Understanding The Recording Process

Typical Chart of Accounts Long-Term Liabilities (220-239) 222 Mortgage Payable OWNERS’ EQUITY (300-399) 301 Capital Stock 330 Retained Earnings SALES (400-499) 400 Sales Revenue EXPENSES (500-599) 500 Cost of Goods Sold 523 Rent Expense 528 Advertising Expense 573 Utility Expense ASSETS (100-199) Current Assets (100-150) 101 Cash 105 Accounts Receivable 107 Inventory Long-Term Assets (151-199) 151 Land 152 Building LIABILITIES (200-299) Current Liabilities (200-219) 201 Notes Payable 202 Accounts Payable

Recording Process Recording Process Step 1 Business documents analyzed Transactions recorded in journals Step 3 Transactions posted to ledgers Recording Process

Overview of the Accounting Process Continued from previous slide Step 4 Trial balance Work sheet (optional) Steps in the Reporting Phase Step 5 Adjustments Continued

Overview of the Accounting Process Step 6 Financial statements Step 7 Adjustments Steps in the Reporting Phase Step 8 Post-closing trial balance (optional)

1. Analyzing Business Documents Transactions are the exchange of goods or services between entities, as well as other events that have an economic impact on a business. Business documents are records that are evidence of transactions.

2. Journalizing Transactions A journal is an accounting record in which business transactions are entered in chronological order. Journal entries record transaction information; debits equal credits. General Journal Entry Format Date Debit Entry.................................. xx Credit Entry............................. xx Explanation.

2. Journalizing Transactions Every journal entry involves a three-step process: Identify the accounts involved with an event or transaction. Determine whether each account increased or decreased. Determine the amount by which each account was affected.

Debits and Credits Assets = Liabilities + Owners’ Equity DR CR DR CR DR CR (+) (–) (–) (+) (–) (+) Capital Stock DR CR (–) (+) Retained Earnings DR CR (–) (+) Continued

Debits and Credits DR CR (–) (+) Expenses DR CR (+) (–) Revenues DR CR Retained Earnings DR CR (–) (+) Expenses DR CR (+) (–) Revenues DR CR (–) (+) Dividends DR CR (+) (–)

General Journal Page 24 2005 Post Ref. Date Description Debits Credits July 1 Dividends 330 25,000 Dividends Payable 260 25,000 Declared semiannual cash dividend on common stock. 10 Equipment 180 7,500 Notes Payable 220 7,500 Issued note for new equipment .

Example: Journal Entry On January 2, sold merchandise costing $60 to a customer on account for $75. Make the journal entry.

Example: Journal Entry On January 2, sold merchandise costing $60 to a customer on account for $75. Make the journal entry. This entry assumes that the perpetual system is used. Jan. 2 Accounts Receivable..................... 75 Sales Revenue.......................... 75 Sold merchandise on account. 2 Cost of Goods Sold...................... 60 Inventory................................. 60 To record cost and reduce inventory.

3. Posting to the Ledger Accounts Posting is the process of transferring amounts from the journal to the general ledger. A ledger is a collection of accounts in which data from transactions recorded in the journals are posted, classified, and summarized. A chart of accounts lists all accounts used by the company.

3. Posting to the Ledger Accounts The Equipment account in the general ledger after the purchase of July 10 (Slide 9) has been posted would appear as follows: Account EQUIPMENT Account No: 180 Date Item PR Debit Credit Balance 2005 July 1 Balance  10,550 10 Purchase Equipment J24 7,500 18,050 To examine the journal entry, click this button to go to Slide 9. To return, click on the word “July” in the entry on Slide 9.

Reporting Phase 4. A trial balance is prepared. 5. Adjusting entries are recorded. 6. Financial statements are prepared. 7. Closing entries are made. 8. A post-closing trial balance is prepared (optional).

4. Preparing a Trial Balance Determine the account balance for each T-Account. A trial balance is a list of all accounts and their balances. It provides a means to assure that debits equal credits.

