The Accounting Process

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The Accounting Process
Hughes Ayers Hoskin John Wiley Sons, Inc.
2004

• Chapter Three
• Prepared by Sarita Sheth
• Santa Monica College

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Why study accounting?
Financial Statements are a companys
representation of its past performance, present
position, and future goals.

• Investors want to make decisions based on
  good information.

Accounting is the process of recording the
transactions that are represented in the
financial statements.
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Chapter Three Objectives

• Recognize business transactions and their impact
  of financial statements.
• Understand the dual nature of accounting
  transactions as reflected in the accounting
  equation.
• Explain the construction of the Statement of
  Financial Position, the Statement of Earnings,
  and the Statement of Cash Flows.
• Distinguish between economic events that are
  commonly recognized in accounting as transactions
  and those that are not.
• Apply the concept of nominal accounts to record
  revenues and expenses and their relationship to
  the Income and Retained Earnings Statements.
• Describe the accounting cycle and recognize the
  timing issues inherent in reporting financial
  results.

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Balance Sheet Accounts
Cash Marketable Securities Accounts
Receivable Inventory Prepaid Expenses Equipment La
nd Buildings Intangible Assets Deferred Tax Assets

• Assets
• Represent probable future economic benefits
  obtained as a result of past transactions

For an example Sale of product results in cash
for a company that can be used for a variety of
future activities
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Balance Sheet Accounts
Accounts Payable Notes Payable Accrued
Liabilities Taxes Payable Deferred Taxes Bonds
Payable
Liabilities Represent probable future economic
sacrifices of economic benefits because of
obligations from past transactions
For an example A promise to pay (accounts
payable) a supplier cash for monthly distribution
of supplies.
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Balance Sheet Accounts
Contributed Capital Common Stock at par
value Additional Paid-In Capital Retained
Earnings Net Income Dividends
Stockholders Equity Represent the investors
claims to assets after creditors have been paid.
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Account characteristics

• Balance Sheet accounts are known as permanent
  accounts.
• Permanent accounts do not close after the fiscal
  period ends.
• Once they are placed on the books, they do not
  disappear because the cycle ends.
• Nominal accounts are temporary accounts they are
  closed at the end of the fiscal cycle.

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Double Entry Accounting System

• A transaction is recorded with an double entry.
• For every debit entry there must be a credit
  entry.
• This system keeps the Accounting Equation
  balanced
• Assets Liabilities Stockholders Equity

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Methodology

• REMEMBER
• Debit means Left Credit means Right
• Debit does not mean increase or decrease
• Credit does not mean decrease or increase
• Rules of the accounting equation dictate what the
  effect of a debit or credit on particular accounts

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Methodology How do we keep Debits and Credits
straight?

• Use T-accounts to help track balances and changes
  in an account

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Methodology Journalizing

• To record transactions more formally and
  chronologically - use the journal.
• Journal entries employs debits and credits
• Debit account is first and not indented xx
• Credit account is second and indented xx

For example Land 300 Cash 300
debit
credit
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Methodology The Ledger

• After journalizing the transaction, post the
  information to the ledger.
• The ledger is a formal T-account that keeps track
  of each accounts running balance.
• In a manual system, there is a page for the cash
  account, page for A/R, page for inventory etc.

Date Dr Cr Balance
101 Cash
1/1/04 500 500 2/3/04 200
300 2/15/04 800 1,100 3/2/04
100 1,200 4/7/04 500 700
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Application Transaction Analysis

• Lets look at some investing and financing
  activities
• Serve Inc, is a tennis supply company ready
  to commence operations on 2/1/0X.
• SERVE issues 5,000 shares of 1 par Common Stock
  for 5.00 per share.
• SERVE acquires property for 10,000 cash.
• SERVE borrows 30,000 on a note payable, due in 3
  years with an interest rate of 5.

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Application Transaction Analysis

General Journal
Common Stock 5,000 APIC 20,000
T-Accounts / Ledger
Additional Paid In Capital
15
Application Transaction Analysis

General Journal
Cash 10,000
T-Accounts / Ledger
10,000
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Application Transaction Analysis

