Accumulating Accounting Data CHAPTER F7 Accumulating Accounting Data © 2007 Pearson Custom Publishing

Identify the eight steps of the accounting cycle. Learning Objective 1 Identify the eight steps of the accounting cycle. © 2007 Pearson Custom Publishing

The Accounting Cycle The accounting cycle consists of a series of steps repeated in each accounting period that enable the firm to analyze, record, classify, and summarize the transactions into financial statements. © 2007 Pearson Custom Publishing

Steps of the Cycle Analyzing Transactions Journalizing Transactions Posting Transactions to the General Ledger Preparing a Trial Balance or Worksheet Adjusting the Accounts Preparing Financial Statements Preparing and Posting Closing Entries Preparing the Post-Closing Trial Balance © 2007 Pearson Custom Publishing

Step 1: Analyzing Transactions Part One: Determine when a transaction occurs. A transaction is any event that results in a change in the amount of an accounting element. Part Two: Identify the nature of the transaction. This entails determining which accounting elements were affected and by how much. © 2007 Pearson Custom Publishing

Step 2: Journalizing Transactions A journal is a book of original entry that contains a chronological list of an entity’s transactions. A special journal records specific types of transactions such as a sales, purchases, cash receipts or cash payments. A general journal records all transactions not recorded in a special journal. © 2007 Pearson Custom Publishing

Step 3: Posting to the Ledger A ledger contains all the accounts of a firm. A chart of accounts is a list of all of the accounts used by a company. After transactions are entered in the journal, the same information is then posted to the ledger accounts. The ledger accounts indicate the current balance for each account. © 2007 Pearson Custom Publishing

Step 4: Preparing a Trial Balance Periodically, usually weekly or monthly, a trial balance is prepared. A trial balance is a listing of all ledger accounts and their balances. The trial balance verifies that the accounting equation is in balance. © 2007 Pearson Custom Publishing

Using a Worksheet Another option for step 4 of the cycle is to prepare a worksheet. The worksheet is a ten column worksheet which begins with the trial balance. A worksheet helps accountants examine the accounts, adjust the accounts, and gather the data to prepare the financial statements. © 2007 Pearson Custom Publishing

Step 5: Adjusting the Accounts Some account balances require adjustment at the end of the accounting period, before the financial statements are prepared. Adjustments are needed to ensure the proper application of the revenue recognition and expense recognition rules. Many adjustments are accruals and deferrals studied in Chapter Six. © 2007 Pearson Custom Publishing

Reconciling the Bank Account Adjusting entries normally do not affect the cash account, except for one adjustment that is needed to change the cash balance to the correct amount as of the end of the period. A bank reconciliation is prepared to determine the appropriate cash balance as part of the firm’s internal control structure. © 2007 Pearson Custom Publishing

Step 6: Preparing Financial Statements After all of the balances in the general ledger accounts have been properly adjusted, the financial statements can be prepared. The income statement is prepared first, then the statement of retained earnings (or owners’ equity), then the balance sheet. © 2007 Pearson Custom Publishing

Step 7: Preparing Closing Entries Closing entries are prepared to reset the balance of temporary accounts to zero. Temporary (or nominal) accounts include all income statement accounts plus dividends or owner withdrawals. Temporary accounts are closed at the end of the period. Most balance sheet accounts are permanent (or real) accounts and are not closed. © 2007 Pearson Custom Publishing

Step 8: Preparing the Post-Closing Trial Balance After closing entries have been journalized and posted, only the balance sheet accounts should have a balance other than zero. A post-closing trial balance provides verification that the closing process was completed properly and also serves as a record of the beginning account balances for the next accounting period. © 2007 Pearson Custom Publishing

The Accounting Equation An accounting system is based on the following equation: Assets = Liabilities + Equity If one side of the equation is changed, the other side must also change, this is the basis of the double-entry system. © 2007 Pearson Custom Publishing

Learning Objective 2 Distinguish between debits and credits and apply them to the accounting equation. © 2007 Pearson Custom Publishing

Debits and Credits Two of the most familiar accounting terms are debits and credits. In the double-entry system, debits must always equal credits. Debit means the left side of the account and is abbreviated as DR. Credit means the right side of the account and is abbreviated as CR. © 2007 Pearson Custom Publishing

Normal Balance Accounts have a normal balance. Left = Right Assets = Liabilities + Equity Debit = Credit Remember there are five components of equity which have differing normal balances. © 2007 Pearson Custom Publishing

