Recording Transactions Lecture 4

Learning Objectives (LO) After studying this chapter, you should be able to Use double-entry accounting Describe the five steps in the recording process Analyze and journalize transactions and post journal entries to the ledgers Prepare and use a trial balance Close revenue and expense accounts and update retained earnings Correct erroneous journal entries and describe how errors affect accounts Explain how computers have transformed the processing of accounting data

LO 4 – Trial Balance Trial Balance – list of all general ledger accounts and their balances

LO 4 – Trial Balance (TB) Taken anytime – but three times are important Unadjusted TB - before making adjustments (Ch. 3) Adjusted TB - after making adjustments (Ch. 4) Could use TBs to prepare the financial statements Post-closing TB – after closing entries (Ch. 3) Accounts’ debit balances equal credit balances? Yes – proceed but errors can still exist – see Learning Objective 6 No – go back and find/fix the error

LO 5 – Closing Accounts Closing the accounts - background Adjustments (Ch. 4) must be made before closing Balance sheet accounts are “permanent” So long as a balance exists, they will be used from year to year, i.e. have a running balance so they are not closed Income statement accounts {Revenue, Expenses, (Gains, Losses – later)} and Dividends are “temporary” accounts Beginning of year - all have a zero balance End of year – if activity occurred, have balances

LO 5 – Closing Accounts Closing the accounts – the concept is to take all temporary accounts and Transfer all income statement account balances to a “collecting” account called Income Summary Transfer the Income Summary balance and Dividends balance to Retained Earnings which is a “permanent” stockholders’ equity account Balance remaining in temporary accounts should equal zero and thus be ready for the next accounting period’s transactions

LO 5 – Closing Accounts Cost of Goods Sold Bal. 100,000 Rent Expense Three Expense and one Revenue accounts need closing to get the ending balance to zero. WHAT NEEDS TO BE DONE? Cost of Goods Sold Bal. 100,000 Rent Expense Income Summary Sales Revenue Bal. 2,000 Bal. 160,000 Depreciation Expense Retained Income Bal 0 Bal. 100

LO 5 – Closing Accounts Three Expense and one Revenue accounts need closing to get the ending balance to zero) WHAT NEEDS TO BE DONE? Credit the Expense accounts; Debit Income Summary act Debit the Revenue account; Credit Income Summary account Determine the balance in the Income Summary account Close the Income Summary balance to Retained Earnings Cost of Goods Sold Bal. 100,000 Rent Expense Income Summary Sales Revenue Bal. 2,000 Bal. 160,000 Depreciation Expense Retained Income Bal. 0 Bal. 100

LO 5 – Closing Accounts Journal entries always precede entries to the ledger accounts Journal Entry: C1 Revenue 160,000 Income Summary 160,000 C2 Income Summary 102,100 Cost of goods sold 100,000 Rent expense 2,000 Depreciation expense 100

LO 5 – Closing Accounts Cost of Goods Sold Bal. 100,000 C2 100,000 Rent Expense Income Summary Sales Revenue Bal. 2,000 C2 2,000 C2 102,100 C1 160,000 C1 160,000 Bal. 160,000 Depreciation Expense Retained Income Bal 0 Bal. 100 C2 100

LO 5 – Closing Accounts Journal entries always precede entries to the ledger accounts Journal Entry: C3 Income Summary 57,900 Retained Earnings 57,900

LO 5 – Closing Accounts Cost of Goods Sold Bal. 100,000 C2 100,000 Rent Expense Income Summary Sales Revenue Bal. 2,000 C2 2,000 C2 102,100 C1 160,000 C1 160,000 Bal. 160,000 C3 57,900 Depreciation Expense Retained Income Bal. 0 Bal. 100 C2 100 C3 57,900 New bal. 57,900

LO 5 – Closing Accounts Close Dividends directly to Retained Earnings (Dividends are not part of income) C4 Retained Earnings 50 Dividends 50 Retained Earnings Dividends C2 102,100 C1 160,000 Bal. 50 C3 57,900 C4 50 C4 50 Bal. 57,850 After closing, four financial statements are prepared - As frequently as management desires - SEC – quarterly and annual reports

LO 6 - Errors Errors are multi-dimensional No entry is made when one should have been made If erroneous entry is made, could be Correct amounts to incorrect accounts Incorrect amounts to correct accounts Transaction omitted GAAP is misapplied Types of accounts involved Permanent – always open so correct anytime Temporary If accounts not closed, simple correction If accounts are closed, use Retained Earnings or just wait (self correcting after 2 years)

LO 6 - Errors Approach to correcting errors – an example What was recorded? Rent Expense 100 Cash 100 What should have been recorded? Prepaid Rent 100 Cash 100 Correcting entry depends on where we are in time? Made and discovered in same fiscal year Made in one fiscal year, discovered next fiscal year

LO 6 - Errors Made and discovered in same fiscal year, the temporary account Rent Expense is still open (not been closed to Retained Earnings) Prepaid Rent 100 Rent Expense 100 Made last year, discovered this year (Rent Expense was closed to Retained Earnings - Do nothing – after 2nd year, will be correct, or Prepaid Rent 100 Retained Earnings 100 - Then later, debit Rent Expense and credit Prepaid Rent

LO 6 - Errors Ledger (“T”) accounts – an analytical tool Information available (black); unavailable (purple) Accounts Receivable Cash Sales Revenue 4,000 Sales ? 6,000 280,000 280,000 Sales Revenue? - Assuming all sales were on credit, what was Sales Revenue? 4,000 + Sales Revenue – 280,000 = 6,000 Sales Revenue =282,000

LO 7 – Computers’ effect on Accounting Data Processing – hardware and software used to record, analyze, store, and report on activities In general, computers Increase Speed of processing data Accuracy of data/reports Reduce Processing costs (perhaps) Errors

LO 7 – Computers’ effect on Accounting Specific to accounting, computers Capture cost of goods sold and inventory changes Activate an order to a supplier Check credit limits and update accounts receivable Prepare invoices/statements to buyers Process journal entries and post to ledger accounts Prepare trial balances and financial statements Extensible Business Reporting Language (XBRL) Facilitate reporting and analyzing financial data