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Unformatted text preview: Chapter 3 Notes An Accounting Information System (AIS) collects and processes transaction data and disseminates the information to interested parties. Basic Terminology: (1) (2) (3) Event: A happening of consequence. An event generally is _________________________ __________________________ . ____________ : An external event involving a transfer or exchange between two or more entities. Account: A systematic arrangement that shows the effect of transactions and other events on a specific asset or equity. A separate account is kept for each asset, liability, revenue, expense, and owners' equity. Real and Nominal Accounts: ______ (permanent) accounts are ______________________ _______________________________________ . __________ (temporary) accounts are _____________________________________________________________________________ _________ . Nominal accounts are periodically closed, while real accounts are not. Ledger: The book (or computer file) containing the accounts. (a) (b) (6) (7) (8) General ledger - ___________________________________________________________ _______________ . Subsidiary ledger - _____________________________________________________ . (4) (5) Journal: The book of original entry where transactions and selected other events are initially recorded. Amounts are transferred to the ledger from journal entries. _______ : The process of transferring the essential facts and figures from a journal entry to the ledger. Trial Balance: __________________________________________________ . An adjusted trial balance is a trial balance taken immediately after all adjusting entries have been posted. A post-closing trial balance is ______________________________ _______________________________________________ . 1 (9) _______________ : Entries made at the end of an accounting period to bring all accounts up to date on an _________ accounting basis so that correct financial statements can be prepared. Financial Statements: Statements that reflect the collection, tabulation, and final summarization of the accounting data. The four involved statements are: (a) _____________ - shows the financial condition of the enterprise at the end of an accounting period. (b) Income statement - ______________________________________________ . (c) Statement of cash flows - reports the cash provided and used by operating, investing, and financing activities during the period. (d) Statement of retained earnings - reconciles the balance of the retained earnings account from the beginning to the end of the period. _______________ : The formal process by which all nominal accounts are reduced to zero and the net income or net loss is determined and transferred to an owners' equity account. (10) (11) Debits and Credits An Account shows the effect of transactions on a given asset, liability, equity, revenue, or expense account. Double - entry accounting system (two-sided effect). Recording done by debiting at least one account and crediting another. DEBITS must equal CREDITS. Account An arrangement that shows the effect of transactions on an account. Debit = "Left" Credit = "Right" Account Name
Debit / Dr. Credit / Cr. An Account can be illustrated in a form. T - Account 2 If Debit entries are greater than Credit entries, the account will have a debit balance. Account Name Debit / Dr. Transaction #1 Transaction #3 $10,000 8,000 Credit / Cr. $3,000 Transaction #2 Balance $15,000 If Credit entries are greater than Debit entries, the account will have credit balance. Account Name
Debit / Dr.
Transaction #1 $10,000 Credit / Cr.
$3,000 8,000 Transaction #2 Transaction #3 Balance $1,000 3 Debits and Credits Summary Normal Balance Debit
Debit / Dr. Credit / Cr. Normal Balance Credit Liabilities
Debit / Dr. Credit / Cr. Normal Balance Chapter 3-24 Equity
Debit / Dr. Credit / Cr. Normal Balance Normal Balance
Chapter 3-23 Expense
Debit / Dr. Credit / Cr. Chapter 3-25 Revenue
Debit / Dr. Credit / Cr. Normal Balance Normal Balance Chapter 3-27 Chapter 3-26 Asset = Liability + Equity
Revenue - Expense Debit Credit 4 Basic Accounting Equation Relationship among the assets, liabilitie s and stockholders' equity of a business: Illustration 3-3 The equation must be in balance after every transaction. For every Debit there must be a Credit. Exercises for the double entry system (for each item below indicate the effect on assets, liabilities and stockholders' equity): (Fill these in)
1. Invested $32,000 cash and equipment valued at $14,000 in the business.
Asset s = Liabilitie s + Sto ckh older s' Equity 2. Paid office rent of $600 for the month.
Asset s = Liabilitie s + Sto ckh older s' Equity 5 3. Received $3,200 advance on a management consulting engagement.
Asset s = Liabilitie s + Sto ckh older s' Equity 4. Received ca sh of $2,300 for services completed for Shuler Co.
Asset s = Liabilitie s + Sto ckh older s' Equity 5. Purchased a computer for $6,100.
Asset s = Liabilitie s + Sto ckh older s' Equity 6. Paid off liabilities of $7,000.
Asset s = Liabilitie s + S to ckh older s' Equity 7. D ec la red a cas h d ivid end of $ 1 0, 0 0 0.
