Chapters 3

1
Chapters 3 4 The Mechanics of Financial
Accounting
2
Financial Accounting
GAAP (Generally Accepted Accounting Principles)
The Accounting Information System
Financial Statements
Financial Statements
Transaction Analysis
Double Entry Accounting
The Accounting Cycle
3
Todays class objectives
The Accounting Information System
Double Entry Accounting
The Accounting Cycle
Debit (DR)
Credit (CR)
A. General Journal Entries
T-Account
Journal Entries
4
How do you handle many transactions?

• The transaction analysis in Ex. 2-44 used a few
  transactions and accounts. However, with
  thousands of transactions and hundreds of
  accounts, the spreadsheet program is not
  sufficient.
• Therefore accountants use a double entry system
  based on debits and credits.
• Each transaction must still be analyzed to
  determine which accounts are involved, whether
  the accounts increase or decrease, and how much
  the balance will change.
• The balance sheet equation can be used for this
  analysis, but with so many transactions, this is
  not realistic.
• In practice, accountants use ledgers.

5
Double Entry AccountingLedger Accounts

• Ledger - a group of related accounts kept current
  in a systematic manner
• Think of a ledger as a book with
  one page for each account.
• The ledger is a companys books.
• General ledger - the collection of accounts that
  accumulates the amounts reported in the major
  financial statements

6
Double Entry AccountingT-Accounts

• A simplified version of a ledger account is
  called the T-account.
• They allow us to capture the essence of the
  accounting process without having to worry about
  too many details.
• The account is divided into two sides for
  recording increases and decreases in the
  accounts.

Account Title
Left Side
Right Side
Debit
Credit
7
Double Entry AccountingT-Accounts

• Debit (dr) - means an entry to the left hand side
  of an account.
• Credit (cr) - means an entry to the right hand
  side of an account.
• This selection is purely arbitrary, but
  consistent throughout U.S. accounting history.

8
Double Entry AccountingT-Accounts

• Balance - difference between total left-side
  amounts and total right-side amounts at any
  particular time
• Assets have left-side balances.
• Increased by entries to the left side
• Decreased by entries to the right side
• Liabilities and Owners Equity have right-side
  balances.
• Decreased by entries to the left side
• Increased by entries to the right side

9
The Double Entry System T-Accounts
B/S
Cash

• T- accounts are used to keep track of balances.
• When cash is received, you record the amount on
  the left. When cash is paid, you record the
  amount on the right
• At the end of the period, the T-account is totaled

Debit (DR)
Credit (CR)
15,000
2,500
850
1,000
Total
3,500
15,850
Bal. 12,350
10
The Double Entry System T-Accounts
B/S
Cash

• T- accounts are used to keep track of balances.
• When cash is received, you record the amount on
  the left. When cash is paid, you record the
  amount on the right
• At the end of the period, the T-account is totaled

Debit (DR)
Credit (CR)
15,000
2,500
850
1,000
Bal. 12,350
11
Double Entry AccountingT-Accounts

• T-accounts and the balance sheet equation
• Assets Liabilities Owners Equity

Assets
Liabilities
Owners Equity
Decreases
Decreases
Increases
Decreases
Increases
Increases
12
Effect of Debits and Credits

• Based on the accounting equation, we can
  increase or decrease various accounts depending
  on their classification
• Assets Liabilities Equity
• Increase DR CR CR
• Decrease CR DR DR

13
Summary by account type

• Assets are increased with a debit.
• Liabilities and equities are increased with a
  credit.
• Revenues (a part of equity) are increased with a
  credit.
• Expenses (which decrease equity) are increased
  with a debit.
• Dividends (which decrease equity) are increased
  with a debit.

14
The Format of a Journal Entry

• To initially record transactions, we use a
  journal entry to represent the debits and
  credits.
• For example, in Ex. 2-44, first transaction
• Debit Credit
• Cash 15,000
• Common Stock 15,000
• Note that the debit is to the left and the
  credit is to the right. First we list the
  account (left hand entry first), then the
  amount. This transaction increased Cash and
  increased Common Stock.

B/S
B/S
15
Now go back to Ex. 2-44 and prepare the other
journal entries

• 9/9 Purchased parts on account, 5,000.
• Auto Parts 5,000
• A/P 5,000
• 9/12 Paid rent of 2,500.
• Rent Expense 2,500
• Cash 2,500

B/S
B/S
I/S
B/S
16
Ex. 2-44, continued

• 9/18 Provided repair services (on
• account) 2,200.
• Accts. Receivable 2,200
• Service Revenue 2,200
• 9/20 Auto parts used for repair.
• Parts expense 1,150
• Auto Parts 1,150

B/S
I/S
I/S
B/S
17
Ex. 2-44, continued

• 9/26 Collected 850 from customers.
• Cash 850
• A/R 850
• 9/29 Paid 1,000 to creditors.
• A/P 1,000
• Cash 1,000

