Review of a Company’s Accounting System C hapter 3 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University

2 1.Understand the components of an accounting system. 2.Know the major steps in the accounting cycle. 3.Prepare journal entries in the general journal. 4.Post to the general ledger and prepare a trial balance. 5.Prepare adjusting entries. 6.Prepare financial statements. Objectives

3 7.Prepare closing entries. 8.Complete a worksheet (spreadsheet). 9.Prepare reversing entries 10.Use subsidiary ledgers. 11.Understand special journals. 12.Convert cash-basis financial statements to accrual-basis (Appendix).

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

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

6 = Liabilities Debts Accounting Equation Liabilities are obligations or debts. A liability is a present obligation for a future sacrifice as a result of a past transaction.

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

8 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

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

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

11 Title Account title Accounts

12 Title Debit “Debit” refers to the left side. Accounts

13 Title DebitCredit Credit refers to the right side. Accounts

14 In the double-entry system, for each transaction that a company records, the total dollar amount of the debits entered in all the related accounts must equal the total dollar amount of the credits. Accounts

15 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

16 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

17 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

18 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

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

20 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.

21 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.

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

23 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

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. 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

25 After posting, the general ledger accounts contain the same information as in the general journal, just in a different format.

26 Cash 1/120,0001/163,000 4/28,0003/3010,840 12/1450 3/ /22,000 4/87,300 7/153,300 10/11,800 12/ /29500 Balance2,922 Ledger T Account The balance of each permanent account is calculated. Determine the account balance.

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

28 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

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

30 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

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

32 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.

33 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.

34 3/ Prepaid Insurance 12/31 Adj. 270 Insurance Expense By December 31, nine months of the policy had expired. By December 31, nine months of the policy had expired. Balance 90 Adjusting Entries

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

36 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.

37 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.

38 12/31 Adj. 150 Unearned Rent 12/ /31 Adj.150 Rent Revenue This entry is posted to the ledger. Balance 300 Adjusting Entries

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

40 10/11,800 Salaries Expense 12/31 Adj.900 Salaries Payable Next, the adjusting entry is posted. 12/31 Adj.900 Adjusting Entries

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

42 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.

43 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

44 Remaining Adjusting Entries

45 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.

46 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.

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

48 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

49 Income Statement

50 Retained Earnings Statement

51 Balance Sheet

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

53 Closing entries (1) reduce the balance in each temporary account to zero, and... …(2) update the retained earnings and inventory accounts.

54 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

55 The following slide shows how the closing entries “closed” the temporary accounts. Closing Entries

56 Closing Entries

57 Sales Returns Sales Returns and Allowances500 Accounts Receivable500 OR debit Sales directly Sales500 Accounts Receivable500

58 Periodic Inventory System Inventory, January 1, 2010$ 0 Purchases12,600 Purchases returns and allowances(300) Purchases discounts(100) Cost of goods available for sale$12,200 Less: Inventory, December 31, 2010 (2,140) Cost of goods sold$10,060

59 A worksheet is prepared to facilitate preparing adjusting entries, closing entries, and the financial statements. Worksheet

60 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

61 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: REVERSING ENTRY General Guidelines for Reversing Entries

62 Reversing Accrued Revenues

63 Reversing Accrued Expenses

64 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

65 Subsidiary Ledgers

66  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

67 Cash-basis accounting is used by small retail stores and professionals such as dentists, doctors, and architects. Appendix: Cash-Basis Accounting

68 Under cash-basis accounting, a company records revenues when cash is collected and records expenses when cash is paid. Appendix: Cash-Basis Accounting

69 Cash Basis Collections from customers + Ending accounts receivable – Beginning accounts receivable = Sales revenue AdjustmentsAccrual Basis Payments to suppliers = Cost of goods sold + Beginning inventory – Ending inventory + Ending accounts payable – Beginning accounts payable Payments for other operating costs = Operating expenses (except depreciation) + Beginning prepaid expenses – Ending prepaid expenses + Ending accrued expenses – Beginning accrued expenses Appendix: Cash-Basis Accounting

70 C hapter 3 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.