded as expenses or receipts- in-advance initially recorded as revenues Reversing entries should be made for any adjusting entry that creates a new balance sheet account as follows: General Guidelines for Reversing Entries

45 1.Adjusting entries related to prepayments of costs initially recorded as assets or receipts-in-advance initially recorded as liabilities 2.Adjusting entries related to estimated items such as depreciation or bad debts Reversing entries should not be made for: General Guidelines for Reversing Entries

46 Reversing Accrued Revenues

47 Reversing Accrued Expenses

48 Why use a subsidiary ledger? 1.To reduce the size of the general ledger 2.To minimize errors 3.To divide the accounting task 4.To keep up-to-date records of its credit customers and suppliers Subsidiary Ledgers

49 Subsidiary Ledgers

50  Sales Journal. Used to record all (and only) sales of merchandise on credit.  Purchases Journal. Used to record all (and only) purchases of merchandise on credit.  Cash Receipts Journal. Used to record all cash receipts.  Cash Payments Journal. Used to record all cash payments.  General Journal. Used to record adjusting, closing, and reversing entries and other transactions not recorded in the special journals. Special Journals