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Principles of Accounting II

Lecture 1

Adjusting the Accounts

Basic Accounting Equation

• What the business owns = What the business owes

• Assets = Liabilities (owed to creditors)+ Owners Equity (residual equity owed to owners)

• liabilities are shown before owners’ equity, because creditors’ claims are paid before owners’ claims if the business is liquidated

• Each transaction has a dual effect on the equation

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Illustration 2-11

Assets Liabilities = Basic

Equation

Expanded

Basic

Equation

+

Summary of Debits/Credits Rules

Relationship among the assets, liabilities and owner’s equity

of a business:

The equation must be in balance after every transaction.

For every Debit there must be a Credit.

LO 2 Define debits and credits and explain their use in recording business transactions.

Owner’s Equity

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Problem 2-2A (Pg 74-75) • Keynes is a licensed dentist. During the first month of operations of her

business, the following events and transactions occurred. April 1 Invested $20,000 cash in her business. 1 Hired a secretary at a salary of $700 per week payable monthly. 2 Paid office rent for the month $1,100. 3 Purchased dental supplies on account from Smile Company $4,000. 10 Performed dental services and billed insurance companies $5,100. 11 Received 1,000 cash advance from Heather Greene for an implant. 20 Received $2,100 cash from services performed from James Chang. 30 Paid secretary for the month $2,800. 30 Paid $2,400 to Smile Company for accounts payable due. The company uses the following chart of account: No. 101 Cash, No. 112

Accounts Receivable, No. 126 Supplies, No. 201 Accounts Payable, No. 209 Unearned Service Revenue, No. 301 Owner’s Capital, No. 400 Service Revenue, No. 726 Salaries Expense, and No. 729 Rent Expense.

(a) Journalize the transactions (b) Post to ledger accounts (c) Prepare a trial balance on April 30, 2014

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The Trial Balance • The trial balance is a list of accounts and their balances at

a given time.

• The primary purpose of a trial balance is to prove debits = credits after posting.

• If debits and credits do not agree, the trial balance can be used to uncover errors in journalizing and posting.

• The Steps in preparing the Trial Balance are: • List the account titles and balances.

• Total the debit and credit columns.

• Prove the equality of the two columns. 10

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Steps of the Accounting Cycle: • Analyze business transactions. • Journalize the transactions. • Post to ledger accounts. • Prepare trial balance. • Journalize and post adjusting entries for deferrals

and accruals. • Prepare an adjusted trial balance. • Prepare financial statements.

– Income Statement. – Owner’s Equity Statement. – Balance Sheet.

• Journalize and Post closing entries. • Prepare a post-closing trial balance.

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The Reasons for Adjusting Entries: • Adjusting entries are made at the end of the accounting

period before preparation of the financial statements.

• Adjusting entries are made to ensure that the revenue recognition principle and the matching principle are followed.

• That is, to ensure that revenues are recorded in the period in which they are earned and that expenses are recorded in the period in which they are incurred.

• Adjusting entries make it possible to report the correct amounts on the balance sheet and on the income statement.

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Illustration 3-2 Categories of adjusting entries

The Basics of Adjusting Entries

Types of Adjusting Entries

1. Prepaid Expenses. Expenses

paid in cash before they are used

or consumed.

Deferrals

1. Accrued Revenues. Revenues

for services performed but not

yet received in cash or recorded.

2. Accrued Expenses. Expenses

incurred but not yet paid in cash

or recorded.

2. Unearned Revenues.

Cash received before services are

performed.

Accruals

LO 3 Explain the reasons for adjusting entries and Identify the major types of adjusting entries. 14

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Remington Repair Services Trial Balance

April 30, 2014

Account Title Dr. Cr.

Cash $6,300

Accounts Receivable 5,500

Supplies 4,100

Prepaid Insurance 3,600

Equipment 25,000

Accumulated depreciation- Equipment $3,600

Account Payable 3,000

Notes Payable 6,000

Unearned Revenue 3,100

Remington, Capital 26,000

Remington, Drawing 2,000

Service Revenue 10,300

Salaries Expense 4,000

Rent Expense 1,500

$52,000 $52,000

Adjustment data: 1. The remaining supplies at April 30 are $1600. 2. The insurance policy was purchased on April 1 for one year. 3. The equipment is depreciated at the rate of $400 per month. 4. $1,850 of unearned service revenue has been earned at the end

of April. 5. Invoices representing $1,300 of services performed during the

month have not been recorded as of April 30. 6. The notes payable represent a 6-month, 10% note that was

signed on April 1. 7. Salaries of $1,000 are accrued at April 30. Instructions: 1. Journalize the adjusting entries at April 30. 2. If the adjusting entries 1 to 7 are not made. Indicate the effect on

net income, assets and liabilities (i.e. Overstatement, Understatement or N/A).

