Post on 24-Dec-2015
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 OwnersDistributions to Owners
Revenues - ExpensesGains - 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 StatementElements
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 SheetElements
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 TransactionPaid $1,000 on Account to XYZ Supplies
Journal Entry
Accounts Payable 1,000
Cash 1,000
Ledgers
• Ledgers - Contain Accounts– General Ledger
• Contains accounts for financial statement elements
Posting • From Journal to General Ledger Account
Journal Entry
Accounts Payable 1,000
Cash 1,000
Accounts Payable
Debit Credit
1,00010,000
9,000
Types of Journal
• General Journals
• Special 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
1 Identify transactions & events to record
2 Journalize transactions & events
3 Post from journals to ledgers
At the end of the accounting period
4 Prepare Unadjusted Trial Balance
5 Journalize & Post adjusting entries
6 Prepare Adjusted Trial Balance
7 Prepare Financial Statements
8 Journalize & Post closing entries
9 Prepare Post Closing Trial Balance
At beginning of next accounting period
10 Journalize & Post reversing entries
Adjusting Entries - Types
Deferrals Accruals Estimated Items Inventory
Deferrals
Prepaid Expenses Unearned revenues
Typical Deferred Expenses
Supplies Prepaid Rent
Bookkeeping Approaches
Record transaction as expense
Record transaction as asset
Accounting Approach
Original debit to expense– Adjusting Entry
Debit Prepaid
Credit Expense
Example:
12/1/x1: Paid 3 month rent in advance, $3,000
Journal Entry
Rent Expense 3,000
Cash 3,000
Year End - 12/31
$1,000 has expired = Expense $2,000 is unexpired = Asset
Have on Books Want on Books
Rent Expense
3,000
Rent Expense
1,000
Prepaid Rent
2,000
Adjustment
Rent Expense
3,000
Prepaid Rent
2,0002,000
Adjusting Entry
Prepaid Rent 2,000
Rent Expense 2,000
1,000
Accounting Approach
Original debit to Asset– Adjusting Entry
Debit Expense
Credit Prepaid
Example:
12/1/x1: Paid 3 month rent in advance, $3,000
Journal Entry
Prepaid Rent 3,000
Cash 3,000
Year End - 12/31
$1,000 has expired = Expense $2,000 is unexpired = Asset
Have on Books Want on Books
Prepaid Rent
3,000
Rent Expense
1,000
Prepaid Rent
2,000
Adjustment
Prepaid Rent
3,000
Rent Expense
1,0001,000
Adjusting Entry
Rent Expense 1,000
Prepaid Rent 1,000
2,000
Unearned Revenues
Obligations to perform services for which money has already been received
Typical Unearned Revenues
Rent Received in Advance Subscriptions Received in Advance
Bookkeeping Approaches
Record transaction as revenue
Record transaction as liability
Accounting Approach
Original credit to Revenue– Adjusting Entry
Debit Revenue
Credit Unearned Revenue
Example:
12/1/x1: Received 3 month rent in advance, $3,000
Journal Entry
Cash 3,000
Rental Revenue 3,000
Year End - 12/31
$1,000 is earned = Revenue $2,000 is unearned = Liability
Have on Books Want 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
2,0002,000
Adjusting Entry
Rental Revenue 2,000
Rent Rec’d in Adv 2,000
1,000
Accounting Approach
Original credit to Liability– Adjusting Entry
Debit Liability
Credit Revenue
Example:
12/1/x1: Received 3 month rent in advance, $3,000
Journal Entry
Cash 3,000
Rent Received
in Advance 3,000
Year End - 12/31
$1,000 in earned = Revenue $2,000 is unearned = Liability
Have on Books Want 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
1,0001,000
Adjusting Entry
Rent Rec in Adv 1,000
Rental Revenue 1,000
2,000
Accruals
Accrued Expenses– Payables
Accrued Revenues– Receivables
Typical Accrued Expenses
Salaries Payable Interest payable Taxes Payable
Most Common Accrued Revenue
Interest Receivable
Typical Estimated Items
Depreciation Bad Debt Expense Pension Expense
Inventory Adjustment
Close Beginning Inventory Close Purchases Insert Ending Inventory Difference = Cost of Goods Sold
Cost of Goods Sold
Beginning Inventory+ Purchases
Goods available for Sale
- Ending Inventory
Cost of Goods Sold
Example
Beginning Inventory 10,000 Purchases 95,000 Ending Inventory 7,000
Cost of Goods Sold
Beg Inv 10,000+ Purchases 95,000
Available 105,000
- End Inv 7,000
CGS 98,000
Have on Books Want on Books
Inventory
10,000
Inventory
7,000
Cost of Goods Sold
98,000Purchases
95,000
Inventory
10,000
Purchases
95,000
CGS
Inventory
10,000
Purchases
95,000
CGS
