Intermediate Accounting - Chap002 pdf

Source documents Record in Journal Financial Statements Transaction Analysis Post to Ledger Unadjusted Trial Balance Record & Post Adjusting Entries Adjusted Trial Balance Close Tempora

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Review of the Accounting Process

2

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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.

Learning Objectives

Analyze routine economic events—

transactions—and record their effects on a company’s financial position using the

accounting equation format.

The Accounting Equation

A = L + OE

- Owner Withdrawals

- Losses + Revenue

+ Gains

Accounting Equation for a Corporation

+ Retained Earnings + Paid-in Capital

- Expenses

- Losses

+ Revenues + Gains

- Dividends

+

Cr -

Temporary accounts

keep track of the changes in the retained earnings component of shareholders’ equity.

Debits and credits affect the Balance Sheet

Model as follows:

Debits and credits affect the Balance Sheet

Model as follows:

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

Learning Objectives

Record transactions using the general journal

format.

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

Learning Objectives

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

Posting Journal Entries

On July 1, 2006, the owners invest $60,000 in a new

business, Dress Right Clothing Corporation

Posting Journal Entries

1

Posting Journal Entries

Posting Journal Entries

4

5

Posting Journal Entries

Posting Journal Entries

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

Posting Journal Entries

Posting Journal Entries

4

5

Posting Journal Entries

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.

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

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.

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.

after a related expense

or revenue is recognized.

Asset Expense

Unadjusted

Balance

Credit Adjustment

Debit Adjustment

Prepaid Expenses

Today, I will pay for my first

6 months’ rent Prepaid Expenses

Items paid for in advance

of receiving their benefits

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

After posting, the accounts look like this:

Prepaid Expenses

Beg bal

-2,000

800 Bal 1,200

Supplies

Beg bal

-800

Bal 800

Supplies Expense

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

Straight-Line Depreciation Expense

=

Asset Cost - Salvage Value

Useful Life

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

2006 Depreciation 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

GENERAL JOURNAL Page 2

July 31 Depreciation Expense 200

Accumulated Depr - Furniture & Fixtures 200

After posting, the accounts look like this:

Depreciation

Beg bal

-12,000 Bal 12,000

Furniture and Fixtures

Beg bal

-200

Bal 200

Accumulated Depreciation

Liability Revenue

Unadjusted Balance

Credit Adjustment

Debit Adjustment

Unearned Revenues

“Go Big Blue”

Buy your season tickets for

all home basketball games NOW! Unearned Revenue

Cash received in advance of performing

services

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

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

Unearned Rent Revenue

Beg bal.

250

250 Bal.

Rent Revenue

Alternative Approach to Record Prepayments

Unearned Revenue Record initial cash receipts

as follows:

Cash $$$

Revenue $$$

Adjusting Entry Record the amount for the unearned liability as

Expense Liability

Credit Adjustment

Debit Adjustment

7/1/06 7/31/06

Month end

Last pay date 7/20/06

Next pay date 8/2/06

Record adjusting journal entry.

Accrued Liabilities

On July 31, 2006, the employees have earned salaries of $5,500.

Bal 10,500

Salaries Payable

Asset Revenue

Credit Adjustment

Debit Adjustment

Accrued Receivables

Yes, you can pay me

in May for your April

15 tax return Accrued Receivables

Revenues earned in a period that are both unrecorded and not yet

received

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

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

Interest Revenue

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.

July 31, 2006 Account Title Debits Credits

Furniture and fixtures 12,000

Accumulated depr.-furniture & fixtures 200

posted.

Dress Right will use these balances to prepare the financial

statements.

Learning Objectives

Describe the four basic financial statements.

The income statement summarizes the results of

operating activities of the company.

Total current assets 131,200

Property and equipment:

Furniture and fixtures 12,000

Less: Accumulated depreciation 200 11,800

The balance sheet presents the financial position

of the company on a particular date

Total shareholders' equity 61,417

Total liabilities and shareholders' equity $ 143,000

Balance Sheet

At July 31, 2006 Liabilities and Shareholders' Equity

The balance sheet presents the financial position

of the company on a particular date

The statement of cash flows discloses the

changes in cash during a period.

Cash flows from operating activities:

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

Dress Right Clothing Corporation Statement of Cash Flows For the Month of July 2006

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

Common Stock

Retained Earnings

Total Shareholders'

Equity Balance 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 Corporation Statement of Shareholders' Equity

For the Month of July 2006

Learning Objectives

Explain the closing process.

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

Temporary Accounts

Revenues

Income Summary

Closing Entries

Adjusted Trial Balance July 31, 2006 Account Title Debits Credits

Furniture and fixtures 12,000

Accumulated depr.-furniture & fixtures 200

GENERAL JOURNAL Page 34

Post

July 31 Sales Revenue 38,500

Now, let’s look at the ledger accounts after

posting this closing entry.

 Close Revenue Accounts to Income

Summary

Income Summary

38,750

38,750

Sales Revenue 38,500

-Rent Revenue 250

250

- Close Revenue Accounts to Income

Summary

Close Expense

accounts to Income Summary.

July 31, 2006 Account Title Debits Credits

Furniture and fixtures 12,000

Accumulated depr.-furniture & fixtures 200

GENERAL JOURNAL Page 34

Date Description

Post

Ref Debit Credit

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

Now, let’s look at the ledger accounts after

posting this closing entry.

 Close Expense Accounts to Income

Summary

Cost of Goods Sold 22,000

22,000

-Depreciation Exp.

200

200

-Salaries Expense

10,500

10,500

-Supplies Expense

800

800

-Rent Expense 2,000

2,000

- Close Expense Accounts to Income Summary

Interest Expense

333

333

-Income Summary 36,333

38,750

2,417

Net Income

500

500

-Close Income

Summary to Retained Earnings.

Adjusted Trial Balance July 31, 2006 Account Title Debits Credits

Furniture and fixtures 12,000

Accumulated depr.-furniture & fixtures 200

GENERAL JOURNAL Page 34

Post

July 31 Income Summary 2,417

Now, let’s look at the ledger accounts after

posting this closing entry.

 Close Income Summary to Retained

Earnings

 Close Income Summary to Retained

Earnings

Income Summary 36,333

38,750 2,417

-Retained Earnings

1,000 2,417

1,417

Post-Closing Trial Balance

Lists permanent accounts and their

balances.

Total debits equal total credits.

DRESS RIGHT CLOTHING CORPORATION

Post-Closing Trial Balance

July 31, 2006 Account Title Debits Credits

Furniture and fixtures 12,000

Accumulated depr.-furniture & fixtures 200

Learning Objectives

Convert from cash basis net income to accrual

basis net income.

Conversion From Cash Basis to Accrual

Conversion From Cash Basis to Accrual

Basis

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.

Conversion From Cash Basis to Accrual

Basis

Prepaid Insurance

Plus: Cash paid 20,000

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.

Appendix 2A

Use of a Worksheet

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.

Balance Sheet

Worksheet, Dress Right Clothing Corporation, July 2006

Unadjusted Trial Balance Adjusting Entries

Adjusted Trial Balance Income Statement

Appendix 2B

Reversing Entries

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.

Bal.

-Salaries Payable

Salaries Expense

5,500

Bal 7/31 Reverse 5,500

Bal.

-Salaries Payable

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.

-Salaries Payable

Appendix 2C

Subsidiary Ledgers and

Special Journals

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.

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.