B/S
B/S
18
Ex. 2-44, Trial Balance

• Account Debit Credit
• Cash 12,350
• Parts 3,850
• A/R 1,350
• A/P 4,000
• C/S 15,000
• Revenues 2,200
• Rent expense 2,500
• Part expense 1,150 .
• Total 21,200 21,200

19
Ex. 2-44, continued

• The process just illustrated is the first step in
  the accounting cycle, the analysis of basic
  activity.
• These types of journal entries are called general
  journal entries (GJEs)
• After the GJEs are recorded, there are several
  additional steps to get us to the preparation of
  financial statements.
• These steps are discussed in the next part

20
The Accounting Cycle

• Components of the accounting cycle include
• A. General Journal Entries
• (Post to the General Ledger)
• B. Adjusting Journal Entries
• (Post to the General Ledger)
• C. Trial Balances
• D. Financial Statements
• E. Closing Journal Entries

21
A. General Journal Entries (GJEs)

• The first step in the accounting process.
• Prepared for daily activity.
• Usually journalized in special journals for
  efficiency, but we will record in General
  Journal format.
• Identified through a document flow
• cash receipt, record a cash sale
• charge receipt, record a credit sale
• bank note, record a notes payable
• employee time card, record wages
• Ex. 2-44 transactions are GJEs.

22
Ex. 3-18 (General JEs)

• 5/1 Cash 20,000
• Common Stock 20,000
• 5/3 Office Equipment 1,800
• A/P 1,800
• 5/5 Cars 3,000
• Cash 1,000
• N/P 2,000
• 5/10 Office Supplies 500
• A/P 500

23
Ex. 3-18 (General JEs)

• 5/15 Rent Expense 300
• Cash 300
• 5/16 A/P 500
• Cash 500
• 5/18 Advertising Expense 200
• A/P 200
• 5/20 Cash 1,500
• Commissions Revenue 1,500

24
Ex. 3-18 (General JEs)

• 5/21 A/P 200
• Cash 200
• 5/23 A/R 800
• Commissions Revenue 800
• 5/25 Salaries Expense 400
• Cash 400
• 5/27 Cash 800
• A/R 800

25
Ex. 3-18 (General JEs)

• 5/29 Utilities Expense 50
• Cash 50

26
Ex 3-18 Trial Balance

• Account Debit Credit
• Cash 19,850
• Office equipment 1,800
• Automobiles 3,000
• Office supplies 500
• A/R -
• A/P 1,800
• N/P 2,000
• C/S 20,000
• Rent exp. 300
• Adv. Exp. 200
• Revenues 2,300
• Salaries exp. 400
• Utilities exp. 50 .
• Total 26,100 26,100

27
The General Ledger

• The G/L serves as a place to total amounts by
  account titles.
• After GJEs are recorded, they are posted (by
  account) to the G/L (Ex. In page 3-5).
• However, we will use T accounts to represent
  G/L accounts where needed.
• The T-accounts are illustrated throughout Chapter
  3. Please note, however, that it is not
  necessary to prepare a T-account after every
  journal entry. We will only be posting before
  financial statements are prepared.

28
Back to Ex. 2-44 Posting to G/LNow post
transactions, for Cash, to T account
Cash
15,000
2,500
850
1,000
Bal. 12,350
.
This posting process is done for each of the
general ledger accounts.
29
Todays class objectives
The Accounting Information System
Double Entry Accounting
The Accounting Cycle
Debit (DR)
Credit (CR)
A. General Journal Entries
B. Adjusting Journal Entries
T-Account
Journal Entries
30
Adjusting Journal Entries (AJEs)

• Adjusting JEs - end-of-period entries that assign
  the financial effects of implicit transactions to
  the appropriate time periods
• AJEs are usually made when the financial
  statements are about to be prepared.
• They are made in the form of journal entries that
  are posted to the general ledger.
• Usually NO document flow to trigger recording.
• Based on the accrual system of accounting which
  records revenues as earned and expenses as
  incurred (rather than based on cash flows).
• They align revenues and expenses (matching).

31
Adjusting Journal Entries (AJEs)

• Most entities use accrual accounting.
• Adjusting entries are at the heart of accrual
  accounting.
• Accrue - to accumulate a receivable or payable
  during a given period even though no explicit
  transaction occurs
• The receivable or payable grows with time, but
  nothing changes hands.
• The goal of adjusting entries is to assure that
  assets, liabilities, and owners equity are
  properly stated.

32
B. Adjusting Journal Entries (AJEs)
3. Deferrals of Expenses
1. Accrual of Expenses
The company received services but did not pay yet
The company paid for services in advance (Prepaid)
4. Deferrals of Revenues
2. Accrual of Revenues
The company provided services but did not collect
yet
The company received cash but did not provide
services yet
5. Other
Depreciation exp., etc.
33
1. Accrual of (Unrecorded) Expenses

• The balances of accrued expenses are only
  important when financial statements are prepared.
• Consequently, adjustments to bring these accounts
  up to date are made at the end of an accounting
  period to match the expenses to the period.