XYZ Company Trial Balance December 31, 2005 Debits Credits Cash $ 21 Accounts Receivable 15 Inventory 12 Land 200 Accounts Payable $ 30 Capital Stock 150 Retained Earnings 24 Sales Revenue 919 Cost of Goods Sold 850 Advertising Expense 10 Misc. Expenses 15 ______ Total $ 1,123 $ 1,123

Illustration October 1, C.R Byrd invests $10,000 cash in an advertising venture to be known as the Pioneer Advertising Agency Oct. 1 Cash C.R.Byrd, Capital (Invested cash in business) 1 40 10,000 October 1, office equipment costing $5,000 is purchased by signing a 3-month, 12%, $5,000 note payable. Oct. 1 Office equipment Notes payable (Issued 3-month, 12%, note for office equipment) 15 25 5,000 October 2, a $1,200 cash advance is received from R. Knox, a client, for advertising services that are expected to be completed.

Illustration Oct. 2 Cash Unearned Fees (Received advance from R.Knox for future service) 1 28 1,200 October 3, office rent for October is paid in cash, $900 Oct. 3 Rent Expense Cash (Paid October Rent) 62 1 900 October 4, $600 is paid for a one-year insurance policy that will expire next year on September 30. Oct. 4 Prepaid Insurance Cash (Paid one-year policy; effective date October 1) 10 1 600

Illustration October 5, an estimated 3-month supply of advertising materials is purchased on account from Aero Supply for $2,500 Oct. 5 Advertising Supplies Account Payable (Purchased supplies on account from Aero Supply) 8 26 2,500 October 9, hire four employees to begin work on October 15. each employee is to receive a weekly salary of $500 for a 5-day work week, payable every 2 weeks – first payment made on October 26. A business transaction has not occurred. There is only an agreement between the employer and the employees to enter into a business. October 20, C.R. Byrd withdraw $500 cash for personal use. Oct. 20 C.R. Byrd, Drawing Cash (Withdraw cash for personal use) 41 1 500

Illustration October 26, employee salaries of $4,000 are owed and paid in cash. (See October 9 transaction) Oct. 26 Salaries Expense Cash (Paid salaries to date) 60 1 4,000 October 31, received $10,000 in cash from Copa Company for advertising services rendered in October. Oct. 31 Cash Fees Earned (Received cash for fees earned) 41 1 500

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 1 2 3 4 CASH Date Explanation Ref Debit Credit Balance Oct. 1 2 3 4 20 26 31 J1 10,000 1,200 900 600 500 4,000 11,200 10,300 9,700 9,200 5,200 15,200 ADVERTISING SUPPLIES NO 8 Date Explanation Ref Debit Credit Balance Oct. 5 J1 2,500 Prepaid Insurance NO 10 Date Explanation Ref Debit Credit B3alance Oct. 4 J1 600

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 1 J1 Office Equipment No. 15 Date Explanation Ref Debit Credit Balance Oct. 1 J1 5,000 Notes Payable NO 25 Date Explanation Ref Debit Credit Balance Oct. 1 J1 5,000 Account Payable NO 26 Date Explanation Ref Debit Credit Balance Oct. 5 J1 2,500 Unearned Fees NO 28 Date Explanation Ref Debit Credit Balance Oct. 2 J1 1,200

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 1 J1 C.R. Byrd, Capital No. 40 Date Explanation Ref Debit Credit Balance Oct. 1 J1 10,000 C.R. Byrd, Drawing NO 41 Date Explanation Ref Debit Credit Balance Oct. 20 J1 500 Fees Earned NO 50 Date Explanation Ref Debit Credit Balance Oct. 31 J1 10,000 Salaries Expense NO 60 Date Explanation Ref Debit Credit Balance Oct. 26 J1 4,000

PIONEER ADVERTISING AGENCY ACCOUNTS GENERAL LEDGER Rent Expense NO 62 Date Explanation Ref Debit Credit Balance Oct. 3 J1 900 PIONEER ADVERTISING AGENCY ACCOUNTS 1-19 = Assets Accounts 20 – 39 = Liabilities 40 – 49 = Owner’s Equity 50 – 59 = Revenues 60 – 69 = Expenses

PIONEER ADVERTISING AGENCY TRIAL BALANCE OCTOBER 31, 2010 DEBIT CREDIT Cash $ 15,200 Advertising Supplies 2,500 Prepaid Insurance 600 Office Equipment 5,000 Notes Payable $ 5,000 Accounts Payable Unearned Fees 1,200 C.R. Byrd, Capital 10,000 C.R. Byrd, Drawing 500 Fees Earned Salaries Expense 4,000 Rent Expense 900 $28,700 =======

5. Preparing Adjusting Entries Adjusting entries are required at the end of each accounting period for accrual- basis accounting, prior to preparing the financial statements. The purpose for adjusting entries are to: bring balance sheet accounts current. reflect proper amounts of revenues, costs, and expenses on the income statement.

