Dr Cr Chapter 2 The Accounting Process

Chapter 2--Learning Objectives 1.Analyze transactions based upon the accounting equation

Accounting Equation Assets = Liabilities + Equity or Assets - Liabilities = Equity

Accounting Equation Assets = Liabilities + Equity Assets Have value Will generate future cash flows

Accounting Equation Assets = Liabilities + Equity Assets Factory building Equipment Accounts receivable

Accounting Equation Assets = Liabilities + Equity Liabilities Obligations Incurred to Acquire Assets

Accounting Equation Assets = Liabilities + Equity Liabilities Accounts Payable Salaries Payable Bonds Payable

Accounting Equation Assets = Liabilities + Equity Equity Owner Claim to Assets Assets - Liabilities

The Accounting Equation Assets = Liabilities + Equity Investments by Owners Distributions to Owners Revenues - Expenses Gains - Losses

Transactions & Events Affect Balance Sheet only Affect Balance Sheet & Earnings

Transactions affecting the balance sheet Investments by owners Distributions to owners Use assets to acquire other assets Use assets to extinguish debt Acquire assets by incurring debt

Accounting Equation Assets = Liabilities + Equity Example Purchased a Car for $22,000 Paid $5,000 down Signed a note for the balance

Effect on Accounting Equation Assets = Liabilities + Equity Car $22,000 Note $17,000 Cash ( 5,000) Assets $17,000 = Liab $17,000

Transactions affecting Earnings Earnings = Change in net assets, excluding investments by and distributions to owners Equity = Net assets Earnings increase equity Earnings = Revenues - Expenses + Gains - Losses Earnings increase equity through revenues, expenses, gains & losses

Chapter 2--Learning Objectives 2.Interpret the four traditional financial statements

Financial Statements 1.Income statement 2.Statement of changes in shareholders’ equity 3.Balance sheet 4.Statement of cash flows

Income Statement Elements _Revenues _Expenses _Gains _Losses For the accounting period }

Statement of changes in shareholders’ equity _Investments by owners _Distributions to owners _Net income or loss For the accounting period }

Balance Sheet Elements _Assets _Liabilities _Equity At the end of the accounting period }

Statement of cash flows _Investing activities _Financing activities _Operating activities For the accounting period }

Relationship of Financial Statements

Income Statement Statement of Owner’s Equity Balance Sheet Revenue + Gains - Expenses -Losses Net Income

Income Statement Balance Sheet Revenue + Gains - Expenses -Losses Net Income R/E Beginning Balance + Net Income - Dividends R/E Ending Balance } Statement of Owner’s Equity

Income Statement Balance Sheet Revenue + Gains - Expenses -Losses Net Income R/E BB + Net Income - Dividends R/E EB Statement of Owner’s Equity

Income Statement Balance Sheet Revenue + Gains - Expenses -Losses Net Income R/E BB + Net Income - Dividends R/E EB Statement of Owner’s Equity Assets Liabilities Equity

Income Statement Revenue + Gains - Expenses -Losses Net Income R/E BB + Net Income - Dividends R/E EB Statement of Owner’s Equity Balance Sheet Assets Liabilities Equity

Income Statement Revenue + Gains - Expenses -Losses Net Income R/E BB + Net Income - Dividends R/E EB Statement of Owner’s Equity Balance Sheet Assets Liabilities Equity

Income Statement Revenue + Gains - Expenses -Losses Net Income R/E BB + Net Income - Dividends R/E EB Statement of Owner’s Equity Balance Sheet Assets Liabilities Equity

Income Statement Revenue + Gains - Expenses -Losses Net Income R/E BB + Net Income - Dividends R/E EB Statement of Owner’s Equity Balance Sheet Assets Liabilities Equity

Income Statement Revenue + Gains - Expenses -Losses Net Income R/E BB + Net Income - Dividends R/E EB Statement of Owner’s Equity Balance Sheet Assets Liabilities Equity

Chapter 2--Learning Objectives 3.Understand the accounting model including the purpose of journals and ledgers

Journals Journals - Books of Original Entry –Record transactions or events i.e, Journal entries –In chronological order –Complete record of effects of transaction on accounts –Accounts and amounts debited /credited

Sample Transaction Paid $1,000 on Account to XYZ Supplies Journal Entry Accounts Payable1,000 Cash1,000