34
Accounting for Payment of Wages

• Paying wages is an explicit transaction driven by
  writing a payroll check.
• As wages are paid, wage expense is recorded while
  cash is decreased.
• Assume Salaries in the amount of 16,000 were
  paid during December 2004. The general journal
  entry is
• Wages expense 16,000
• Cash 16,000

I/S
B/S
35
Accounting for Accrual of Wages

• With accrued expenses, the accountant must
  determine if something additional should appear
  in the financial statements but as yet does not.
• Accrued expenses are recorded for amounts that
  are owed at the end of an accounting period but
  have not been paid in that accounting period.

36
Accounting for Accrual of Wages

• Furniture Inc. pays its employees 16,000 during
  the month of December 2004. Furniture also owes
  its employees 2,000 for services rendered during
  the last three days of December, but the
  employees will not be paid until January 2nd,
  2005.
• To ensure that all wages for the month of
  December are recorded, an adjustment must be made
  on 12/31/2004.
• Wages expense 2,000
• Accrued wages payable 2,000

I/S
B/S
37
Accounting for Accrual of Wages

• In both the actual payment and in the accrual of
  wages, an expense is created.
• In the payment, an asset (cash) is decreased
  (Credit).
• But in the accrual, a liability (accrued wages
  payable) is recorded and increased (Credit).

38
Accrual of Interest

• Interest is much like rent paid for the use of
  money.
• Interest accumulates (accrues) as time goes on,
  regardless of when the interest is actually paid.
• Interest Principal x Interest rate x Fraction
  of a year
• The entry to record the accrual of interest
  expense is very similar to the entry to record
  the accrual of wage expense.
• Interest expense xxx
• Accrued interest payable xxx

I/S
B/S
39
Accrual of Income Taxes

• As income is generated, income tax expense is
  accrued rather than paid by the company each time
  a dollar comes in.
• The entry to record accrued income
  taxes is similar to the accrual of
  other expenses.
• Tax expense xxx
• Accrued tax payable xxx

I/S
B/S
40
Accrual of Expenses - Summary

• Probably the most common type of AJE.
• AJE has the general form of
• ____ Expense xx
• ____ Payable xx
• Note this is a skeletal journal entry, where
  the xx simply indicate values to be calculated
  later and the ____ represent a specific account
  name. The focus is on the type of account and
  direction.

I/S
B/S
41
2. Accrual of (Unrecorded) Revenues

• The accrual of unrecorded revenues is the mirror
  image of the accrual of unrecorded expenses.
• The adjusting entries show the recognition of
  revenues that have been earned, but the entity
  has not received cash.
• Examples include unbilled fees. Fees have been
  earned, but the customers have not yet been
  billed.

42
Accounting for Revenues

• Receiving revenues is an explicit transaction
  driven by an invoice and a payment.
• As revenues are received, cash is increased while
  revenue is recorded (increased).
• Assume revenues in the amount of 10,000 were
  received during December 2004 for services render
  during the month. The general journal entry is
• Cash 10,000
• Revenues 10,000

B/S
I/S
43
Accrual of (Unrecorded) Revenues

• Example A patient is admitted to a hospital on
  12/28/2004. At the end of the month, the patient
  has incurred 5,000 of charges but will not be
  billed until he leaves the hospital, sometime in
  January.
• AJE on 12/31/2004
• Accounts Receivable 5,000
• Service Revenues 5,000

B/S
I/S
44
Accrual of (Unrecorded) Revenues

• Security Inc. was hired on 12/15/2004 to provide
  security services on a monthly basis. The first
  payment in the amount of 1,000 will be received
  on 1/15/2005.
• AJE on 12/31/2004
• Accounts Receivable 500
• Service Revenues 500

B/S
I/S
45
Accrual of Revenues - Summary

• For revenues that have not yet been recorded at
  the end of the period.
• AJE has the general form of
• ______ Receivable xx
• _______ Revenue xx

B/S
I/S
46
3.Deferral of Expenses (Prepaids)

• Cash is paid now, but (part of the) expense is
  not recognized until later.
• Ex purchase and pay 1 year insurance policy for
  1,200 on Oct. 1, 2004.