Tips Regarding Adjusting Entries Analytical Process. You must determine what original entry was made (if any) and what the ending balances should be before you know what adjusting entry to make. You cannot memorize adjusting entries. Adjusting entries always incorporate a balance sheet account and an income statement account. Adjusting entries never involve a cash account.

Most Common Adjusting Entries Unrecorded Revenues—Revenues that have been earned but not yet recorded. Unearned Revenues—Revenues that have been recorded but not yet earned. Unrecorded Expenses—Expenses that have been incurred but not yet recorded. Prepaid Expenses—Expenses that have been recorded but not yet incurred.

Three-Step Process for Adjusting Entries 1. Identify the original entries that were made, if any. Original entries are only made for unearned revenues and prepaid expenses. 2. Determine what the correct balances should be at this point in time. 3. Make the adjustments needed to bring the balances to the desired amounts.

Asset Depreciation Rosi, Inc. purchased buildings in 2000 at a cost of $156,000, an expected life of 20 years, and no anticipated residual value. Each year, 5% of the cost is depreciated. At the end of 2005, the following adjusting entry is made: Adjusting Entry 12/31 Depreciation Expense—Buildings 7,800 Accumulated Depr.—Buildings 7,800 To record depreciation on building at 5% per year.

Bad Debts An estimation of bad debts based on the ending receivables balance reveals that the allowance account needs to be increased by $1,100. Adjusting Entry 12/31 Bad Debts Expense 1,100 Allowance for Bad Debts 1,100 To adjust for estimated bad debts expense.

Bad Debts Later, on March 19 that a $150 receivable is deemed to be uncollectible. Using the allowance account, the uncollectible account is written off the books. 3/19 Allowance for Bad Debts 150 Accounts Receivable 150 To write off an uncollectible account. Note that this entry is not an adjusting entry. It is made when the account is determined to be uncollectible.

Accrued Expenses At the end of the fiscal period, Rosi, Inc. had accrued salaries and wages totaling $2,150. Adjusting Entry 12/31 Salaries and Wages Expense 2,150 Salaries and Wages Payable 2,150 To record accrued salaries and wages.

Accrued Revenues Rosi, Inc. holds a note receivable from a customer on which interest total $250 has accrued. Adjusting Entry 12/31 Interest Receivable 250 Interest Revenue 250 To record accrued interest on a note receivable.

Original debit to an asset account Prepaid Expenses Rosi, Inc.’s trial balance shows that the asset account Prepaid Insurance has a balance of $8,000. By December 31, only $3,800 applies to future periods. Adjusting Entry 12/31 Insurance Expense 4,200 Prepaid Insurance 4,200 To record expired insurance. $8,000 – $3,800 Original debit to an asset account

Original debit to an expense account Prepaid Expenses Rosi, Inc.’s trial balance shows that the asset account Insurance Expense has a balance of $8,000. By December 31, $3,800 applies to future periods. Adjusting Entry 12/31 Prepaid Insurance 3,800 Insurance Expense 3,800 To record expired insurance. $8,000 – $4,200 Original debit to an expense account

Original credit to a revenue account Deferred Revenues Rosi, Inc. receives a payment of $2,550 from a customer prior to the services being rendered. By December 31, $2,075 in services have been provided. $2,550 – $2,075 Adjusting Entry 12/31 Rent Revenue 475 Unearned Rent Revenue 475 To record unearned rent revenue. Original credit to a revenue account

Original credit to a liability account Deferred Revenues Rosi, Inc. receives a payment of $2,550 from a customer prior to the services being rendered. By December 31, $2,075 in services have been provided. $2,550 – $475 Adjusting Entry 12/31 Unearned Rent Revenue 2,075 Rent Revenue 2,075 To record rent revenue. Original credit to a liability account