copyright © 2007 by the mcgraw-hill companies, inc. all rights reserved. review of the accounting...

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Review of the Accounting

Process

2

Insert Book Cover Picture

2-2

The Basic Model

Economic events cause changes in the financial position of a company.

External events involve an exchange

between the company and another entity.

Internal events do not involve an exchange

transaction but do affect the company’s

financial position.

2-3

Learning Objectives

Analyze routine economic events—transactions—and record their effects on a

company’s financial position using the accounting equation format.

2-4

The Accounting Equation

A = L + OE- Owner Withdrawals+ Owner Investments

- Expenses- Losses

+ Revenue+ Gains

2-5

Accounting Equation for a Corporation

A = L + SE+ Retained Earnings+ Paid-in Capital

- Expenses- Losses

+ Revenues+ Gains

- Dividends

2-6

Account Relationships

Debits and credits affect the Balance Sheet Model as follows:


A = L + PIC + REAssets

Dr.+

Cr.-

LiabilitiesDr.-

Cr.+

Paid-inCapital

Dr.-

Cr.+

Retained EarningsDr.-

Cr.+

Revenues and GainsDr.-

Cr.+

Expenses and Losses

Dr.+

Cr.-

2-7

Account Relationships

A = L + PIC + RE + R + G- E - L

Permanent accounts represent the basic financial position elements of the

accounting equation.

Temporary accounts keep track of the changes in the

retained earnings component of

shareholders’ equity.



2-8

Source documents

Record in Journal

Financial Statements

Transaction Analysis

Post to Ledger

Unadjusted Trial Balance

Record & Post Adjusting

Entries

Adjusted Trial Balance

Close Temporary Accounts

Post-Closing Trial Balance

The Accounting Processing

Cycle

2-9

Learning Objectives

Record transactions using the general journal format.

2-10

Accounting Processing Cycle

On January 1, 2007, $40,000 was borrowed from a bank and a note payable was signed.

Prepare the journal entry.

Two accounts are affected:Cash (an asset) increases by $40,000.Notes Payable (a liability) increases by $40,000.

Account numbers are references for posting to

the General Ledger.

2-11

General Ledger

The “T” account is a shorthand used byaccountants to analyze transactions. Itis not part of the bookkeeping system.

2-12

Learning Objectives

Post the effects of journal entries to T-accounts and prepare an unadjusted trial

balance.

2-13

Posting Journal Entries

On July 1, 2006, the owners invest $60,000 in a new business, Dress Right Clothing Corporation.

GENERAL JOURNAL Page 1

Date DescriptionPost. Ref. Debit Credit

July 1 Cash 60,000Common Stock 60,000

Post the debit portion of the entry to the Cash ledger account.Post the debit portion of the entry to the Cash ledger account.

2-14


1

2-15


2 3

2-16


4

5

2-17

6


2-18


Post the credit portion of the entry to the Common Stock ledger account.

Post the credit portion of the entry to the Common Stock ledger account.

1

2-19


23

2-20


4

5

2-21

6


2-22

After recording all entries for the period, Dress Right’s Trial Balance would be as follows:

After recording all entries for the period, Dress Right’s Trial Balance would be as follows:

Debits = Credits

A Trial Balance is a listing of all

accounts and their

balances at a point in

time.

A Trial Balance is a listing of all

accounts and their

balances at a point in

time.

2-23

Additional Consideration

Perpetual Inventory System

Inventory account is continually updated to

reflect purchases and sales.

Cost of goods sold account is continually updated to

reflect sales.

Periodic Inventory System

Purchases account reflects purchases of

inventory.

Cost of goods sold and inventory are adjusted at

period end.

Discussed in more depth in

Chapters 8 & 9.

2-24

Adjusting Entries

At the end of the period, some transactions or

events remain unrecorded.

Because of this, several accounts in the ledger

need adjustments before their balances appear in the financial

statements.

2-25

Learning Objectives

Identify and describe the different types of adjusting journal entries.

Determine the required adjustments, record adjusting journal entries in general journal

format, and prepare an adjusted trial balance.

2-26

Prepaym ents(Deferrals)

Accruals Estimates

Adjusting Entries

Transactions where cash is paid or received

before a related expense or revenue is

recognized.

Transactions where cash is paid or received after a related expense

or revenue is recognized.