I n s u r a n c e P o l i c y P e r i o d
O n e Y e a r
10/1/2004
12/31/2004
9/30/2005
9 months of service 900
3 months of service 300
47
Deferral of Expenses (Prepaids)

• IF the General JE at 10/1/04 debits ASSET
  (prepaid insurance)
• Prepaid Insurance 1,200
• Cash 1,200
• Then the Adjusting JE at end of the period
  12/31/2004 (for the used portion of 300)
• Insurance Expense 300
• Prepaid Insurance 300

B/S
B/S
I/S
B/S
48
Deferral of Expenses (Prepaids)

• IF the General JE at 10/1/04 debits EXPENSE
  (Insurance expense)
• Insurance Expense 1,200
• Cash 1,200
• Then the Adjusting JE at end of the period (for
  the unused portion of 900)
• Prepaid Insurance 900
• Insurance Expense 900

I/S
B/S
B/S
I/S
49
Deferral of Expenses (Prepaids)

• Choosing to post to an expense (Insurance
  Expense) at the date of payment is equally
  acceptable to the choice of posting to an asset
  (Prepaid Insurance).
• Although the use of the asset account appears to
  be the correct posting, once any amount of time
  has passed (a few days or weeks), the balance in
  the asset account is no longer correct.
• Large companies often direct their employees to
  post specific activities to specific expense
  accounts, then let the CPAs decide at the end of
  the period how much of the payment (if any)
  remains unused.

50
Deferral of Expenses (Prepaids)
Suggestion for analysis Use T-accounts to
analyze the balances and prepare the AJE. First
decide what ending balances should appear in the
asset (Prepaid Insurance) and expense (Insurance
Expense) accounts. In this example, 3 months
expense had been used, therefore 300 should be
shown in Insurance Expense (1,200/12 months x 3
months). Also, at December 31, there are still 9
months remaining (unused), and 900 should be
shown in Prepaid Insurance.

.
51
Deferral of Expenses (Prepaids)
Now post GJE (initial posting to asset account)
and desired ending balances to the T-accounts
Prepaid Insurance
Insurance Expense
B/S
I/S
-0-
1,200
300 AJE
AJE 300
900
300
Once the beginning and ending balances are
inserted, you can then see the amount that must
be posted as the AJE (in the boxes) to get from
the starting balances to the desired ending
balance.
.
52
Deferral of Expenses (Prepaids)

• Therefore, the AJE (when the original amount was
  debited to an asset account) would be
• Insurance Expense 300
• Prepaid Insurance 300

I/S
B/S
53
Deferral of Expenses (Prepaids)
Now post GJE (initial posting to expense account)
and desired ending balances to the T-accounts
I/S
Prepaid Insurance
Insurance Expense
B/S
1,200
-0-
AJE 900
900 AJE
900
300
Note the desired ending balances are the same
as before. The initial posting has changed
therefore, the AJE must change, to get from the
starting balances to the desired ending balance.
.
54
Deferral of Expenses (Prepaids)

• Therefore, the AJE (when the original amount was
  debited to an expense account) would be
• Prepaid Insurance 900
• Insurance Expense 900
• (This entry decreases Insurance Expense down
  to 300, and creates a balance for Prepaid
  Insurance.)

B/S
I/S
55
4. Deferral of Revenue (Unearned)

• Cash is received now, but revenue is not
  recognized until later (when goods/services
  delivered).
• Ex collect 1 year rent income of 2,400 in
  advance on Sept. 1, 2004.

R e n t P e r i o d O n e Y e a r -
2,400
9/1/2004
12/31/2004
8/31/2005
8 months of rent 8 200 1,600
4 months of rent 4 200 800
56
Deferral of Revenue (Unearned)

• IF the General JE at 9/1/04 credits LIABILITY
  (unearned revenue)
• Cash 2,400
• Unearned Revenue 2,400
• Then the Adjusting JE at end of the period
  12/31/04 (for the earned portion of 800)
• Unearned Revenue 800
• Rent Revenue 800

B/S
B/S
B/S
I/S
57
Deferral of Revenue (Unearned)

• IF the General JE at 9/1/04 credits REVENUE
• Cash 2,400
• Rent Revenue 2,400
• Then the Adjusting JE at end of the period (for
  the unearned portion of 1,600)
• Rent Revenue 1,600
• Unearned Revenue 1,600
• Note this AJE decreases Rent Revenue down
  to the earned portion of 800, and establishes a
  liability of 1,600 which indicates that the
  company still owes services of 1,600 for next
  year (2005).

B/S
I/S
I/S
B/S
58
Deferral of Revenue (Unearned)
Use T-accounts to analyze the balances and
prepare the AJE. First decide what ending
balances should appear in the liability (Unearned
Revenue) and revenue (Rent Revenue) accounts. In
this example, 4 months revenue had been earned
by 12/31, therefore 800 should be shown in Rent
Revenue (2,400/12 months x 4 months). Also, at
December 31, there are still 8 months remaining
(unearned), and 1,600 should be shown in
Unearned Revenue.