Normal Balances Assets = debits Liabilities = credits Owner’s contributions = credits Owner’s distributions = debits Revenues = credits Expenses = debits © 2007 Pearson Custom Publishing

A Debit Increases assets. Decreases liabilities. Decreases owner’s capital or capital stock accounts. Increases withdrawal or dividend accounts. Decreases revenues or gains. Increases expenses and losses. © 2007 Pearson Custom Publishing

A Credit Decreases assets. Increases liabilities. Increases owner’s capital or capital stock accounts. Decreases withdrawal or dividend accounts. Increases revenues or gains. Decreases expenses and losses. © 2007 Pearson Custom Publishing

Describe accounts, journals, ledgers, and worksheets. Learning Objective 3 Describe accounts, journals, ledgers, and worksheets. © 2007 Pearson Custom Publishing

The Account Each accounting element is represented by a separate account. The following information is required: Account name and number Date of each transaction Beginning balance for the period Each posted transaction from the journal including the date, reference, and amount Ending balance for the period © 2007 Pearson Custom Publishing

T-Accounts For illustration purposes, accountants will often use a T-account. A T-account is a simplified version of the real account format used in the accounting records. In a T-account, you can see the effect of various transactions on any particular account. Debits, credits, and balances can all be shown with clarity. © 2007 Pearson Custom Publishing

T-Account Format Any Account DEBIT (Left Side) CREDIT (Right Side) © 2007 Pearson Custom Publishing

T-Accounts for Assets ANY ASSET NORMAL BALANCE Debit Credit © 2007 Pearson Custom Publishing

T-Accounts for Liabilities ANY LIABILITY NORMAL BALANCE Credit Debit © 2007 Pearson Custom Publishing

T-Accounts for Owner’s Contributions or Capital Stock ANY OWNERS’ CONTRIBUTIONS OR CAPITAL STOCK NORMAL BALANCE Credit Debit © 2007 Pearson Custom Publishing

T-Accounts for Owner’s Withdrawals or Dividends ANY OWNERS’ WITHDRAWALS OR DIVIDENDS NORMAL BALANCE Credit Debit © 2007 Pearson Custom Publishing

T-Accounts for Revenues/Gains and Expenses/Losses ANY EXPENSE OR LOSS ANY REVENUE OR GAIN NORMAL BALANCE Debit NORMAL BALANCE Credit Credit Debit © 2007 Pearson Custom Publishing

Summarizing the Rules of Debits and Credits Normal Increase Decrease Balance Assets DR CR DR Liabilities CR DR CR Owners’ equity CR DR CR Revenues CR DR CR Expenses DR CR DR © 2007 Pearson Custom Publishing

Illustration Using T-Accounts Let’s use T-accounts to analyze the effect on the accounting elements of three basic business transactions. In each case, we will: Determine the accounts affected Apply the rules of debits and credits Enter the appropriate amount © 2007 Pearson Custom Publishing

Record transactions in journals and post them to the general ledger. Learning Objective 4 Record transactions in journals and post them to the general ledger. © 2007 Pearson Custom Publishing

Transaction #1 Record the initial sale of stock by a new corporation, 10,000 shares of no-par stock at $10 per share. CASH COMMON STOCK 100,000 100,000 © 2007 Pearson Custom Publishing

The new corporation purchased equipment for $20,000 cash. Transaction #2 The new corporation purchased equipment for $20,000 cash. EQUIPMENT CASH 20,000 20,000 © 2007 Pearson Custom Publishing

Transaction #3 The firm purchased supplies for $2,000 cash. SUPPLIES © 2007 Pearson Custom Publishing

Summary of the Cash Account After the first three transactions, the cash account would look like this: CASH 100,000 20,000 2,000 balance 78,000 © 2007 Pearson Custom Publishing

Journal Entries Remember that the T-accounts are for illustration purposes only. Real accounting systems rely on journal entries and ledger accounts. Entries are made in a journal to formally record each event for the company. Using the same three transactions, the journal will look like the example on the next slide. © 2007 Pearson Custom Publishing

© 2007 Pearson Custom Publishing

Posting to the Ledger After the journal entries are made, the debits and credits need to be posted to the appropriate ledger accounts on a periodic basis. The next slide will show the result of having posted the three transactions to the cash account. © 2007 Pearson Custom Publishing

Cash General Ledger Account © 2007 Pearson Custom Publishing

Compound Journal Entries Journal entries with more than two accounts affected are called compound journal entries. Assume we buy a $25,000 delivery truck with a $5,000 cash down payment. © 2007 Pearson Custom Publishing