2-27

Asset Expense

UnadjustedBalance

CreditAdjustment

DebitAdjustment

Prepaid Expenses

Today, I will payfor my first

6 months’ rent. Prepaid Expenses

Items paid for in advance of receiving their benefits

2-28

Prepaid Expenses

Assume that on July 31, 2006, Dress Right determines that at the end of July $1,200 of supplies remains. Let’s look at the adjusting

journal entry needed on July 31, 2006.

Prepare the adjusting entry.

$2,000 - $1,200 = $800 supplies used

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After posting, the accounts look like this:

Prepaid Expenses

Beg. bal. - 2,000 800

Bal. 1,200

SuppliesBeg. bal. -

800 Bal. 800

Supplies Expense

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Depreciation is the process of computing expense by allocating the cost of plant and equipment over their expected useful lives.

Straight-LineDepreciationExpense

= Asset Cost - Salvage Value

Useful Life

Depreciation

2-31

Depreciation

Recall the Furniture and Fixtures for $12,000 listed on Dress Right’s unadjusted trial balance. Assume the

following:

Let’s calculate the depreciation expense for the month ended July 31, 2006.

Asset Cost 12,000$ Salvage Value - Useful Life 60 months

2-32

2006Depreciation

Expense=

$12,000 - $0

60 months= $200

Recall the Furniture and Fixtures for $12,000 listed on Dress Right’s unadjusted trial balance. Assume the

following:

Depreciation

Now, prepare the adjusting entry for July

31, 2006.

Asset Cost 12,000$ Salvage Value - Useful Life 60 months

2-33

GENERAL JOURNAL Page 2Date Description PR Debit Credit

July 31 Depreciation Expense 200Accumulated Depr. - Furniture & Fixtures 200

To record depreciation Contra Asset

Depreciation

Let’s see how the accounts would look after posting!

2-34


Depreciation

Beg. bal. - 12,000

Bal. 12,000

Furniture and FixturesBeg. bal. -

200 Bal. 200

Depreciation Expense

- Beg. bal.200 200 Bal.

Accumulated Depreciation

2-35

Liability RevenueUnadjusted

BalanceCredit

AdjustmentDebit

Adjustment

Unearned Revenues

“Go Big Blue”

Buy your season tickets forall home basketball games NOW! Unearned Revenue

Cash received in advance of performing

services

2-36

For Dress Right Corporation, the only unearned revenue in the trial balance is unearned rent revenue. On July 16

Dress Right received $1,000 in advance for the first two months’ rent.

First, let’s prepare the entry for July 16.

Unearned Revenues

Liability Account

2-37

Unearned Revenues

For Dress Right Corporation, the only unearned revenue in the trial balance is unearned rent revenue. On July 16

Dress Right received $1,000 in advance for the first two months’ rent.

Now, let’s prepare the adjusting entry for July 31.

2-38

Unearned Revenues


- Beg. bal.250 1,000

750 Bal.

Unearned Rent Revenue- Beg. bal.250 250 Bal.

Rent Revenue

2-39

Alternative Approach to Record Prepayments

Unearned RevenueRecord initial cash receipts

as follows:

Cash $$$ Revenue $$$

Adjusting EntryRecord the amount for the

unearned liability as follows:

Revenue $$ Unearned revenue $$

Prepaid ExpensesRecord initial cash

payments as follows:

Expense $$$ Cash $$$

Adjusting EntryRecord the amount for the

prepaid expense as follows:

Prepaid expense $$ Expense $$

2-40

Expense LiabilityCredit

AdjustmentDebit

Adjustment

Accrued Liabilities

I won’t pay youuntil the job is done!

Accrued Liabilities

Costs incurred in a period that are both unpaid and

unrecorded

2-41

7/1/06 7/31/06Month end

Last paydate

7/20/06

Next paydate

8/2/06

Record adjustingjournal entry.

Accrued Liabilities

On July 31, 2006, the employees have earned

salaries of $5,500.

2-42

Accrued Liabilities


Beg. bal. - 5,000 5,500

Bal. 10,500

Salaries Expense- Beg. bal.

5,500 5,500 Bal.

Salaries Payable

2-43

Asset Revenue

CreditAdjustment

DebitAdjustment

Accrued Receivables

Yes, you can pay mein May for your April

15 tax return.Accrued Receivables

Revenues earned in a period that are both

unrecorded and not yet received

2-44

Assume that Dress Right loaned another corporation $30,000 at the beginning of August. Terms of the note

call for the payment of principal, $30,000, and interest at 8% in three months.

First, let’s determine the amount of interest to accrue at August 31, 2006.