.
59
Deferral of Revenue (Unearned)
Now post GJE (initial posting to liability
account) and desired ending balances to the
T-accounts
B/S
I/S
Unearned Revenue
Rent Revenue
2,400
-0-
AJE 800
800 AJE
1,600
800
Once the beginning and ending balances are
inserted, you can then see the amount that must
be posted as the AJE (in the boxes) to get from
the starting balances to the desired ending
balance.
.
60
Deferral of Revenue (Unearned)

• Therefore, the AJE (when the original amount was
  credited to a liability account) would be
• Unearned Revenue 800
• Rent Revenue 800

B/S
I/S
61
Deferral of Revenue (Unearned)
Now post GJE (initial posting to revenue account)
and desired ending balances to the T-accounts
Unearned Revenue
Rent Revenue
B/S
I/S
-0-
2,400
1,600 AJE
AJE 1,600
1,600
800
Once the beginning and ending balances are
inserted, you can then see the amount that must
be posted as the AJE (in the boxes) to get from
the starting balances to the desired ending
balance.
.
62
Deferral of Revenue (Unearned)

• Therefore, the AJE (when the original amount was
  credited to a revenue account) would be
• Rent Revenue 1,600
• Unearned Revenue 1,600
• (This entry decreases Rent Revenue down to
  800, and creates a balance for Unearned
  Revenue.)

I/S
B/S
63
Depreciation Transactions

• With depreciation, a new account, Accumulated
  Depreciation, is introduced.
• Accumulated depreciation - the cumulative sum of
  all depreciation recognized since the date of
  acquisition of a particular asset

64
Depreciation Transactions

• An accounts such as Accumulated Depreciation is
  called a contra account, which is a separate but
  related account that offsets or is a deduction
  from a companion account.
• Book value - the balance of an account, net of
  any contra accounts (a.k.a net book value,
  carrying amount, or carrying value)
• The book value of an asset is its acquisition
  cost minus accumulated depreciation.

65
A Note on Accumulated Depreciation

• Why use accumulated depreciation? Why not just
  reduce the asset account as it expires?
• Accountants want the acquisition cost to remain
  on the books, so the asset must be reduced in
  some manner.
• Also, the acquisition cost of the asset is a
  reliable and objective number, whereas
  accumulated depreciation is an estimate of the
  allocation of the cost of that asset over the
  period that it benefits.

66
5. Other Adjusting JEs

• Relate primarily to assets whose purchase is
  recorded at cost, then an estimate to be charged
  against the account is recorded using a contra
  account.
• Ex. Depreciation on Equipment (more in Chapter
  6)
• Depreciation Expense xx
• Accumulated Depr. xx
• Ex Uncollectible Accounts Receivable (more in
  Chapter 7)
• Bad Debt Expense xx
• Allow. For Bad Debts xx

I/S
B/S
I/S
B/S
67
Contra Accounts

• Note, for the previous estimates, the debit is to
  an expense account (on the income statement), and
  the credit is to a contra account on the balance
  sheet.
• Accumulated Depreciation (A/D) is posted as an
  offset to the cost of Property, Plant and
  Equipment on the balance sheet.
• Allowance for Bad Debts (ABD) is posted as an
  offset to the recorded value for Accounts
  Receivable on the balance sheet.

68
Ex. 4-1, part (a)(AJEs)
First, insert preadjustment balances
Next, calculate and insert ending balances
2,400/12 200/mo., so 7 mos. earned
1,400, 5 mos. unearned 1,000.
Unearned Rent Revenue
Rent Revenue
2,400
-0-
AJE 1,400
1,400 AJE
1,000
1,400
Finally, calculate and insert the amount for the
AJE that would be needed to get to the ending
balances.
.
AJE Unearned Rent Revenue 1,400 Rent
Revenue 1,400
69
Ex. 4-1, part (b)(AJEs)
Preadjustment balances?
Ending balances? SAME 1,400 earned,
1,000 unearned
Unearned Rent Revenue
Rent Revenue
-0-
2,400
1,000 AJE
AJE 1,000
1,000
1,400
AJE?
.
AJE Rent Revenue 1,000 Unearned Rent
Revenue 1,000
70
Ex. 4-1, part (c) (AJEs)

• None paid yet,
• so accrue 7 months x 200 1,400.
• AJE Rent Receivable 1,400
• Rent Revenue 1,400

71
Ex. 4-6 (Adjusting JEs)

• a. Property Tax Expense 500
• Property Tax Payable 500
• b. Wages Expense 2,400
• Wages Payable 2,400
• c. Interest Receivable 75
• Interest Revenue 75
• d. From Oct. 31 - December 31 62 days x 4
• Rental Expense 248
• Rental Payable 248

72
Ex. 4-6, part (e)(AJEs)
e. Preadjustment balances?
Ending balances? 3,600/12 300/mo.,
so 2 mos. earned 600, 10 mos. unearned
3,000.
Unearned Rent Revenue
Rent Revenue
3,600
-0-
AJE 600
600 AJE
3,000
600
AJE?
.
AJE Unearned Rent Revenue 600 Rent
Revenue 600
73
Ex. 4-6 (Adjusting JEs)

• f. 3 months rent earned, but not collected.
• 1,200/12 100/month x 3 300
• AJE
• Rent Receivable 300
• Rent Revenue 300
• g. How much rent owed as of Dec. 31?
• None, so NO AJE.