Asset s = Liabilitie s + Sto ckh older s' Equity 6 Ownership structure dictates the types of accounts that are part of the equity section. Proprietorship or Partnershi p Corporation Capital Account Drawing Account Common Stock Additional Paid-in Capital Dividends Declared Retained Earnings Balance Sheet
Stockholders' Equity Illustration 3-4 Co m mon Sto ck (In ve st me nt by sto ck holde rs) Ret ain ed E ar nin gs (N et in co m e ret ai ned in busi ne ss) Dividends Net income or Net loss (R evenue s le ss ex pe nses) Inco me St at em ent Statement of Retained Earnings 7 The Accounting Cycle Transactions 9. Reversing entries 1. Journalization 8. Post-closing trail balance 2. Posting 7. Closing entries 3. Trial balance 6. Financial Statements Work Sheet 5. Adjusted trial balance 4. Adjustments Transactions a nd Eve nts
What to Record? FASB states, "transactions and other events and circumstances that affect a business enterprise." Types of Events: External between a business and its environment. Internal event occurring entirely within a business. 8 Review "Transactions and Events"
(indicate whether "internal," "external" or "not recorded." 1. A supplier of a company`s raw material is paid an amount owed on account. 2. A customer pays its open account. 3. A new chief executive officer is hired. 4. The biweekly payroll is paid. 5. Raw materials are entered into production. 6. A new advertising agency is hired. 7. The accountant determines the federal income taxes owed based on the income earned. 1. Jour nalizing
General Journal a chronological record of transactions. Journal Entries are recorded in the journal. Date Jan. 3 Account Title Cash Common stock Ref. 100 300 130 220 Debit 100,000 Credit 100,000 10 Building Note payable 150,000 150,000 9 2. Posting
Posting the process of transferring amounts from the journal to the ledger accounts. Date Jan. 3 Account Title Cash Common stock Ref. Debit 100,000 Credit 100,000 Cash
Date Explanation Ref. Debit Acct. No. 100
Credit Balance 3. Trial Balance
Trial Balance a list of each account and its balance; used to prove equality of debit and credit balances.
Acct. No. 100 105 110 130 200 220 300 330 400 500 Cash Accounts receivable Inventory Building Accounts payable Note payable Common stock Retained earnings Sales Cost of goods sold 30,000 $ 385,000 Account Debit $ 140,000 35,000 30,000 150,000 $ 60,000 150,000 100,000 75,000 $ 385,000 Credit 10 4. Adjusti ng Entries Revenues - recorded in the period in which they are earned. earned Expenses - recognized in the period in which they are incurred. incurred Adjusting entries - needed to ensure that the revenue recognition and matching principles are followed.
Illustration 3-20 Prepayments a. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. Accruals c. Accrued Revenues. Revenues earned but not yet received in cash or recorded. b. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned. c. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded. a. Prepaid Expenses
Payment of cash that is recorded as an asset because service or benefit will be received in the future. Cash Payment BEFORE Expense Recorded Prepayments often occur in regard to: rent maintenance on equipment fixed ass ets insurance supplies advertising 11 Example: On Jan. 1 st , Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1 st . (Try this) Debit Credit Debit Credit Example, cont;d: On Jan. 1 st , Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the adjusting jou rnal entry required at Jan. 31 st . (try this) Debit Credit Debit Credit 12 b. Unearned Revenues
Receipt of cash that is recorded as a liability because the revenue has not been earned. Cash Receipt BEFORE Revenue Recorded Unearned revenues often occur in re gard to: rent airline tickets school tuition magazine subscriptions customer deposits Example: On Nov. 1 st , Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. Show the jou rnal entry to record t he receipt on Nov. 1 st . (try this) Debit Credit Debit Credit 13 Example, cont'd: On Nov. 1 st , Ph oenix Corp. received $24,000 from Arcadia High School for 3 months rent in adv ance. Show the adjusting journal entry required on Nov. 30 th . (try this) Debit Credit Debit Credit c. Accrued Revenues
Revenues earned but not yet received in cash or recorded. Adjusting entry results in: Revenue Recorded BEFORE Cash Receipt Accrued revenues often occur in regard to: rent interest se rvices performed 14 Example: On July 1 st , Ph oenix Corp. i nvested $300,000 in securities that return 5% interest per year. Show the journal entry to record the investment on July 1 st . (try this) Debit Credit Debit Credit Example,cont'd: On July 1 st , Ph oenix Corp. invested $300,00 0 in securities that return 5% interest per year. Show the adjusting journal entry required on July 31 st . (tr y this) Debit Credit Debit Credit d. Accrued Expenses
