Review 2 of the Accounting Process
PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
The Accounting Equation
A = L + OE
+ Owner Investments - Owner Withdrawals + Revenues + Gains - Expenses - Losses
2-2
Accounting Equation for a Corporation
A = L + SE
+ Paid-in Capital + Retained Earnings + Revenues - Expenses - Dividends + Gains - Losses
2-3
Accounting Equation, Debits and Credits, Increases and Decreases
Permanent Accounts--assets, liabilities, paid-in capital, retained earnings Temporary Accounts-revenues, gains, expenses, losses
2-4
During the Accounting Period
Source documents
Transaction Analysis
Record in Journal
Post to Ledger
At the End of the Accounting Period
Financial Statements
Adjusted Trial Balance
Record & Post Adjusting Entries
Unadjusted Trial Balance
At the End of the Year Close Temporary Accounts
2-5
Post-Closing Trial Balance
The Accounting Processing Cycle
The Accounting Processing Cycle
On July 1, two individuals each invested $30,000 in a new business, Dress Right Clothing Corporation. Each investor was issued 3,000 shares of common stock.
Two accounts are affected:
Cash
(an asset) increases by $60,000. Common stock (a shareholders' equity) increases by $60,000. July 1 Cash Common stock
2-6
60,000 60,000
General Ledger
The "T" account is a shorthand format of an account used by accountants to analyze transactions. It is not part of the bookkeeping system.
2-7
Posting Journal Entries
2-8
After recording all entries for the period, Dress Right's After recording all entries for the period, Dress Right's Unadjusted Trial Balance would be as follows: Unadjusted Trial Balance would be as follows:
A Trial A Trial Balance is a Balance is a list of all list of all accounts accounts and their and their balances at balances at a particular a particular date. date.
Debits = Credits
2-9
Adjusting Entries
At the end of the period, adjusting entries are required to satisfy the realization principle and the matching principle.
Prepayments
Transactions where cash is paid or received before a related expense or revenue is recognized.
Accruals
Transactions where cash is paid or received after a related expense or revenue is recognized.
Estimates
Accountants must often make estimates in order to comply with the accrual accounting model.
2 - 10
Prepaid Expenses
Asset
Unadjusted Balance Credit Adjustment
Expense
Debit Adjustment
Today, I will pay for my first 6 months' rent.
Prepaid Expenses Items paid for in advance of receiving their benefits
2 - 11
Depreciation
Depreciation is the process of allocating the cost of plant and equipment over their expected useful lives.
Straight-Line Depreciation Asset Cost - Salvage Value = Useful Life
2 - 12
Depreciation
Recall the Furniture and Fixtures for $12,000 listed on Dress Right's unadjusted trial balance. Assume the following:
Asset Cost $ 12,000 Salvage Value Useful Life 60 months
Let's calculate the depreciation expense for the month ended July 31, 2011.
2 - 13
Depreciation
Recall the Furniture and Fixtures for $12,000 listed on Dress Right's unadjusted trial balance.
Asset Cost $ 12,000 Salvage Value Useful Life 60 months
July Depreciation Expense $12,000 - $0 = 60 months = $200 per month
July 31 Depreciation expense Accumulated depreciationfurniture and fixtures
2 - 14
200 200
Depreciation
After posting, the accounts look like this:
Furniture and Fixtures Beg. bal. 12,000 Bal. 12,000 Depreciation Expense Beg. bal. 200 Bal. 200
Accumulated Depreciation Beg. bal. 200 200 Bal.
2 - 15
Unearned Revenues
Liability
Debit Adjustment Unadjusted Balance
Revenue
Credit Adjustment
Buy your season tickets for all home basketball games NOW!
Unearned Revenue Cash received in advance of performing services
"Go Big Red"
2 - 16
Alternative Approach to Record Prepayments
Prepaid Expenses Record initial cash payments as follows: Expense Cash $$$ $$$ Unearned Revenue Record initial cash receipts as follows: Cash $$$ Revenue $$$ Adjusting Entry Record the amount for the unearned liability as follows: Revenue $$$ Unearned revenue $$$
Adjusting Entry Record the amount for the prepaid expense as follows: Prepaid expense $$$ Expense $$ $
2 - 17
Accrued Liabilities
Expense
Debit Adjustment
Liability
Credit Adjustment
I won't pay you until the job is done!
Accrued Liabilities Liabilities recorded when an expense has been incurred prior to cash payment.
2 - 18
Accrued Receivables
Asset
Debit Adjustment
Revenue
Credit Adjustment
Yes, you can pay me in May for your April 15 tax return.
Accrued Receivables Revenue earned in a period prior to the cash receipt.
2 - 19
Estimates
Accountants often must make estimates of future events to comply with the accrual accounting model.