Accrued Receivables

P × R × T $30,000 .08 1/12

Interest = $200

2-45

Assume that Dress Right loaned another corporation $30,000 at the beginning of August. Terms of the note

call for the payment of principal, $30,000, and interest at 8% in three months.

Now, let’s prepare the adjusting entry for August 31, 2006.

Accrued Receivables

2-46

Accrued Receivables


Beg. bal. - 200

Bal. 200

Interest Receivable- Beg. bal.200 200 Bal.

Interest Revenue

2-47

Estimates

Uncollectible accounts and depreciation of fixed assets are estimated.

An estimated item is a function of future events and developments.

$$

2-48

Estimates

The estimate of bad debt expense at the end of the period is an example of an adjusting entry that requires

an estimate.

Assume that Dress Right’s management determines that of the $2,000 of accounts receivable recorded at July 31,

2006, only $1,500 will ultimately be collected. Prepare the adjusting entry for July 31, 2006.

2-49DRESS RIGHT CLOTHING CORPORATIONAdjusted Trial Balance

July 31, 2006Account Title Debits CreditsCash 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.

2-50

Learning Objectives

Describe the four basic financial statements.

2-51

The income statement summarizes the results of operating activities of the company.

2-52

Current assets: Cash 68,500$ Accounts receivable 2,000$ Less: Allowance for uncollectible accounts 500 1,500 Supplies 1,200 Inventory 38,000 Prepaid rent 22,000 Total current assets 131,200 Property and equipment: Furniture and fixtures 12,000 Less: Accumulated depreciation 200 11,800 Total assets 143,000$

Dress Right Clothing CorporationBalance SheetAt July 31, 2006

Assets

The balance sheet presents the financial position of the company on a particular date.

2-53

Current liabilities: Accounts payable 35,000$ Salaries payable 5,500 Unearned rent revenue 750 Interest payable 333 Note payable 10,000 Total current liabilities 51,583 Long-term liabilities: Note payable 30,000 Shareholders' equity: Common stock 60,000$ Retained earnings 1,417 Total shareholders' equity 61,417 Total liabilities and shareholders' equity 143,000$

Dress Right Clothing CorporationBalance SheetAt July 31, 2006

Liabilities and Shareholders' Equity

The balance sheet presents the financial position of the company on a particular date.

2-54

The statement of cash flows discloses the changes in cash during a period.

Cash flows from operating activities:Cash inflows: From customers 36,500$ From rent 1,000 Cash outflows: For rent (24,000) For supplies (2,000) To suppliers for merchandise (25,000) To employees (5,000) Net cash used by operating activities (18,500)$ Cash flows from investing activities: Purchase of furniture and fixtures (12,000) Cash flows from financing activities: Issue of capital stock 60,000$ Increase in notes payable 40,000 Payment of cash dividend (1,000) Net cash provided by financing activities 99,000 Net increase in cash 68,500$

Dress Right Clothing CorporationStatement of Cash Flows

For the Month of July 2006

2-55

The statement of shareholders’ equity presents the changes in permanent shareholder accounts.

Common Stock

Retained Earnings

Total Shareholders'

EquityBalance at July 1, 2006 -$ -$ -$ Issue of capital stock 60,000 60,000 Net income for July 2006 2,417 2,417 Less: Dividends (1,000) (1,000) Balance at July 31, 2006 60,000$ 1,417$ 61,417$

Dress Right Clothing CorporationStatement of Shareholders' Equity

For the Month of July 2006

2-56

Learning Objectives

Explain the closing process.

2-57

The Closing Process

Resets revenue, expense and dividend account balances to zero at the end of the period.

Helps summarize a period’s revenues and expenses in the Income Summary account.

Identify accounts for closing.

Record and post closing entries.

Prepare post-closing trial balance.

2-58

Temporary Accounts

Revenues

Income Summary

Exp

ense

s

Divid

end

s

Permanent Accounts

Assets

Lia

bili

ties

Sh

areho

lders’

Eq

uity

The closing process applies only to temporary accounts.

Temporary and Permanent Accounts

2-59

Close Revenue accounts to Income Summary.

Close Expense accounts to Income Summary.

Close Income Summary account to Retained Earnings.

Let’s prepare the closing entries for

Dress Right.

Closing Entries

2-60DRESS RIGHT CLOTHING CORPORATIONAdjusted Trial Balance


Close Revenue accounts to

Income Summary.

2-61



July 31 Sales Revenue 38,500

Rent Revenue 250

Income Summary 38,750

Now, let’s look at the ledger accounts after posting this closing entry.