Ledgers Ledgers - Contain Accounts –General Ledger Contains accounts for financial statement elements

Posting From Journal to General Ledger Account

Journal Entry Accounts Payable1,000 Cash1,000 Accounts Payable Debit Credit 1,000 10,000 9,000

Types of Journal General Journals Special Journals

Cash Receipts Journal Cash Disbursements Journal Purchases Journal Sales Journal

Cash Receipts Journal Record All receipts of Cash –ie, deposits to the bank Examples: –Cash sales –Received Cash on account –Sold company truck for cash

Cash Disbursements Journal Record All payments of Cash –ie, checks written Examples: –Paid supplier on account –Purchased truck for cash –Made mortgage payment

Sales Journal Record All Sales on Account –When sale is made and no cash is received

Purchases Journal Record All Purchases of merchandise on Account –When purchases are made and no cash is paid –Purchases of items other than merchandise are recorded in the general journal

General Journal For All other Journal Entries Examples: –Adjusting –Closing –Sales & purchase returns

Chapter 2--Learning Objectives 4.Perform the steps in the accounting process

Inputs Source Docs Transactions Events Outputs Financial Statements Record Accumulate in Accounts Accounting Cycle

During the Accounting Period 1Identify transactions & events to record 2Journalize transactions & events 3Post from journals to ledgers

At the end of the accounting period 4Prepare Unadjusted Trial Balance 5Journalize & Post adjusting entries 6Prepare Adjusted Trial Balance 7Prepare Financial Statements 8Journalize & Post closing entries 9Prepare Post Closing Trial Balance

At beginning of next accounting period 10 Journalize & Post reversing entries

Adjusting Entries - Types uDeferrals uAccruals uEstimated Items uInventory

Deferrals uPrepaid Expenses uUnearned revenues

Typical Deferred Expenses uSupplies uPrepaid Rent Bookkeeping Approaches u Record transaction as expense u Record transaction as asset

Accounting Approach uOriginal debit to expense –Adjusting Entry Debit Prepaid Credit Expense

Example: u12/1/x1: Paid 3 month rent in advance, $3,000 uJournal Entry Rent Expense 3,000 Cash3,000

Year End - 12/31 u$1,000 has expired = Expense u$2,000 is unexpired = Asset

Have on BooksWant on Books Rent Expense 3,000 Rent Expense 1,000 Prepaid Rent 2,000

Adjustment Rent Expense 3,000 Prepaid Rent 2,000 Adjusting Entry Prepaid Rent2,000 Rent Expense2,000 1,000

Accounting Approach uOriginal debit to Asset –Adjusting Entry Debit Expense Credit Prepaid

Example: u12/1/x1: Paid 3 month rent in advance, $3,000 uJournal Entry Prepaid Rent 3,000 Cash3,000

Year End - 12/31 u$1,000 has expired = Expense u$2,000 is unexpired = Asset

Have on BooksWant on Books Prepaid Rent 3,000 Rent Expense 1,000 Prepaid Rent 2,000

Adjustment Prepaid Rent 3,000 Rent Expense 1,000 Adjusting Entry Rent Expense1,000 Prepaid Rent1,000 2,000

Unearned Revenues uObligations to perform services for which money has already been received

Typical Unearned Revenues uRent Received in Advance uSubscriptions Received in Advance Bookkeeping Approaches u Record transaction as revenue u Record transaction as liability

Accounting Approach uOriginal credit to Revenue –Adjusting Entry Debit Revenue Credit Unearned Revenue

Example: u12/1/x1: Received 3 month rent in advance, $3,000 uJournal Entry Cash 3,000 Rental Revenue 3,000

Year End - 12/31 u$1,000 is earned = Revenue u$2,000 is unearned = Liability

Have on BooksWant on Books Rental Revenue 3,000 Rental Revenue 1,000 Rent Received in Advance 2,000

Adjustment Rental Revenue 3,000 Rent Received in Advance 2,000 Adjusting Entry Rental Revenue2,000 Rent Rec’d in Adv2,000 1,000

Accounting Approach uOriginal credit to Liability –Adjusting Entry Debit Liability Credit Revenue

Example: u12/1/x1: Received 3 month rent in advance, $3,000 uJournal Entry Cash3,000 Rent Received in Advance3,000

