Fundamental Financial Accounting Concepts Third Edition by Edmonds, McNair, Milam, Olds

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Fundamental Financial Accounting ConceptsThird
EditionbyEdmonds, McNair, Milam, Olds

• PowerPoint presentation by
• J. Lawrence Bergin

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Chapter 4 The Recording Process
4- 2
Irwin/McGraw-Hill

• The McGraw-Hill Companies, Inc., 2000

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The Accounting Cycle...

• Transactions occur in the normal course of
  business. We record them in our records with a
  JOURNAL ENTRY (called Journalizing).
• Journal entries are posted to the GENERAL LEDGER
  (called Posting).
• ADJUSTING ENTRIES are made and posted.

Transactions
Financial Statements
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Accounting cycle continued...

• A trial balance is taken, which shows the
  balances in each account.
• Financial statements are written.
• Closing journal entries are made and posted (and
  a post-closing trial balance may be prepared).

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DOUBLE-ENTRY ACCOUNTING

• Each account can be increased or decreased.
• Debit means left side
• Credit means right side
• Assets are increased with debits and decreased
  with credits
• Liabilities and Equity are increased with credits
  and decreased with debits
• In each journal entry, i.e. recording of a
  transaction, DEBITS CREDITS. (No exceptions!)

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T-Accounts

• In a transaction that increases an asset, put
  that amount on the left.

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T-Accounts

• In a transaction that increases an asset, put
  that amount on the left.

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T-Accounts

• In a transaction that increases an asset, put
  that amount on the left.

• In a transaction that decreases an asset, put
  that amount on the right.

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T-Accounts

• In a transaction that increases an asset, put
  that amount on the left.

• In a transaction that decreases an asset, put
  that amount on the right.

In our accounting records, we never cross out or
subtract or change a number. Instead, we use
debits and credits to change the balance in an
account.
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T-Accounts

• In a transaction that increases an asset, put
  that amount on the left.

• In a transaction that decreases an asset, put
  that amount on the right.

Calculate the balance in an asset account at any
time by adding the amounts on the left and
subtracting the amounts on the right.
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T-accounts Assets
CASH
DEBITS on the left!!
debits increase assets

e.g., when we receive cash, we debit the CASH
account
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T-accounts Assets
Credits on the right!!
e.g., when we disburse cash, we credit the CASH
account
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T-accounts Liabilities and Equity
Debits on the left!
Accounts Payable
debits liabilities
Credits on the right!!
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T-accounts Liabilities and Equity
Debits on the left!
Accounts Payable
debits liabilities
Credits on the right!!
e.g., when we pay off some of our accounts payable
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T-accounts Liabilities and Equity
Debits on the left!
Accounts Payable
debits liabilities
credits liabilities
Credits on the right!!
e.g., when we pay off some of our accounts payable
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T-accounts Liabilities and Equity
Debits on the left!
Accounts Payable
debits liabilities
credits liabilities
Credits on the right!!
e.g., when we pay off some of our accounts payable
e.g., when we record an amount we owe someone
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T-Accounts
4- 17
Permanent Equity accts work like liability
accounts do
Permanent Equity Accts.are
Cont. Cap. Ret.Earn.
Deductions from these accounts are put on the
left.
Additions to these accounts are put on the right.
Irwin/McGraw-Hill

• The McGraw-Hill Companies, Inc., 2000

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T-Accounts
4- 18
Nominal (Temporary) Equity accounts require
thought.
Question What effect will an increase in this
Nominal account have on Owners Equity?

Answer An increase in Expenses decreases profit
thus, decreases permanent OE. Since decreases
in permanent OE are recorded with debits, Expense
increases are recorded with debits.
Expenses Distributions
Distributions are also called dividends.
Additions to these accounts are put on the left
because an increase in Expenses decreases Net
Income and Owners Equity (thru a decrease in
Ret. Earn).
Deductions from these accts are put on the right.