General Journal
Notes Payable 30,000
T-Accounts / Ledger
3
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Application Transaction Analysis
Serve Inc., Ledger Accounts as of 2/28/0X
Take the balances from the ledger to the
financial statements
Notes Payable
Cash
30,000
3
1
25,000
2
10,000
3
30,000
Bal 45,000
30,000 Balance
Common Stock
Land
Additional Paid In Capital
1
2
1
5,000
20,000
10,000
Balance 10,000
5,000 Balance
20,000 Bal
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Application Financial Statement
Serve Inc., Balance Sheet (in thousands) as of
2/28/0X
Liabilities and Stockholders Equity Liabilities
Notes Payable 30 Total
Liabilities 30 Stockholders
Equity Common Stock 5 Additional Paid in
Capital 20 Retained Earnings 0 Total
Stockholders Equity 25 Total Liabilities
Stockholders Equity 55
Assets Current Assets Cash 45 Property,
Plant, and Equipment 10 Total Assets 55
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Application Financial Statement
Serve Inc., Statement of Cash Flows for the
month ended 2/28/0X
Cash Flow from Investing Activities Purchase
of Land (10,000) Cash Flow
from Financing Activities Proceeds from
Issuance of Common Stock 25,000 Proceeds
from Loan 30,000 Total Cash from
Financing Activities 55,000 Net Change in
Cash 45,000 Cash Balance
2/1/0X 0 Cash Balance 2/28/0X 45,000

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More about Revenues Expenses

• Revenues increase Retained Earnings
• (credit Retained Earnings)
• Expenses decrease Retained Earnings
• (debit Retained Earnings)
• The Retained Earnings account is a Balance Sheet
  account.
• Retained Earnings reflect the effect of revenues,
  expenses, and dividends since the companys
  inception.

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More about Revenues Expenses

• In order to keep track of the current years
  income, use the nominal accounts
• Track revenues when earned in the revenue account
  (an increase in RE) by a credit entry.
• Track expenses when incurred in expense accounts
  (a decrease in RE) with a debit entry.

Retained Earnings
Expenses
Revenues
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Quick Questions

• The Accounts Receivable account is a(n)
• Permanent Account
• Asset Account
• Balance Sheet Account
• All of the above
• The Payroll Expense Account is a(n)
• Nominal Account
• Permanent Account
• Income Statement Account
• a and c
• All of the above

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Application More Entries

• SERVE purchased inventory worth 50,000 on
  account.
• SERVE sold 40,000 of merchandise which cost
  25,000 to a major sporting goods chain on
  account.
• SERVE purchased fixtures on account for 4,000.
  BALL estimates that the fixtures will be used for
  4 years.
• Customers pay in full for merchandise bought on
  account in entry 5.
• SERVE declares and pays dividends of 5,000.
• SERVE pays for utilities bill of 3,000.
• SERVE pays 2,000 for fixtures bought on acct in
  6.
• Annual depreciation expense on the fixtures was
  1,000 (4,000/4 yrs).
• SERVE pays interest on the 5 note payable
  30,000.

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Application Transaction Analysis

General Journal
Accounts Payable
50,000
T-Accounts / Ledger
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Application Transaction Analysis
Entry 5 Part 1 - SERVE made merchandise sale
of 40,000 to a major sporting goods chain on
account.

General Journal
Sales 40,000
T-Accounts / Ledger
Sales
40,000
40,000
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Application Transaction Analysis
Entry 5 Part 2 The cost of goods sold in
Part 1 was 25,000.

General Journal
Inventory 25,000
T-Accounts/ Ledger
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Application Transaction Analysis
Entry 6 SERVE purchased fixtures on account
for 4,000. SERVE estimates that the fixtures
will be used for 4 years.

General Journal
Accounts Payable 4,000
T-Accounts/ Ledger
4,000
4,000
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Application Transaction Analysis
Entry 7 Customer pay in full for merchandise
bought on account in entry 5.

General Journal
Accounts Receivable 40,000
T-Accounts/ Ledger
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Application Transaction Analysis
Entry 8 SERVE declares and pays dividends of
25,000.

General Journal
Cash
5,000
T-Accounts/ Ledger
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Application Transaction Analysis
Entry 9 SERVE pays for utilities bill 3,000.

General Journal
Cash 3,000
T-Accounts / Ledger
25,000
3,000
9
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Application Transaction Analysis
Entry 10 SERVE pays 2,000 on account for
the supplies bought in Transaction 6.

General Journal
Cash 2,000
T-Accounts/ Ledger
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Application Transaction Analysis
Entry 11 Annual depreciation expense on the
fixtures was 1,000 (4,000/4yrs).

• To show that SERVE has reaped the benefits of
  using the fixtures for one year, they must show
  depreciation of the asset.
• SERVE recognizes depreciation expense (DR), and
  reduces the Fixtures account by crediting a
  special account - Accumulated Depreciation-
  Fixtures (a contra asset account).
• The contra asset account will allow us to keep
  the fixtures on our books at the historical cost,
  but also keep track of the ongoing depreciation
  to the asset.