Close Revenue Accounts to Income Summary

2-62

Income Summary38,750

38,750

Sales Revenue38,500 38,500

-

Rent Revenue250 250

-

Close Revenue Accounts to Income Summary

2-63

Close Expense accounts to

Income Summary.

DRESS RIGHT CLOTHING CORPORATIONAdjusted Trial Balance


2-64



July 31 Income Summary 36,333

Cost of goods sold 22,000

Salaries expense 10,500

Supplies expense 800

Rent expense 2,000

Depreciation expense 200

Interest expense 333

Bad debts expense 500


Close Expense Accounts to Income Summary

2-65

Cost of Goods Sold22,000 22,000

-

Depreciation Exp.200 200

-

Salaries Expense10,500 10,500

-

Supplies Expense800 800

-

Rent Expense2,000 2,000

-

Close Expense Accounts to Income Summary

Interest Expense333 333

-

Income Summary36,333 38,750

2,417

Net Income

Bad Debts Exp.500 500

-

2-66

Close Income Summary to

Retained Earnings.

DRESS RIGHT CLOTHING CORPORATIONAdjusted Trial Balance


2-67



July 31 Income Summary 2,417

Retained Earnings 2,417


Close Income Summary to Retained Earnings

2-68 Close Income Summary to Retained Earnings

Income Summary36,333 38,750 2,417

-

Retained Earnings1,000 2,417

1,417

2-69

Post-Closing Trial Balance

Lists permanent accounts and their

balances.

Total debits equal total credits.

DRESS RIGHT CLOTHING CORPORATIONPost-Closing Trial Balance

July 31, 2006Account Title Debits CreditsCash 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$

2-70

Learning Objectives

Convert from cash basis net income to accrual basis net income.

2-71

Conversion From Cash Basis to Accrual Basis

Adjusting entries, for the most part, are conversions from cash to accrual.

Let’s look at an example.

2-72


Jeter, Inc. paid $20,000 cash for insurance during the current period. On Jan. 1, Prepaid Insurance was $5,000, and on Dec. 31, the account balance

was $3,000.

Determine Insurance Expense for the period.

2-73


Prepaid Insurance

Balance, 1/1 5,000$ Plus: Cash paid 20,000 Less: Insurance expense (22,000) Balance, 12/31 3,000$

Jeter, Inc. paid $20,000 cash for insurance during the current period. On Jan. 1, Prepaid Insurance was $5,000, and on Dec. 31, the account balance

was $3,000.

2-74

Appendix 2A

Use of a Worksheet

2-75

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. Enter account titles in column 1 and the unadjusted trial balances in columns 2 and 3.

2. Determine end-of-period adjusting entries and enter them in columns 4 and 5.

3. Add or deduct the effects of the adjusting entries on the account balances and enter in columns 6 and 7.

4. Transfer the temporary retained earnings account balances to columns 8 and 9.

5. Transfer the balances in the permanent accounts to columns 10 and 11.

Let’s look at the completed worksheet for Dress Right.

2-76

Account Title Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 68,500 68,500 68,500 Accounts receivable 2,000 2,000 2,000

Allowance for uncollectible accounts - (7) 500 500 500 Supplies 2,000 (1) 800 1,200 1,200 Prepaid rent 24,000 (2) 2,000 22,000 22,000 Inventory 38,000 38,000 38,000 Furniture and fixtures 12,000 12,000 12,000 Accumulated depr.- furniture & fixtures - (3) 200 200 200 Accounts payable 35,000 35,000 35,000 Note payable 40,000 40,000 40,000 Unearned rent revenue 1,000 (4) 250 750 750 Salaries payable - (5) 5,500 5,500 5,500 Interest payable - (6) 333 333 333 Common stock 60,000 60,000 60,000 Retained earnings 1,000 1,000 1,000 Sales revenue 38,500 38,500 38,500 Rent revenue - (4) 250 250 250 Cost of goods sold 22,000 22,000 22,000 Salaries expense 5,000 (5) 5,500 10,500 10,500 Supplies expense - (1) 800 800 800 Rent expense - (2) 2,000 2,000 2,000 Depreciation expense - (3) 200 200 200 Interest expense - (6) 333 333 333 Bad debt expense - (7) 500 500 500 Totals 174,500 174,500 9,583 9,583 181,033 181,033

Net income 2,417 2,417 Totals 38,750 38,750 144,700 144,700

Balance Sheet

Worksheet, Dress Right Clothing Corporation, July 2006Unadjusted Trial

Balance Adjusting Entries Adjusted Trial

Balance Income Statement

2-77

Appendix 2B

Reversing Entries

2-78

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.