Year End - 12/31 u$1,000 in earned = Revenue u$2,000 is unearned = Liability

Have on BooksWant on Books Rent Rec’d in Advance 3,000 Rental Revenue 1,000 Rent Rec’d in Advance 2,000

Adjustment Rent Rec’d in Advance 3,000 Rental Revenue 1,000 Adjusting Entry Rent Rec in Adv1,000 Rental Revenue1,000 2,000

Accruals uAccrued Expenses –Payables uAccrued Revenues –Receivables

Typical Accrued Expenses uSalaries Payable uInterest payable uTaxes Payable

Most Common Accrued Revenue uInterest Receivable

Typical Estimated Items uDepreciation uBad Debt Expense uPension Expense

Inventory Adjustment uClose Beginning Inventory uClose Purchases uInsert Ending Inventory uDifference = Cost of Goods Sold

Cost of Goods Sold Beginning Inventory + Purchases Goods available for Sale - Ending Inventory Cost of Goods Sold

Example uBeginning Inventory10,000 uPurchases95,000 uEnding Inventory 7,000

Cost of Goods Sold Beg Inv 10,000 + Purchases 95,000 Available105,000 - End Inv 7,000 CGS 98,000

Have on BooksWant on Books Inventory 10,000 Inventory 7,000 Cost of Goods Sold 98,000 Purchases 95,000

Inventory 10,000 Purchases 95,000 CGS

Inventory10,000Purchases 95,000 CGS

Inventory10,000Purchases 95,000 CGS

Inventory10,000Purchases95,000CGS

Inventory 10,000 Purchases 95,000 CGS

Inventory 10,000 Purchases 95,000 CGS 7,000 7,000

Inventory 10,000 Purchases 95,000 CGS 7,000 98,000

Inventory 10,000 Purchases 95,000 CGS Inventory10,000 Account DebitCredit

InventoryPurchases95,000CGS Inventory10,000 Purchases95,000 Account DebitCredit

InventoryPurchasesCGS Inventory10,000 Purchases95,000 7,000 Inventory 7,000 Cost of Goods Sold 98,000 Account DebitCredit

InventoryPurchasesCGS Inventory10,000 Purchases95,000 10,000 Inventory 7,000 Cost of Goods Sold 98,000 10,000 7,000 95,000 7,000 95,000 98,000 Account DebitCredit

Balance Sheet Assets Liabilities Equity Closing the Books The only thing left Permanent Accounts

Income Statement R/E EB Statement of Owner’s Equity R/E BB + Net Income - Dividends Revenue + Gains - Expenses -Losses Net Income TemporaryTemporary

Income Statement R/E EB Statement of Owner’s Equity R/E BB + Net Income - Dividends Revenue + Gains - Expenses -Losses Net Income Close to R/E

Closing uClose all income statement accounts to the Income Summary uClose Income Summary to R/E uClose Dividends to R/E

Adjusted Trial Balance Debits Current Assets 40,000 Investments 15,000 Plant Assets 90,000 Dividends 2,000 CGS 45,000 Adm Expenses 11,000 Selling Expense14,000 Interest Expense 4,000 Total221,000 Credits Current Liabs 15,000 Long Term Liabs 65,000 Common Stock 27,000 Retained Earnings 6,000 Net Sales 100,000 Interest Revenue 8,000 Total 221,000

Close Income Statement Accounts DebitCredit Net Sales Net Sales 100, ,000 Interest Revenue 8,000 8,000 CGS 45,000 Admin Expenses 11,000 11,000 Selling Expense 14,000 14,000 Interest Expense Interest Expense 4,000 4,000 Income Summary 34,000 34,000

Close Income Summary Account DebitCredit Income Summary Income Summary 34,000 34,000 Retained Earnings 34,000 34,000

Close Dividends DebitCredit Retained Earnings Retained Earnings 2,000 2,000 Dividends

Income Summary 34,000 38,000 Retained Earnings 6,000 34,000 0 Dividends 2,000 38,000

Reversing Entries  Reverse certain adjusting entries  Dated: Beginning of next accounting period  Facilitate the bookkeeping process

What entries to reverse?  All Accruals  Those deferrals that increased balance sheet accounts –i.e., returns amounts to expense & revenue accounts