74
Ex. 4-6, part (h)(AJEs)
h. Preadjustment balances?
Ending balances? 360/36 months
10/mo., so (through 12/31/X1) 4 mos. used
40, 32 mos. unused 320.
Prepaid Insurance
Insurance Expense
-0-
360
AJE 320
320 AJE
320
40
AJE?
.
AJE Prepaid Insurance 320 Insurance
Expense 320
75
Ex 4-10

• a. Depreciation expense 20,000
• Accumulated depreciation 20,000
• b. No adjustment
• c. Unearned consulting fees 5,000
• Consulting fees 5,000
• d. No adjustment
• e. No adjustment
• f. Supplies expense 356
• Supplies 356

76
Ex. 4-14 (AJEs only)
1. Where was original entry posted?
Prepaid Insurance
Ending balances 900/36 months
25/mo., so (through 12/31/X1) 6 mos. used
150, 30 mos. unused 750.
Prepaid Insurance
Insurance Expense
900
-0-
AJE 150
150 AJE
750
150
AJE?
.
AJE Insurance Expense 150 Prepaid Insurance
150
77
Ex. 4-14 (Adjusting JEs)

• 2. Depreciation per year 4,000/10 400
• (more on salvage value in Chapter 9)
• AJE
• Depreciation Expense 400
• Accumulated Depr. 400

78
Ex. 4-14 (AJEs)
3. Where was original entry posted?
Unearned Revenues
Ending balances? 1,500/3 500 earned
on Dec. 1 so unearned 1,000.
Unearned Revenue
Service Revenue
1,500
-0-
AJE 500
500 AJE
1,000
500
AJE?
.
AJE Unearned Revenue 500 Service Revenue 500
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Ex. 4-14 (Adjusting JEs)

• 4. Interest Expense 20
• Interest Payable 20
• Note that Interest Payable is usually recorded
  separately from the related Notes Payable.

80
Ex. 4-14 (AJEs only)
5. Where was original entry posted?
Rent Expense
Ending balances? 600/12 months
50/mo., so (through 12/31/X1) 5 mos. used
250, 7 mos. unused 350.
Prepaid Rent
Rent Expense
-0-
600
350 AJE
AJE 350
350
250
AJE?
.
AJE Prepaid Rent 350 Rent Expense 350
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Ex. 4-14 (Adjusting JEs)

• 6. Salaries Expense 100
• Salaries Payable 100

82
Ex. 4-14 (AJEs only)
7. Where was original entry posted?
Supplies Expense
Ending balances Supplies on hand
unused Supplies Inventory 500 So
supplies used Supplies Expense 1,500
Supplies Inventory
Supplies Expense
-0-
2,000
500 AJE
AJE 500
500
1,500
AJE?
.
AJE Supplies Inventory 500 Supplies
Expense 500

83
C. Trial Balances

• Trial balances are prepared throughout the
  accounting cycle. They represent G/L totals (by
  account) at a particular point in time. The
  three trial balances that will be of interest to
  us are
• Unadjusted trial balance (reflecting totals after
  the GJEs). This list is used to prepare AJEs.
• Adjusted trial balance (reflecting totals after
  the AJEs). This list is used to prepare
  financial statements.
• After-closing trial balance.

84
Class Exercise - Trial BalanceCowboy Company,
December 31, 2004

• Unadjusted Adjusting JE Adjusted
• Debit Credit Debit Credit
  Debit Credit
• Cash 10 10
• Accounts Receivable 12 12
• Supplies Inventory 24
• Accounts Payable 12 12
• Unearned Revenues 22
• Common Stock 6 6
• Retained Earnings 2 2
• Dividends 4 4
• Service Revenues 14
• Salaries Expense 6 6
• Supplies Expense 0
• Totals 56 56

85
Class Exercise - Trial BalanceCowboy Company,
December 31, 2004

• A physical count made at the end of the period
  revealed that there were supplies on hand with a
  cost of 16.
• AJE Supplies Expense 8
• Supplies Inventory 8
• Of the balance in the unearned revenues account,
  16 had not been earned as of year-end.
• AJE Unearned Revenues 6
• Service Revenues 6

86
Class Exercise - Trial BalanceCowboy Company,
December 31, 2004

• Unadjusted Adjusting JE Adjusted
• Debit Credit Debit Credit
  Debit Credit
• Cash 10 10
• Accounts Receivable 12 12
• Supplies Inventory 24
• Accounts Payable 12 12
• Unearned Revenues 22
• Common Stock 6 6
• Retained Earnings 2 2
• Dividends 4 4
• Service Revenues 14
• Salaries Expense 6 6
• Supplies Expense 0
• Totals 56 56