• The McGraw-Hill Companies, Inc., 2000

Irwin/McGraw-Hill
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How do journal entries relate to T-accounts?

• Journal entries are recorded chronologically as
  the transactions occur
• e.g., On Jan. 6 services are rendered for 100
  cash
• Date Account Title PR
  Debit Credit
• Jan. 6 Cash 100

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How do journal entries relate to T-accounts?

• Journal entries are recorded chronologically as
  the transactions occur
• e.g., On Jan. 6 services are rendered for 100
  cash
• Date Account Title PR
  Debit Credit
• Jan. 6 Cash 100
• Service Revenue 100
• An explanation goes here.
• Journal entries are written in a journal and then
  posted to the general ledger accounts
  (our t-accounts)

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They are then posted to the General Ledger (our
t-accounts)

CASH
SERVICE REVENUE
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They are then posted to the General Ledger (our
t-accounts)

CASH
100
SERVICE REVENUE
100
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Summary of Balance Sheet Accounts and Debits and
Credits

• Assets Liabilities
• increase - decrease -decrease
  increase
• Owners Equity

-decrease
increase
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Summary of Journal Entries

• Assets are increased with debits.
• Assets include
• Cash
• A/R
• Inventory
• Supplies
• Prepaid Insurance
• Prepaid Rent
• Equipment

• Liabilities and Permanent Owners Equity accounts
  are increased with credits.
• Liabilities include all PAYABLES.
• Permanent Equity accounts include
• Contributed Capital
• Retained Earnings

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Summary of Journal Entries
Rules for Temporary Owners Equity accounts
(Nominal accts.)

• Expense Accts. and Distributions (Also called
  Dividends) are increased with debits.

• Revenue accounts are increased with credits.
• Revenue accounts include
• Sales
• Service Revenue
• Interest Revenue
• or Interest Income
• or Interest Earned

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Summary of Debit/Credit Rules
ACCOUNT TITLE Debit Side
Credit Side Increases in
Assets Decreases in Assets Decreases in
Liabilities Increases in
Liabilities Decreases in Own. Eq.
Increases in Own. Eq. Decrease in Cont. Cap.
Increase in Cont. Cap. Decrease in Ret.
Earn. Increase in Ret. Earn. Decrease in
Revenue Increase in Revenue Increase in
Expenses Decrease in Exp. Increase
in Distribution Decrease in Distrib.
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An asset source transaction...

• ABC Company received 4,000 from a client for
  services to be performed at a future date.

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An asset source transaction...

• ABC Company received 4,000 from a client for
  services to be performed at a future date.

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An asset source transaction...

• ABC Company received 4,000 from a client for
  services to be performed at a future date.

Cash
Unearned Revenue
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An asset source transaction...

• ABC Company received 4,000 from a client for
  services to be performed at a future date.

Cash
Unearned Revenue
4,000
4,000
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An asset exchange transaction...

• ABC Company paid 3,000 for a new piece of office
  equipment.

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An asset exchange transaction...

• ABC Company paid 3,000 for a new piece of office
  equipment.

Cash
Equipment
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An asset exchange transaction...

• ABC Company paid 3,000 for a new piece of office
  equipment.

Cash
Equipment
3,000
3,000
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An asset use transaction...

• ABC Company paid 1,500 to employees for work
  completed.

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An asset use transaction...

• ABC Company paid 1,500 to employees for work
  completed.

Cash
Salary Expense
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An asset use transaction...

• ABC Company paid 1,500 to employees for work
  completed.

Cash
Salary Expense
1,500
1,500
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A claims exchange transaction...

• Recognized one-fourth of the 4,000 unearned
  revenue (liability), received in a previous
  transaction, was now earned because 25 of the
  work was completed.

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A claims exchange transaction...

• Recognized one-fourth of the 4,000 unearned
  revenue (liability), received in a previous
  transaction, was now earned because 25 of the
  work was completed.

Unearned Revenue

4,000
previously recorded
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A claims exchange transaction...

