Dr Cr Chapter 2 The Accounting Process. Chapter 2--Learning Objectives 1.Analyze transactions based...

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

Have value

Will generate future cash flows

Accounting Equation


Assets

Factory building

Equipment

Accounts receivable

Accounting Equation


Liabilities

Obligations

Incurred to Acquire Assets

Accounting Equation


Liabilities

Accounts Payable

Salaries Payable

Bonds Payable

Accounting Equation


Equity

Owner Claim to Assets

Assets - Liabilities

The Accounting Equation


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


Example

Purchased a Car for $22,000

Paid $5,000 down

Signed a note for the balance

Effect on Accounting Equation


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


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


Balance SheetElements

Assets Liabilities Equity

At the end of the accounting period}

Statement of cash flows

Investing activities

Financing activities

Operating activities


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


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


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


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


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


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


Rent Rec’d in Advance

3,000

Rental Revenue

1,000


2,000

Adjustment


3,000

Rental Revenue

1,0001,000

Adjusting Entry

Rent Rec in Adv 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


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

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


Inventory Purchases CGS


7,000

Inventory 7,000Cost of Goods Sold

98,000

98,000


Inventory Purchases CGS


10,000

Inventory 7,000Cost of Goods Sold

98,000

98,000

10,0007,000

95,000

7,000

95,000

98,000


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



Cash 5,000

Salary Expense Salaries Payable

2,000 2,000

At year end

Adjusting Entry


2,000 2,0002,000

Closing Entry


2,000

Beginning of next accounting period


2,0003,000 2,000

Pay Salaries


3,000

Account balances after payment

Assume instead:The following reversing entry was made


Salary Expense

2,000

Payment of the Salaries

• When the salaries are paid the following Monday


Cash

5,000


2,000 2,000

At year end

Adjusting Entry


2,000 2,0002,000

Closing Entry


2,0002,000 2,000

Beginning of next accounting period

Reversing Entry


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


Increase Balance Sheet Account?

Yes or No

Reverse? Yes or No

SUPPLIES

SUPPLIES EXPENSE



Yes or No

Reverse? Yes or No

INTEREST EXPENSE

INTEREST PAYABLE


Reverse? Yes or No

RENT RECEIVED IN ADVANCE

RENTAL REVENUE



Yes or No

Reverse? Yes or No

RENTAL REVENUE

RENT RECEIVED IN ADVANCE



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

Dr Cr Chapter 2 The Accounting Process. Chapter 2--Learning Objectives 1.Analyze transactions based...

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