8
16
6
16
6
20
8
8
14
14
56
56
87
Class Exercise - Adjusted Trial BalanceCowboy
Company, December 31, 2004

• Debit Credit
• Cash 10
• Accounts Receivable 12
• Supplies Inventory 16
• Accounts Payable 12
• Unearned Revenues 16
• Common Stock 6
• Retained Earnings 2
• Dividends 4
• Service Revenues 20
• Salaries Expense 6
• Supplies Expense 8
• Totals 56 56

88
D. Financial Statements

• Use the previous Adjusted Trial Balance (Class
  Exercise) to prepare financial statements for
  Cowboy Company.
• Prepare the following for Cowboy Company
• Income Statement
• Statement of Retained Earnings
• Balance Sheet - for the balance sheet, we will
  use the simple format based on Assets
  Liabilities Stockholders Equity, rather than a
  more formal classified balance sheet which
  presents assets and liabilities classified by
  current/noncurrent status (current assets, PPE,
  current liabilities, long-term debt, etc.)

89
Class Exercise
Cowboy Company Income Statement For the Year
Ended December 31, 2004 Revenues Service
revenues 20 Total revenues 20 Expenses Sala
ries expense
6 Supplies expense
8 Total expenses . 14 Net income
6
90
Cowboy Company Statement of Retained Earnings For
the Year Ended December 31, 2004 Beginning
balance 2 Plus Net income 6 Less
Dividends (4) Ending balance 4
91
Cowboy Company Balance Sheet December 31,
2004 Assets Cash 10 Accounts receivable
12 Supplies 16 Total assets 38
Liabilities and Stockholders Equity Accounts
payable 12 Unearned revenue 16 Common stock
6 Retained earnings 4 Total liabilities and
stockholders equity 38
92
E. Closing Journal Entries (CJEs)

• Prepared after the financial statements have been
  prepared.
• Close temporary accounts to retained earnings, so
  that the balances in those accounts at the start
  of the next accounting period will be zero.
• Temporary accounts include revenues, expenses and
  dividends.

93
Closing Journal Entries

• Using the Class Exercise (Cowboy Company) as an
  example, prepare the journal entries to
• Close revenues and expenses to Retained Earnings.
• Close dividends to Retained Earnings.
• Note the use of the Income Summary account is
  not required. You may close revenue and expense
  totals directly to retained earnings for any
  class applications.

94
Class Exercise - Adjusted Trial Balance - Use the
following information to prepare closing journal
entries

• Debit Credit
• Cash 10
• Accounts Receivable 12
• Supplies 16
• Accounts Payable 12
• Unearned Revenues 16
• Common Stock 6
• Retained Earnings 2
• Dividends 4
• Service Revenues 20
• Salaries Expense 6
• Supplies Expense 8
• Totals 56 56

95
Closing Journal Entries

• 1.Close revenues and expenses to retained
  earnings
• Service Revenue 20
• Salaries Expense 6
• Supplies Expense 8
• Retained Earnings 6
• 2. Close dividends to retained earnings
• Retained Earnings 4
• Dividends 4

96
Closing Journal Entries
What is the ending balance in Retained
Earnings after all these items are closed? Post
to T-account
Retained Earnings
2 Beginning Balance
6 Net Income
Dividends 4
4 Ending Balance
.
97
After-closing Trial Balance

• Debit Credit
• Cash 10
• Accounts Receivable 12
• Supplies 16
• Accounts Payable 12
• Unearned Revenues 16
• Common Stock 6
• Retained Earnings 4
• Totals 38
  38
• Note the After-closing Trial Balance consists
  only of balance sheet accounts. All of the
  temporary accounts have been closed to Retained
  Earnings, and we are now ready to start a new
  year, and accumulate new balances for revenues,
  expenses, and dividends.

98
Ex. 3-23 (Closing JEs)

• Close revenues and expenses to Retained
  Earnings (or Income Summary, then to RE)
• Fees Earned 37,000
• Supplies Expense 1,000
• Salaries 14,000
• Utilities 900
• Property Taxes 500
• Retained Earnings 20,600

99
Ex. 3-23 (Closing JEs)

• Close dividends to Retained Earnings
• Retained Earnings 5,000
• Dividends 5,000

100
Ex. 3-23 - After closing trial balance

• Cash 32,700
• Accounts receivable 9,000
• Supplies 900
• Unearned fees 12,000
• Common stock 15,000
• Retained earnings 15,600
• Totals 42,600 42,600

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Ex 4-14 Closing JE

• Service revenues 4,600
• Rent expense 250
• Salaries expense 1,100
• Supplies expense 1,500
• Other expenses 200
• Insurance expense 150
• Depreciation expense 400
• Interest expense 20
• Retained earnings 980

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Ex 4-14 Closing JE

• Retained earnings 400
• Dividends 400

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Worksheets

• Worksheets can aid the accountant in the
  preparation of financial statements, but are not
  required to complete the accounting cycle.
• Worksheets are helpful for the preparation of
  adjusting journal entries, and for audit/tax
  work.
• The worksheet for financial accounting sorts the
  accounts into columns for each financial
  statement (see illustration, Page 4-7).
• Note that the totals (at the bottom of the income
  statement, statement of retained earnings, and
  the balance sheet) represent the closing journal
  entry process.