• Recognized one-fourth of the 4,000 unearned
  revenue (liability), received in a previous
  transaction, was now earned because 25 of the
  work was completed.

Unearned Revenue
Service Revenue
4,000
previously recorded
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A claims exchange transaction...

• Recognized one-fourth of the 4,000 unearned
  revenue (liability), received in a previous
  transaction, was now earned because 25 of the
  work was completed.

Unearned Revenue
Service Revenue
4,000
1,000
1,000
previously recorded
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A claims exchange transaction...

• Recognized one-fourth of the 4,000 unearned
  revenue (liability), received in a previous
  transaction, was now earned because 25 of the
  work was completed.

Unearned Revenue
Service Revenue
4,000
1,000
1,000
Earned this period.
3,000
Still not earned.
previously recorded
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Trial Balance

• Since debits credits in all journal entries,
  at any point in time we should be able to take
  the balances in all of our general ledger
  accounts and confirm that DEBITS CREDITS for
  all accounts together.

credits
debits
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Trial Balance (amounts assumed)
Calculate balances of each Ledger account
(T-accts) and place them on a Trial Balance form.
Accounts in Ledger Dr. Cr.

debits
credits
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Trial Balance (amounts assumed)
Calculate balances of each Ledger account
(T-accts) and place them on a Trial Balance form.
Accounts in Ledger Dr. Cr. Cash
10 Accounts. Receivable 40 Prepaid Rent
30 Equipment 700 Accumulated Deprec.
50 Accounts Payable 30 Note
Payable 300 Contributed Capital 100 Retained
Earnings 200 Service Revenue 800 Salary
Expense 500 Rent Expense 200 Totals
1480 1480

debits
credits
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Adjusting entries...

• Before financial statements are prepared,
  adjusting entries must be journalized and posted
  to make sure that all accounts are properly
  stated and that nothing has been omitted.
• Adjustments need to be made for all
• Accruals
• Deferrals

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Adjusting for Accruals

• ACCRUALS--actions that have been completed but
  for which the cash has not changed hands (and the
  events are not yet recorded)
• ABC Company has a CD on which 500 of interest
  had been earned during the year but not yet
  received (or recorded).

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Adjusting for Accruals

• ACCRUALS--actions that have been completed but
  for which the cash has not changed hands (and the
  events are not yet recorded)
• ABC Company has a CD on which 500 of interest
  had been earned during the year but not yet
  received (or recorded).

Interest receivable
Interest revenue
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Adjusting for Accruals

• ACCRUALS--actions that have been completed but
  for which the cash has not changed hands (and the
  events are not yet recorded)
• ABC Company has a CD on which 500 of interest
  had been earned during the year but not yet
  received (or recorded).

Interest receivable
Interest revenue
500
500
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Adjusting for Deferrals

• Deferrals--dollars have been exchanged and
  recorded before the action is completed
• ABC Company paid 900 for rent on December 1.
  The rent was for the months of December, January
  and February. When they paid it, ABC recorded it
  as Prepaid Rent. Now, on 12/31, one months
  worth of rent has expired (that is, has been used
  up).

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Adjusting for Deferrals

• Deferrals--dollars have been exchanged and
  recorded before the action is completed
• ABC Company paid 900 for rent on December 1.
  The rent was for the months of, December, January
  and February. When they paid it, ABC recorded it
  as Prepaid Rent. Now, on 12/31, one months
  worth of rent has expired (that is, has been used
  up).

Prepaid Rent
Rent Expense
900
previously recorded
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Adjusting for Deferrals

• Deferrals--dollars have been exchanged and
  recorded before the action is completed
• ABC Company paid 900 for rent on December 1.
  The rent was for the months of, December, January
  and February. When they paid it, ABC recorded it
  as Prepaid Rent. Now, on 12/31, one months
  worth of rent has expired (that is, has been used
  up).