Inventory
10,000
Purchases
95,000
CGS
Inventory
10,000
Purchases
95,000
CGS
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
7,000
98,000
Inventory
10,000
Purchases
95,000
CGS
Inventory 10,000
Account Debit Credit
Inventory Purchases
95,000
CGS
Inventory 10,000Purchases 95,000
Account Debit Credit
Inventory Purchases CGS
Inventory 10,000Purchases 95,000
7,000
Inventory 7,000Cost of Goods Sold
98,000
98,000
Account Debit Credit
Inventory Purchases CGS
Inventory 10,000Purchases 95,000
10,000
Inventory 7,000Cost of Goods Sold
98,000
98,000
10,0007,000
95,000
7,000
95,000
98,000
Account Debit Credit
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
Temporary
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
Close all income statement accounts to the Income Summary
Close Income Summary to R/E Close Dividends to R/E
Adjusted Trial BalanceDebits
Current Assets 40,000
Investments 15,000
Plant Assets 90,000
Dividends 2,000
CGS 45,000
Adm Expenses 11,000
Selling Expense 14,000
Interest Expense 4,000
Total 221,000
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
Debit Credit
Net SalesNet Sales 100,000100,000Interest RevenueInterest Revenue 8,0008,000
CGSCGS 45,00045,000Admin ExpensesAdmin Expenses 11,00011,000
Selling ExpenseSelling Expense 14,00014,000
Interest ExpenseInterest Expense 4,0004,000
Income SummaryIncome Summary 34,00034,000
Close Income Summary Account
Debit Credit
Income SummaryIncome Summary 34,00034,000
Retained EarningsRetained Earnings 34,00034,000
Close Dividends
Debit Credit
Retained EarningsRetained Earnings 2,0002,000
DividendsDividends 2,0002,000
Income Summary
34,000
38,000
Retained Earnings
6,000
34,000
0
Dividends
2,000
2,000
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 Expense 2,000
Salaries Payable 2,000
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 Payable 2,000
Salary Expense 3,000
Cash 5,000
Salary Expense Salaries Payable
2,000 2,000
At year end
Adjusting Entry
Salary Expense Salaries Payable
2,000 2,0002,000
Closing Entry
Salary Expense Salaries Payable
2,000
Beginning of next accounting period
Salary Expense Salaries Payable
2,0003,000 2,000
Pay Salaries
Salary Expense Salaries Payable
3,000
Account balances after payment
Assume instead:The following reversing entry was made
Salaries Payable 2,000
Salary Expense
2,000
Payment of the Salaries
• When the salaries are paid the following Monday
Salary Expense 5,000
Cash
5,000
Salary Expense Salaries Payable
2,000 2,000
At year end
Adjusting Entry
Salary Expense Salaries Payable
2,000 2,0002,000
Closing Entry
Salary Expense Salaries Payable
2,0002,000 2,000
Beginning of next accounting period
Reversing Entry
Salary Expense Salaries 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 ExpensesOriginal =
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
Cash 3,000
Adjustment
Adjusting Entry
Prepaid Rent 2,000
Rent Expense 2,000
Rent Expense
3,000
Prepaid Rent
2,0002,000
1,000
Year End Balances
Closing Entry
Rent Expense
1,000
Prepaid Rent
2,0001,000
Beginning of Next Year
Reversing Entry
Rent Expense Prepaid Rent
2,0002,000 2,000
Example:
12/1/x1: Paid 3 month rent in advance, $3,000 Original entry to asset Journal Entry
Prepaid 3,000
Cash 3,000
Adjustment
Adjusting Entry
Rent Expense 1,000
Prepaid Rent 1,000
Prepaid
3,000
Rent Expense
1,0001,000
2,000
Year End Balances
Closing Entry
Rent Expense
1,000
Prepaid Rent
2,0001,000
Beginning of Next Year
Don’t Reverse
Rent Expense Prepaid 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? Yes or No
SUPPLIES EXPENSE
SUPPLIES
Accrual (A) or Deferral (D)
Increase Balance Sheet Account?
Yes or No
Reverse? Yes or No
SUPPLIES
SUPPLIES EXPENSE
Accrual (A) or Deferral (D)
Increase Balance Sheet Account?
Yes or No
Reverse? Yes or No
INTEREST EXPENSE
INTEREST PAYABLE
Accrual (A) or Deferral (D)
Reverse? Yes or No
RENT RECEIVED IN ADVANCE
RENTAL REVENUE
Accrual (A) or Deferral (D)
Increase Balance Sheet Account?
Yes or No
Reverse? Yes or No
RENTAL REVENUE
RENT RECEIVED IN ADVANCE
Accrual (A) or Deferral (D)
Increase Balance Sheet Account?
Yes or No
Reverse? Yes or No
Other Adjusting Entries
Estimated Items Cost of Goods Sold Should they be reversed?
NEVER
DEPRECIATION EXPENSE
ACCUMULATED DEPRECIATION
Reverse? Yes or No
Estimated Item
Never Reverse
INVENTORY
COST OF GOODS SOLDPURCHASES
Reverse? Yes or No
Cost of Goods Sold
Never Reverse