109
Ex 4-8 Adjusting JE

• 1. Supplies expense 400
• Supplies 400
• 2. Rent expense 75
• Prepaid rent 75
• 3. Salaries expense 500
• Salaries payable 500

110
Ex 4-8 Adjusting JE

• 4. Unearned revenues 600
• Commissions revenues 600
• 5. Insurance expense 7.50
• Prepaid insurance 172.50
• Miscellaneous expense 180

111
Ex 4-8 Adjusted Trial Balance

• Account Debit Credit
• Cash 6,000
• Supplies 100
• Prepaid Rent 825
• Land 8,500
• A/P 4,000
• Unearned Revenues 450
• Common Stock 6,000
• Retained Earnings 4,000
• Dividends 1,000
• Commissions earned 10,700
• Salaries expense 8,000
• Miscellaneous expense 570
• Supplies expense 400
• Rent expense 75
• Salaries Payable 500
• Insurance expense 7.5
• Prepaid Insurance 172.5 .
• Total 25,650 25,650

112
Ex 4-8 Closing JE

• Commissions revenues 10,700
• Salaries expense 8,000
• Miscellaneous expense 570
• Supplies expense 400
• Rent expense 75
• Insurance expense 7.5
• Retained earnings 1,647.5

113
Ex 4-8 Closing JE

• Retained earnings 1,000
• Dividends 1,000

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Ex. 3-18 (General JEs)

• 5/1 Cash 20,000
• Common Stock 20,000
• 5/3 Office Equipment 1,800
• A/P 1,800
• 5/5 Automobiles 3,000
• Cash 1,000
• N/P 2,000
• 5/10 Office Supplies 500
• A/P 500

115
Ex. 3-18 (General JEs)

• 5/15 Rent Expense 300
• Cash 300
• 5/16 A/P 500
• Cash 500
• 5/18 Advertising Expense 200
• A/P 200
• 5/20 Cash 1,500
• Commissions Revenue 1,500

116
Ex. 3-18 (General JEs)

• 5/21 A/P 200
• Cash 200
• 5/23 A/R 800
• Commissions Revenue 800
• 5/25 Salaries Expense 400
• Cash 400
• 5/27 Cash 800
• A/R 800

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Ex. 3-18 (General JEs)

• 5/29 Utilities Expense 50
• Cash 50

118
Notes on Accrual and Cash Basis
119
Accrual Basis and Cash Basis

• The most common ways of measuring income are the
  accrual basis and the cash basis.
• Accrual basis - recognizes the impact of
  transactions for the time periods when revenues
  and expenses occur even if no cash changes hands
• Cash basis - recognizes the impact of
  transactions only when cash is received or
  disbursed

120
Accrual Basis and Cash Basis

• Under the accrual basis
• Revenues are recorded when earned.
• For example, a sale on account is recorded as
  revenue when the transaction takes place even
  though the seller receives no cash at that
  moment.
• Expenses are recorded when incurred.
• For example, a purchase on account is recorded as
  an expense when the transaction takes place even
  though the buyer disburses no cash at that moment.

121
Accrual Basis and Cash Basis

• Under the cash basis
• Revenues are recorded when a sale is made for
  cash at the time when the cash changes hands.
• Expenses are recorded when a purchase is made for
  cash at the time when the cash changes hands.

122
Accrual Basis and Cash Basis

• The accrual basis is the current standard for the
  measurement of income.
• Presents a more complete summary of what happened
  during the year
• Recognizes revenues when they are earned and
  expenses when they are incurred
• Matches costs to revenues

123
Accrual Basis

• Revenue Recognition has two parts. Both must
  occur for revenues to be recognized
• Earned Delivery has occurred or services have
  been rendered.
• Realization Cash collection is reasonably
  assured.
• Matching is the recording of expenses in the
  same time period as the related revenues are
  recognized. There are two types of expenses
• Product costs, which are naturally linked with
  revenues (e.g., cost of goods sold).
• Period costs, which are expenses that are
  incurred over a particular time period.

124
Todays class objectives
The Accounting Information System
Double Entry Accounting
The Accounting Cycle
Debit (DR)
Credit (CR)
A. General Journal Entries
B. Adjusting Journal Entries
T-Account
C. Trial Balance
Journal Entries
D. Financial Statements
E. Closing Journal Entries