Prepaid Rent
Rent Expense
900
300
300
previously recorded
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Adjusting for Deferrals

• Deferrals--dollars have been exchanged and
  recorded before the action is completed
• ABC Company paid 900 for rent on December 1.
  The rent was for the months of, December, January
  and February. When they paid it, ABC recorded it
  as Prepaid Rent. Now, on 12/31, one months
  worth of rent has expired (that is, has been used
  up).

Prepaid Rent
Rent Expense
900
300
300
Bal. 600
previously recorded
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Adjusting for Deferrals

• Questions
• How much of the rent should be reported as an
  asset on the 12/31 Balance Sheet?
• Answer
• How much of the rent should be reported on the
  Income Statement for the year ended 12/31?
• Answer

Prepaid Rent
Rent Expense
900
300
300
Bal. 600
previously recorded
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Adjusting for Deferrals

• Questions
• How much of the rent should be reported as an
  asset on the 12/31 Balance Sheet?
• Answer 600
• How much of the rent should be reported on the
  Income Statement for the year ended 12/31?
• Answer

Prepaid Rent
Rent Expense
900
300
300
Bal. 600
previously recorded
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Adjusting for Deferrals

• Questions
• How much of the rent should be reported as an
  asset on the 12/31 Balance Sheet?
• Answer 600
• How much of the rent should be reported on the
  Income Statement for the year ended 12/31?
• Answer 300

Prepaid Rent
Rent Expense
900
300
300
Bal. 600
previously recorded
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The goal of the whole process

• Financial Statements that reflect the financial
  condition and transactions of the company
• Balance Sheet
• Income Statement
• Statement of Changes in Owners Equity
• Statement of Cash Flows

communicating information to users
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Closing Entries

• All temporary accounts (income statement accounts
  and distributions) are closed at the end of the
  accounting period, after the statements are
  prepared.
• Their balances are brought to ZERO, and the
  balancing entry is made to the retained earnings
  account.

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Closing Entries

• Since revenue and expense accounts keep track of
  transactions for a period of time, we need them
  to be zero at the end of an accounting period.
• To do this, we close them to retained earnings.
• This effectively kicks them from the income
  statement to the balance sheet

Revenues Expenses
Balance Sheet
Income Statement
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Journal Entries to Close Revenue and Expense
Accounts Closing Entries

• Like all entries, Closing entries are Journalized
  and then Posted.
• Revenue accounts have credit balances, so we must
  DEBIT them to close them (to get a zero balance)
• What should we credit?
• Retained Earnings

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Closing continued...

• To close expense accounts, we should credit the
  expense account and debit the Retained Earnings
  account.
• We are emptying the revenue and expense
  accounts...

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Closing continued...
Closing entries

• Debit all the revenue accounts to close them to
  0.
• Credit all the expense accounts to close them to
  0.
• Their balances should be zero after closing them!
  
• Retained Earnings

Service Rev. Rent Exp. Wage Exp.
100 bal. 20 bal. 40 bal.
500 beg.bal.
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Closing continued...
Closing entries

• Debit all the revenue accounts to close them to
  0.
• Credit all the expense accounts to close them to
  0.
• Their balances should be zero after closing them!
  
• Retained Earnings

Service Rev. Rent Exp. Wage Exp.
100 bal. 20 bal. 40 bal.
500 beg.bal. 100

100
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Closing continued...
Closing entries

• Debit all the revenue accounts to close them to
  0.
• Credit all the expense accounts to close them to
  0.
• Their balances should be zero after closing them!
  
• Retained Earnings

Service Rev. Rent Exp. Wage Exp.
100 bal. 20 bal. 40 bal.
500 beg.bal. 100

100 0 end
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Closing continued...
Closing entries

• Debit all the revenue accounts to close them to
  0.
• Credit all the expense accounts to close them to
  0.
• Their balances should be zero after closing them!
  