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Review Problem- Your turn David Advertising

Trial Balance December 31, 2014

Account Title Dr. Cr.

Cash $7,600

Accounts Receivable 8,400

Supplies 4,700

Prepaid Insurance 3,600

Equipment 24,000

Accumulated depreciation- Equipment $6,500

Accounts Payable 4,400

Notes Payable 9,000

Unearned Revenue 3,600

Owner’s, Capital 20,000

Owner’s, Drawings 2,500

Service Revenue 14,000

Salaries Expense 5,200

Rent Expense 1,500

$57,500 $57,500

Adjustment data: 1. The remaining supplies at December 31 are $1,500. 2. The insurance policy was purchased on December 1 for

one year. 3. The equipment is depreciated at the rate of $500 per

month. 4. $2,000 of the unearned service revenue has been earned

at the end of December. 5. Invoices representing $1,600 of services performed during

December have not been recorded as of December 31. 6. The notes payable represent a 3-month 10% note that

was signed on December 1. 7. Salaries of $1,800 are accrued at December 31. Instructions: 1. Journalize the adjusting entries for David Advertising at

December 31.

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Pioneer Advertising Agency Trial Balance

October 31, 2010

Account Title Dr. Cr.

Cash $15200

Advertising Supplies 2500

Prepaid Insurance 600

Office Equipment 5000

Notes Payable $5000

Accounts payable 2500

Unearned Revenue 1200

C. R. Byrd, Capital 10000

C. R. Byrd, Drawing 500

Service Revenue 10000

Salaries Expense 4000

Rent Expense 900

$28700 $28700 19

Exercise 3 (solved) • Assume the following adjustments: 1. Supplies on hand at October 31 total $500. 2. Expired insurance for the month is $50. 3. Depreciation for the equipment for the month is $50. (Note: the

company uses straight line depreciation; useful life= 7 years, salvage value= $800).

4. Services related to unearned service revenue in October worth $600 were performed.

5. Services performed but not recorded at October 31 are $300. 6. Interest accrued at October 31 is $95. 7. Accrued salaries at October 31 are $1,625. • Instructions a) Determine the type of adjustment required for each of the cases

above b) Prepare the adjusting entries for the items above.

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Prepaid Expenses

1. Oct.31 Supplies Expense 2,000 Supplies ($2,500 – $500) 2,000 Note: supplies used= supplies balance $2500 – supplies on hand $500

= $2000

2. 31 Insurance Expense 50 Prepaid Insurance 50 Note: annual insurance = $600; hence monthly insurance= $600 ÷ 12

months = $50/ month

3. 31 Depreciation Expense 50 Accumulated Depreciation— Equipment 50

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Depreciation

• Any business owns a variety of assets such as equipment, building, trucks,….etc., These long-lived assets provide services for a number of years called the useful life of the asset.

• Depreciation is the process of allocating the cost of the long-lived asset to expense over its useful life in a systematic manner.

• From an accounting standpoint, the purchase of equipment or a building is viewed as a long–term prepayment for services.

• Companies need to make periodic adjusting entries for depreciation. These entries record the portion of the asset that has been used (an expense) during the period, and report the unexpired portion (an asset) at the end of the period.

• A common procedure in computing depreciation is to divide the cost of the asset by its useful life.

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• Pioneer Advertising Agency estimates depreciation on the office equipment to be $600 a year, or $50 ($600 ÷ 12) per month.

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Unearned Revenues

4. Oct. 31 Unearned Service Revenue 600

Service Revenue 600

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Accrued Revenues

5. 31 Accounts Receivable 300 Service Revenue 300

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Accrued Expenses

6. Oct.31 Interest Expense 95

Interest Payable 95

7. 31 Salaries and Wages Expense 1,625

Salaries and Wages Payable 1,625

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The Basics of Adjusting Entries

LO 5 Prepare adjusting entries for accruals.

Summary of Basic Relationships Illustration 3-22

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End of Lecture 1