Adjusting entry results in: Expense Recorded BEFORE Cash Payment, if any* 15 Accrued expenses often occur in regard to: rent interest taxes salaries bad debts* Example: On Feb. 2 nd , Phoenix Corp. b orrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Feb. 2 nd . (try this) Debit Credit Debit Credit Example, cont'd: On Feb. 2 nd , Phoenix Corp. borrowe d $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Feb. 28 th . (try this) Debit Credit Debit Credit 16 5. Adjusted Trial Balance
Shows the balance of all accounts, after adjusting entries, at the end of the accounting period. 6. Preparing Fina ncial Statements
Financial Statements are prepared directly from the Adjusted Trial Balance. Balance Sheet Income Statement Statement of Retained Earnings Statement of Cash Flows 17 18 7. Cl osing Entries To reduce the balance of the income statement ( revenue and expense ) accounts to zero. To transfer net income or net loss to owner's equity. Balance sheet ( asset , liability , and equity ) accounts are not closed. Dividends are closed directly to the Retained Earnings account. Example : Assume the following Adjusted Trial Balance
Acct. No. 100 105 130 220 300 330 380 400 430 500 520 550 Cash Accounts receivable Building Note payable Common stock Retained earnings Dividends declared Sales Interest income Cost of goods sold Salary expense Depreciation expense 47,000 25,000 43,000 $ 490,000 $ 490,000 10,000 185,000 17,000 Account Debit $ 140,000 35,000 190,000 $ 150,000 100,000 38,000 Credit Example: Prepare the Cl osing journal entry from the adjusted trial balance on the previous page. (try this) 19 8. Post - Closing Trial Balance
Acct. No. 100 105 130 220 300 330 380 400 430 500 520 550 Cash Accounts receivable Building Note payable Common stock Retained earnings Dividends declared Sales Interest income Cost of goods sold Salary expense Depreciation expense $ 365,000 $ 365,000 Account Debit $ 140,000 35,000 190,000 $ 150,000 100,000 115,000 Credit 20 9. Reversing Entries
The exact opposite of the related adjusting entry made in the previous period A reversing entry is made at the beginning of the next accounting period The recording of reversing entries is an optional step (for an entity to perform) in the accounting cycle. The purpose of reversing entries is ___________________________________________________ _______ . The use of reversing entries does not change the amounts reported in the financial statements for the previous period. Example - use the following information: Total employee payroll of $1,000/day, paid biweekly, with one 5 day unpaid period falling at the end of the fiscal year. First pay day in `06 is Jan 6 for $10,000. 12/31 Adj Entry: 1/1 Rev Entry: None 1/06 Pay Day Entry: Perpetual Inventory System Inventory account i ncreased with each purchase. Inventory account reduced and Cost of Goods Sold account increased with each sale. Balance in Inventory account theoretically should equal inventory amount on hand. Physical inventory performed to conf irm balance in Inventory accou nt. 21 Periodic Inventory Sy stem Inventory account remains unchanged during period. Purchases account increased with each purchase. Purchases account closed. Inventory account adjusted to physical count as part of the closing entires. At end of accounting period: Cash versus Accrual
Cash basis of accounting measures ____________________
Carter Company Year 2 Year 3 Year 1 Total $300,000 Sales on Credit $100,000 $100,000 $100,000 -----------------------------------------------------------------------------------------------------------------Net Operating Cash Flows: Cash receipts $ 50,000 $125,000 $125,000 Cash Disbursements Three year's rent (60,000) -0-0year' Salaries to employees (50,000) (50,000) (50,000) Utilities ( 5,000) (15,000) (10,000) Total (65,000) 60,000 65,000 $300,000 ( 60,000) (150,000) ( 30,000) 60,000 Accrual based accounting measures Revenues "when earned" and expenses "when incurred" to derive _________________
Carter Company Income Statements Year 2 Year 3 $100,000 $100,000 (20,000) (50,000) (15,000) 15,000 (20,000) (50,000) (10,000) 20,000 Revenues Expenses Rent Expense Salaries to employees Utilities Total Year 1 $100,000 (20,000) (50,000) ( 5,000) 25,000 Total $300,000 ( 60,000) (150,000) ( 30,000) 60,000 Note that the Total column is the same as under the cash basis. The difference between Cash and Accrual relates to "timing." Over the three year period there is no difference between cash and accrual. 22 Converting cash to accrual (and accrual to cash)
Oftentimes businesses wish to convert from cash to accrual. The general approach is: Revenues = Cash receipts -beg AR + end AR + beg Unearned Rev - end Unearned Rev. Expenses = Cash disbursements - beg Accrued Liab + end Accrued Liab + beg Prepaids - end Prepaids 23 ...
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