Examples
Depreciation Uncollectible accounts
$
2 - 20
Estimates
Assume that Dress Right's management determines that of the $2,000 of accounts receivable recorded at July 31, only $1,500 will ultimately be collected. Prepare the adjusting entry for July 31. July 31 Bad debt expense Allowance for uncollectible accounts
2 - 21
500 500
DRESS RIGHT CLOTHING CORPORATION Adjusted Trial Balance July 31, 2011 Account Title Debits Credits Cash $ 68,500 Accounts receivable 2,000 Allowance for uncollectible accounts $ 500 Supplies 1,200 Prepaid rent 22,000 Inventory 38,000 Furniture and fixtures 12,000 Accumulated depr.-furniture & fixtures 200 Accounts payable 35,000 Note payable 40,000 Unearned rent revenue 750 Salaries payable 5,500 Interest payable 333 Common stock 60,000 Retained earnings 1,000 Sales revenue 38,500 Rent revenue 250 Cost of goods sold 22,000 Salaries expense 10,500 Supplies expense 800 Rent expense 2,000 Depreciation expense 200 Interest expense 333 Bad debt expense 500 Totals $ 181,033 $ 181,033
This is the Adjusted Trial Balance for Dress Right after all adjusting entries have been recorded and posted. Dress Right will use these balances to prepare the financial statements.
2 - 22
The Income Statement
The income statement summarizes the results of profit-generating activities of the company.
2 - 23
The Balance Sheet
Dress Right Clothing Corporation Balance Sheet At July 31, 2011 Assets Current assets: Cash Accounts receivable Less: Allowance for uncollectible accounts Supplies Inventory Prepaid rent Total current assets Property and equipment: Furniture and fixtures Less: Accumulated depreciation Total assets $ $ 2,000 500 68,500 1,500 1,200 38,000 22,000 131,200
12,000 200 $
11,800 143,000
The balance sheet presents the financial position of the company on a particular date.
2 - 24
The Balance Sheet
Dress Right Clothing Corporation Balance Sheet At July 31, 2011 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Salaries payable Unearned rent revenue Interest payable Note payable Total current liabilities Long-term liabilities: Note payable Shareholders' equity: Common stock Retained earnings Total shareholders' equity Total liabilities and shareholders' equity $ 35,000 5,500 750 333 10,000 51,583 30,000 60,000 $ 1,417 $ 61,417 143,000
2 - 25
Notice that assets of $143,000 equals total liabilities plus shareholders' equity of $143,000.
The Statement of Cash Flows
Dress Right Clothing Corporation Statement of Cash Flows For the Month of July 2011 Cash flows from Operating Activities: Cash inflows: From customers From rent Cash outflows: For rent For supplies To suppliers for merchandise To employees Net cash used by operating activities Cash flows from Investing Activities: Purchase of furniture and fixtures Cash flows from Financing Activities: Issue of capital stock Increase in notes payable Payment of cash dividend Net cash provided by financing activities Net increase in cash
$
36,500 1,000 (24,000) (2,000) (25,000) (5,000) $ (18,500) (12,000)
$
60,000 40,000 (1,000) $ 99,000 68,500
The statement of cash flows discloses the changes in cash during a period.
2 - 26
The Statement of Shareholders' Equity
Dress Right Clothing Corporation Statement of Shareholders' Equity For the Month of July 2011 Total Common Retained Shareholders' Stock Earnings Equity $ $ $ 60,000 60,000 2,417 2,417 (1,000) (1,000) $ 60,000 $ 1,417 $ 61,417
Balance at July 1, 2011 Issue of capital stock Net income for July 2011 Less: Dividends Balance at July 31, 2011
The statement of shareholders' equity presents the changes in permanent shareholder accounts.
2 - 27
The Closing Process
Revenues Expenses Liabilities Assets
Shareholders' Equity
Dividends
Temporary Accounts
Permanent Accounts
Income Summary
The closing process applies only to temporary accounts.
2 - 28
Post-Closing Trial Balance
DRESS RIGHT CLOTHING CORPORATION Post-Closing Trial Balance July 31, 2011 Account Title Debits Credits Cash $ 68,500 Accounts receivable 2,000 Allowance for uncollectible accounts $ 500 Supplies 1,200 Prepaid rent 22,000 Inventory 38,000 Furniture and fixtures 12,000 Accumulated depr.-furniture & fixtures 200 Accounts payable 35,000 Note payable 40,000 Unearned rent revenue 750 Salaries payable 5,500 Interest payable 333 Common stock 60,000 Retained earnings 1,417 Totals $ 143,700 $ 143,700
Lists permanent accounts and their balances.
Total debits equal total credits.
2 - 29
Conversion From Cash Basis to Accrual Basis
Increases Assets Liabilities Add Deduct
Decreases Deduct Add
2 - 30
Appendix 2A: Use of a Worksheet
A worksheet can be used as a tool to facilitate the preparation of adjusting and closing entries and the financial statements.