• Retained Earnings

Service Rev. Rent Exp. Wage Exp.
100 bal. 20 bal. 40 bal.
500 beg.bal. 100
20 40
60 100 0 end

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Closing continued...
Closing entries

• Debit all the revenue accounts to close them to
  0.
• Credit all the expense accounts to close them to
  0.
• Their balances all should be zero after closing
  them!
• Retained Earnings

Service Rev. Rent Exp. Wage Exp.
100 bal. 20 bal. 40 bal.
500 beg.bal. 100
20 40
60 100 0 end 0
end 0 end
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One more account to close Distributions (or
Dividends)

• Retained Earnings

Beginning balance
Revenues
- Expenses
Ending balance
The DISTRIBUTIONS (to owners) account is closed
with a credit, since it has a debit balance, and
a debit to RETAINED EARNINGS.
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One more account to close

• Retained Earnings

Beginning balance
Revenues
- Expenses
- Distributions
Ending balance
The DISTRIBUTIONS (to owners) account is closed
with a credit, since it has a debit balance, and
a debit to RETAINED EARNINGS.
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One more account to close

• Distributions (Div.) Retained
  Earnings
• Bal. 10
  500 Beg. Bal.
• 
  (-exp) 60 100 ( rev.)
• 
  

The DISTRIBUTIONS (to owners) account is closed
with a credit, since it has a debit balance, and
a debit to RETAINED EARNINGS.
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One more account to close

• Distributions (Div.) Retained
  Earnings
• Bal. 10
  500 Beg. Bal.
• 
  (-exp) 60 100 ( rev.)
• 10 (to close)
  (-dist) 10
  

The DISTRIBUTIONS (to owners) account is closed
with a credit, since it has a debit balance, and
a debit to RETAINED EARNINGS.
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One more account to close

• Distributions (Div.) Retained
  Earnings
• Bal. 10
  500 Beg. Bal.
• 
  (-exp) 60 100 ( rev.)
• 10 (to close)
  (-dist) 10
  
• end 0
  530 End Bal.

The DISTRIBUTIONS (to owners) account is closed
with a credit, since it has a debit balance, and
a debit to RETAINED EARNINGS.
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One more account to close

• Distributions (Div.) Retained
  Earnings
• Bal. 10
  500 Beg. Bal.
• 
  (-exp) 60 100 ( rev.)
• 10 (to close)
  (-dist) 10
  
• end 0
  530 End Bal.

The DISTRIBUTIONS (to owners) account is closed
with a credit, since it has a debit balance, and
a debit to RETAINED EARNINGS.
Do NOT close the Retained Earnings account. Its
530 ending balance becomes next periods
beginning balance.
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The Closing Entries Journalized
Date Account Title
PR Dr. Cr. Dec. 31 Service
Revenue 100 Retained
Earnings 100 To close revenue
account
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The Closing Entries Journalized
Date Account Title
PR Dr. Cr. Dec. 31 Service
Revenue 100 Retained
Earnings 100 To close revenue
account 31 Retained Earnings
60 Rent Expense 20
Wages Expense 40 To close
expense accounts
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The Closing Entries Journalized
Date Account Title
PR Dr. Cr. Dec. 31 Service
Revenue 100 Retained
Earnings 100 To close revenue
account 31 Retained Earnings
60 Rent Expense 20
Wages Expense 40 To close
expense accounts 31 Retained
Earnings 10
Distributions 10 To
close Distribution account
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The post-closing trial balance

• A trial balance written after closing the books
  is called a post-closing trial balance.
• What accounts will be on this trial balance?

THE END
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The post-closing trial balance

• A trial balance written after closing the books
  is called a post-closing trial balance.
• What accounts will be on this trial balance?

THE END
Assets Liabilities Permanent OE accts.
(Cont. Cap. Ret. Earn.)
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The post-closing trial balance

• A trial balance written after closing the books
  is called a post-closing trial balance.
• What accounts will be on this trial balance?

THE END
Assets Liabilities Permanent OE accts.
(Cont. Cap. Ret. Earn.) There will be NO
Revenue, Expense or Distribution accounts on the
Trial Balance.
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Chapter 4
The End