Let’s consider the following accrual adjusting entry made by Dress Right.

2-79

Reversing Entries

If reversing entries are not used, when salaries actually are paid in August, the accountant needs to remember to debit

salaries payable and not salaries expense.

Bal. 7/31 10,500

Bal. 10,500

Salaries Expense5,500 Bal. 7/31

Payment 5,500 - Bal.

Salaries Payable

2-80

Reversing Entries

If reversing entries are used, the following reversing entry is made on August 1, 2006. This entry reduces the salaries payable account to zero and reduces the salaries expense

account by $5,500.

Bal. 7/31 10,500 5,500 Reverse

Bal. 5,000


Reverse 5,500 - Bal.

Salaries Payable

2-81

Reversing Entries

When salaries actually are paid in August, the debit is to salaries expense, thus increasing the account by $5,500. We can see that the ending balances in the accounts are

identical whether or not reversing entries are used.

Bal. 7/31 10,500 Payment 5,500 5,500 ReverseBal. 10,500


Reverse 5,500 - Bal.

Salaries Payable

2-82

Appendix 2C

Subsidiary Ledgers and

Special Journals

2-83

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.

2-84

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. Journalizing the effects of a particular transaction is made more efficient through the use of specifically designed formats.

2. 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.

3. The responsibility for recording journal entries for the repetitive types of transactions is placed on individuals who have specialized training in handling them.

Let’s look at some special journals.

2-85

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 Page 1

Accounts Receivable Subsidiary

Account No. Customer Name

Sales Invoice Number

Cr. Sales Revenue (400)Dr. Accounts

Receivable (110)

Aug. 5 801 Leland High School 10-221 1,500

9 812 Mr. John Smith 10-222 200

18 813 Greystone School 10-223 825

22 803 Ms. Barbara Jones 10-224 120

29 805 Hart Middle School 10-225 650

3,295

Date

2006

Other columns capture

information needed for

updating the accounts

receivable subsidiary

ledger.

2-86

Sales Journal

SALES JOURNAL Page 1

Accounts Receivable Subsidiary

Account No. Customer Name

Sales Invoice Number

Cr. Sales Revenue (400)Dr. Accounts

Receivable (110)

Aug. 5 801 Leland High School 10-221 1,500

9 812 Mr. John Smith 10-222 200

18 813 Greystone School 10-223 825

22 803 Ms. Barbara Jones 10-224 120

29 805 Hart Middle School 10-225 650

3,295

Date

2006

Bal. 7/31 2,000 Aug. 31 SJ1 3,295 Bal. 5,295

Accounts Receivable- Beg. bal.

3,295 Aug. 31 SJ13,295 Bal.

Sales Revenue

Aug. 5 SJ1 1,500

Bal. 1,500

Leland High School 801

Accounts Receivable Subsidiary Ledger

2-87

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 Page 1

DateExplanation or Account Name

Dr. Cash (100)

Cr. Accounts

Receivable (110)

Cr. Sales

Revenue (400)

Cr. Other

Other Accounts

Aug. 7 Cash sale 500 500

11 Borrowed cash 10,000 10,000

Notes payable

(220)

17 Leland High School 750 750

20 Cash sale 300 300

25 Mr. John Smith 200 200

11,750 950 800 10,000

2006

2-88

Cash Receipts Journal

Aug. 5 SJ1 1,500 750 Aug. 17 CR1

Bal. 750

Leland High School 801

Accounts Receivable Subsidiary Ledger

CASH RECEIPTS JOURNAL Page 1

DateExplanation or Account Name

Dr. Cash (100)

Cr. Accounts

Receivable (110)

Cr. Sales

Revenue (400)

Cr. Other

Other Accounts

Aug. 7 Cash sale 500 500

11 Borrowed cash 10,000 10,000

Notes payable

(220)

17 Leland High School 750 750

20 Cash sale 300 300

25 Mr. John Smith 200 200

11,750 950 800 10,000

2006

2-89

End of Chapter 2

copyright © 2007 by the mcgraw-hill companies, inc. all rights reserved. review of the accounting...

Documents

posting journal entries

effects of journal entries

journal entry

losses revenue gains

book cover picture slide

general journal format

dress rights trial balance

balance sheet model