General Journal
Accumulated Depreciation- Fixtures
1,000
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Application Transaction Analysis
Entry 12 SERVE pays interest on the note
payable 125. (30,000 x 5 X 1/12) .

General Journal
Cash 125
T-Accounts/ Ledger
8
5,000
10
12
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Application Balances in Accounts from
Transactions

• Accounts Payable (50,000 4,000 2,000)
  52,000
• Notes Payable 30,000

• Cash (25,000 30,000 40,000) -
• (10,000 5,000 3,000 2,000 125)
  74,875
• Accounts Receivable (40,000 40,000) 0
• Inventory (50,000 25,000) 25,000
• Fixtures 4,000
• Accumulated Depreciation (1,000)
• Land 10,000
• Total Assets 112,875

Common Stock 5,000 Additional Paid-In Capital
20,000 Sales 40,000 Cost of Goods Sold
(25,000) Utilities Expense (3,000) Depreciation
Expense (1,000) Interest Expense
(125) Dividends (5,000) Total Lia and SHE
112,875
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Application Financial Statement
Serve Inc., Statement of Earnings for the month
ended 2/28/0X
Sales Revenue 40,000 Less
Cost of Goods Sold
(25,000) Gross Profit 15,000 Operating
Expenses Utilities Expense
3,000 Depreciation Expense
1,000 Interest Expense 125 Total
Operating Expenses 4,125 Net Income
10,875 Earnings per share 2.1750
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Application Financial Statement
Serve Inc., Statement of Stockholders Equity
(in thousands) for the month ended 2/28/0X
Common Stock (par value 1)
5,000 Additional Paid-In Capital
20,000 Retained Earnings Retained Earnings 2/1/
0X 0 Net Income 10,875 Less
Dividends (5,000) Retained Earnings
2/28/0X 5,875 Total Stockholders
Equity 30,875
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Application Financial Statement
Serve Inc., Balance Sheet as of 2/28/0X
Liabilities and Stockholders Equity Liabilities
Accounts Payable 52,000 Notes Payable
30,000 Total Liabilities 82,000
Stockholders Equity Common Stock
5,000 Additional Paid in Capital
20,000 Retained Earnings 5,875 Total
Stockholders Equity 30,875 Total
Liabilities Stockholders Equity
112,875
Assets Current Assets Cash
74,875 Accounts Receivable
0 Inventory 25,000 Total
Current Assets 99,875 Plant Property
Equipment Land 10,000 Fixtures
4,000 Less Accum Deprec (1,000) Net Book
Value Fixtures 3,000 Property,
Plant, and Equipment 13,000 Total Assets
112,875
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Application Financial Statement
Serve Inc., Statement of Cash Flows for the
month ended 2/28/0X
Cash from Operations Net Income
10,875 Add Noncash Expenses
Depreciation 1,000 Less
Changes in Current Assets and Current
Liabilities 25,000 Total Cash
from Operations 36,875 Cash
Flow from Investing Activities Cash from
Investing Purchase of Land
(10,000) Purchase of Fixtures
(2,000) Cash flow from
Investing Activities (12,000) Cash
Flow from Financing Activities Proceeds from
Common Stock 25,000
Proceeds from Loan 30,000 Payment of
Dividends (5,000) Total Cash
from Financing Activities 50,000 Total
Change in Cash 74,875
Cash Balance 2/1/0X 0 Net Change in Cash
74,875 Cash Balance
2/28/0X 74,875
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Closing Entries

• All of the nominal (temporary or income
  statement) accounts must be closed at the end of
  the period
• These are Revenues and Expenses accounts
• They are closed by making the balance zero by
  Debiting the Revenue Accounts and Crediting the
  Expense accounts
• The balances are transferred to the Income
  Summary Account
• Income Summary is then closed to Retained Earnings

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Application Closing Process
1.
2.
Expenses
Revenues
40,000
25,000 3,000 1,000 125
40,000 Balance
Closing Dr 40,000
Balance 29,125
13,000 Closing Cr
0
0
3.
Income Summary
Retained Earnings
40,000
10,875
5,000
29,875
10,875 Balance
Closing Dr 10,875
5,875 Balance
0
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Quick Question

• We close which of the following accounts?
• Land account
• Sales accounts
• Notes Payable accounts
• Depreciation Expense account
• Accumulated Depreciation account
• Cost of Goods Sold account
• Dividends