Steps to Follow for Worksheet Completion: 1. 2. 3. 4. 5. Enter account titles in column A and the unadjusted account balances in columns B and C. Determine end-of-period adjusting entries and enter them in columns E and G. Add or deduct the effects of the adjusting entries on the account balances and enter in columns H and I. Transfer the temporary retained earnings account balances to columns J and K. Transfer the balances in the permanent accounts to columns L and M.
Let's look at the completed worksheet for Dress Right.
2 - 31
A B C D E F G Worksheet, Dress Right Clothing Corporation, July 2011 Unadjusted Trial Balance Adjusting Entries Account Title Dr. Cr. Dr. Cr. Cash 68,500 Accounts receivable 2,000 Allowance for uncollectible accounts (7) 500 Supplies 2,000 (1) 800 Prepaid rent 24,000 (2) 2,000 Inventory 38,000 Furniture and fixtures 12,000 Accumulated depr.furniture & fixtures (3) 200 Accounts payable 35,000 Note payable 40,000 Unearned rent revenue 1,000 (4) 250 Salaries payable (5) 5,500 Interest payable (6) 333 Common stock 60,000 Retained earnings 1,000 Sales revenue 38,500 Rent revenue (4) 250 Cost of goods sold 22,000 Salaries expense 5,000 (5) 5,500 Supplies expense (1) 800 Rent expense (2) 2,000 Depreciation expense (3) 200 Interest expense (6) 333 Bad debt expense (7) 500 Totals 174,500 174,500 9,583 9,583 Net income Totals
H
I
J
K
L
M
Adjusted Trial Balance Dr. Cr. 68,500 2,000 500 1,200 22,000 38,000 12,000 200 35,000 40,000 750 5,500 333 60,000 1,000 38,500 250 22,000 10,500 800 2,000 200 333 500 181,033
Income Statement Dr. Cr.
Balance Sheet Dr. Cr. 68,500 2,000 500 1,200 22,000 38,000 12,000 200 35,000 40,000 750 5,500 333 60,000 1,000
38,500 250 22,000 10,500 800 2,000 200 333 500
181,033 2,417 38,750 38,750 144,700 2,417 144,700
2 - 32
Appendix 2B: Reversing Entries
Reversing entries remove the effects of some of the adjusting entries made at the end of the previous reporting period for the sole purpose of simplifying journal entries made during the new period. Reversing entries are optional and are used most often with accruals.
2 - 33
Appendix 2C: Subsidiary Ledgers
Subsidiary ledgers contain a group of subsidiary accounts associated with particular general ledger control accounts. Subsidiary ledgers are commonly used for accounts receivable, accounts payable, plant and equipment, and investments.
For example, there will be a subsidiary ledger for accounts receivable that keeps track of the increases and decreases in the accounts receivable balance for each of the company's customers purchasing goods and services on credit.
After all of the postings are made from the appropriate journals, the balance in the accounts receivable control account should equal the sum of the balances in the accounts receivable subsidiary ledger accounts.
2 - 34
Appendix 2C: Special Journals Special journals are used to capture the dual effect of repetitive types of transactions in debit/credit form.
Special journals simplify the recording process in the following ways: 1. 2. Journalizing the effects of a particular transaction is made more efficient through the use of specifically designed formats. Individual transactions are not posted to the general ledger accounts but are accumulated in the special journals and a summary posting is made on a periodic basis. The responsibility for recording journal entries for the repetitive types of transactions is placed on individuals who have specialized training in handling them.
3.
2 - 35
Sales Journal Sales journals record all credit sales. Every entry in the sales journal has the same effect on the accounts; the sales revenue account is credited and the accounts receivable control account is debited.
SALES JOURNAL
Accounts Receivable Subsidiary Account No. 5 9 18 22 29 801 812 813 803 805 Sales Invoice Number 10-221 10-222 10-223 10-224 10-225 Page 1 Cr. Sales Revenue (400) Dr. Accounts Receivable (110) 1,500 200 825 120 650 3,295
Date 2011 Aug.
Customer Name Leland High School Mr. John Smith Greystone School Ms. Barbara Jones Hart Middle School
Other columns capture information needed for updating the accounts receivable subsidiary ledger.
2 - 36
Cash Receipts Journal Cash receipts journals record all cash receipts, regardless of the source. Every entry in the cash receipts journal produces a debit to the cash account with the credit to various other accounts.
CASH RECEIPTS JOURNAL
Explanation or Account Name Dr. Cash (100) 500 Cr. Accounts Receivable (110) Cr. Sales Revenue (400) 500 Notes payable (220) Cr. Other Page 1 Date 2011 Aug. 7 Cash sale Other Accounts
11 Borrowed cash 17 Leland High School 20 Cash sale 25 Mr. John Smith
10,000 750 300 200 11,750 200 950 800 750 300
10,000
10,000
2 - 37
End of Chapter 2
2 - 38