Prepare trial balances and worksheets. Learning Objective 5 Prepare trial balances and worksheets. © 2007 Pearson Custom Publishing

Trial Balance Prepare a list of the entire general ledger accounts with their corresponding debit or credit balances. Total each column of debits and credits. The debit and credit totals should be equal. © 2007 Pearson Custom Publishing

Trial Balance Russell Jones Company Trial Balance December 31, 2007 Debits Credits Cash $125,000 Inventory 128,000 Accounts Payable $ 90,000 Jones, Capital 85,000 Jones, Withdrawals 45,000 Revenues 200,000 Expenses 77,000 Total $375,000 $375,000 © 2007 Pearson Custom Publishing

Prepare adjusting journal entries and reconcile a bank account. Learning Objective 6 Prepare adjusting journal entries and reconcile a bank account. © 2007 Pearson Custom Publishing

Adjusting Entries As discussed in Chapter 6, there are various accounts that require adjustment prior to the preparation of the financial statements. Example of adjustments include: accrued interest expense or revenue, accrued wages, deferred service revenues, and the like. These adjustments must be journalized. © 2007 Pearson Custom Publishing

Bank Reconciliation Along with the typical adjustments for accruals, deferrals, and depreciation, the bank statement needs to be analyzed for any additional adjustments. Typically, the cash account needs to be adjusted and the amount of the adjustment is determined by preparing a bank reconciliation. © 2007 Pearson Custom Publishing

Reconciling the Bank Statement Follow the steps as outlined on the bank reconciliation form. The bank statement balance is reconciled to a corrected bank balance. The balance per books (from the cash account in the general ledger) is reconciled to a corrected book balance. Both balances should be the same! © 2007 Pearson Custom Publishing

Bank Reconciliation - Top Half © 2007 Pearson Custom Publishing

Bank Reconciliation - Bottom Half © 2007 Pearson Custom Publishing

Prepare financial statements from a worksheet. Learning Objective 7 Prepare financial statements from a worksheet. © 2007 Pearson Custom Publishing

Preparing Financial Statements After all accounts have been adjusted, the financial statements can be prepared. At this point, you should be able to prepare the three financial statements shown in Chapter 6: (1) the income statement, (2) the statement of owner’s (stockholders’) equity, and (3) the balance sheet. © 2007 Pearson Custom Publishing

Prepare closing journal entries. Learning Objective 8 Prepare closing journal entries. © 2007 Pearson Custom Publishing

Closing the Accounts After the year-end financial statements have been prepared, the temporary (or nominal) accounts are closed. Closing an account means that the account will have a zero balance after the entry is journalized and posted. © 2007 Pearson Custom Publishing

Closing the Accounts Balance sheet accounts (permanent or real accounts) are not closed, their ending balance becomes the beginning balance for the next period. © 2007 Pearson Custom Publishing

Preparing Closing Entries There are four closing entries: Close all revenue accounts to Income Summary Close all expense accounts to Income Summary Close Dividends to Retained Earnings, or close Withdrawals to the Owners’ Capital account(s) Close Income Summary to Retained Earnings or to the Owners’ Capital account(s) © 2007 Pearson Custom Publishing

Trial Balance Before Closing Entries Russell Jones Company Trial Balance December 31, 2007 Debits Credits Cash $125,000 Inventory 128,000 Accounts Payable $ 90,000 Jones, Capital 85,000 Jones, Withdrawals 45,000 Revenues 200,000 Expenses 77,000 Total $375,000 $375,000 © 2007 Pearson Custom Publishing

Preparing the Closing Entries © 2007 Pearson Custom Publishing

Prepare a post-closing trial balance. Learning Objective 9 Prepare a post-closing trial balance. © 2007 Pearson Custom Publishing

Post-Closing Trial Balance The final step in the accounting cycle is to prepare a post-closing trial balance. Since the nominal accounts have all been closed, only the real accounts will appear in the post-closing trial balance. These account balances also serve as the opening balances for the next accounting period. © 2007 Pearson Custom Publishing

Post-Closing Trial Balance Russell Jones Company Post-Closing Trial Balance December 31, 2007 Debits Credits Cash $125,000 Inventory 128,000 Accounts Payable $ 90,000 Jones, Capital 163,000 Total $253,000 $253,000 © 2007 Pearson Custom Publishing

The End © 2007 Pearson Custom Publishing