Accrual Example  Salaries are $1,000/day. The year ended on Tuesday. Salaries are paid each Monday for the previous week.  Year end adjustment (for 2 days) Salary Expense2,000 Salaries Payable2,000

Accounting Approaches  Make reversing entry  Don’t make reversing entry

Payment of the Salaries: Assume no reversing entry is made  When the salaries are paid the following Monday Salaries Payable2,000 Salary Expense3,000 Cash 5,000

Salary ExpenseSalaries Payable 2,000 At year end Adjusting Entry

Salary ExpenseSalaries Payable 2,000 Closing Entry

Salary ExpenseSalaries Payable 2,000 Beginning of next accounting period

Salary ExpenseSalaries Payable 2,0003,0002,000 Pay Salaries

Salary ExpenseSalaries Payable 3,000 Account balances after payment

Assume instead: The following reversing entry was made Salaries Payable2,000 Salary Expense2,000

Payment of the Salaries When the salaries are paid the following Monday Salary Expense5,000 Cash 5,000

Salary ExpenseSalaries Payable 2,000 At year end Adjusting Entry

Salary ExpenseSalaries Payable 2,000 Closing Entry

Salary ExpenseSalaries Payable 2,000 Beginning of next accounting period Reversing Entry

Salary ExpenseSalaries Payable 2,000 3,000 5,000 Pay Salaries End result is the same

Deferrals Adjusting Entry Increases Asset or Liability Reverse Adjusting Entry Decreases Asset or Liability Don’t Reverse

Deferrals: Example - Deferred Expenses Original = Debit to Expense Adjusting Entry Debit Prepaid Credit Expense –Reverse Original = Debit to Asset Adjusting Entry Debit Expense Credit Prepaid –Don’t Reverse

Example:  12/1/x1: Paid 3 month rent in advance, $3,000  Original entry to expense  Journal Entry Rent Expense 3,000 Cash3,000

Adjustment Adjusting Entry Prepaid Rent2,000 Rent Expense2,000 Rent Expense 3,000 Prepaid Rent 2,000 1,000

Year End Balances Closing Entry Rent Expense 1,000 Prepaid Rent 2,000 1,000

Beginning of Next Year Reversing Entry Rent ExpensePrepaid Rent 2,000

Example:  12/1/x1: Paid 3 month rent in advance, $3,000  Original entry to asset  Journal Entry Prepaid 3,000 Cash3,000

Adjustment Adjusting Entry Rent Expense1,000 Prepaid Rent1,000 Prepaid 3,000 Rent Expense 1,000 2,000

Year End Balances Closing Entry Rent Expense 1,000 Prepaid Rent 2,000 1,000

Beginning of Next Year Don’t Reverse Rent ExpensePrepaid Rent 2,000

Exercise Given: Adjusting Entries Determine whether each AJE relates to –Accrual (A) – Deferral (D) If a deferral, Did the entry Increase a Balance Sheet Account? Reverse AJE?

SALARY EXPENSE SALARIES PAYABLE Accrual (A)or Deferral (D) Reverse?YesorNo

SUPPLIES EXPENSE SUPPLIES Accrual (A)or Deferral (D) Increase Balance Sheet Account? YesorNo Reverse?YesorNo

SUPPLIES SUPPLIES EXPENSE Accrual (A)or Deferral (D) Increase Balance Sheet Account? YesorNo Reverse?YesorNo

INTEREST EXPENSE INTEREST PAYABLE Accrual (A)or Deferral (D) Reverse?YesorNo

RENT RECEIVED IN ADVANCE RENTAL REVENUE Accrual (A)or Deferral (D) Increase Balance Sheet Account? YesorNo Reverse?YesorNo

RENTAL REVENUE RENT RECEIVED IN ADVANCE Accrual (A)or Deferral (D) Increase Balance Sheet Account? YesorNo Reverse?YesorNo

Other Adjusting Entries  Estimated Items  Cost of Goods Sold  Should they be reversed? NEVER

DEPRECIATION EXPENSE ACCUMULATED DEPRECIATION Reverse?YesorNo Estimated Item Never Reverse

INVENTORY COST OF GOODS SOLD PURCHASES Reverse?YesorNo Cost of Goods Sold Never Reverse