Test yourself:

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Test yourself

• List four main financial statements
• The accounting equation is
• Net Income
• Retained Earnings
• The Statement of Cash Flows has 3 sections

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Answers

• 1. List four main financial statements
• the Balance Sheet
• the Income Statement
• the Statement of Cash Flows
• the Statement of Retained Earnings
• 2. The accounting equation is Assets
  Liabilities Equity
• 3. Net Income Revenues - Expenses
• 4. Retained EarningsBeginning of the year
  Retained Earnings Net Income - Dividends
• 5. The Statement of Cash Flows has 3 sections
• operating, investing and financing.

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How Do Companies Keep Track of Account Balances?
Journal entries
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Direction of Transaction Effects

• The left side of the
• T-account is always the debit side.

The right side of the T-account is always
the credit side.
Account Name
Left
Right
Debit
Credit
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The Debit-Credit Framework
A L SE
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A L SE

Next, lets see how Revenues and Expenses affect
Retained Earnings.
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Expanded Transaction Analysis Model

Dividends decrease Retained Earnings.
Net Income increases Retained Earnings.
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Analytical Tool The Journal Entry
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Analytical Tool The T-Account

• After journal entries are prepared, the
  accountant posts (transfers) the dollar amounts
  to each account that was affected by the
  transaction.

Ledger
Post
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Transaction Analysis Illustrated
Lets prepare some journal entries for Papa
Johns and post them to the ledger.
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Papa Johns issues 2,000 of additional common
stock to new investors for cash.
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The company borrows 6,000 from the local bank,
signing a one-year note.
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Papa Johns purchases 10,000 of new equipment,
paying 2,000 in cash and signing a two-year note
payable for the rest.
Papa Johns purchases 10,000 of new equipment,
paying 2,000 in cash and signing a two-year note
payable for the rest.
Lets see how to post this entry . . .
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Papa Johns purchases 10,000 of new equipment,
paying 2,000 in cash and signing a two-year note
payable for the rest.
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How are Unadjusted Financial Statements Prepared?
After posting all of the January transactions to
T-accounts, we can prepare Papa Johns unadjusted
financial statements.
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The Unadjusted Trial Balance

• A listing of individual accounts, usually in
  financial statement order.
• Ending debit or credit balances are listed in two
  separate columns.
• Total debit account balances should total
  credit account balances.

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Note that total debits total credits
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Business Background
Revenues are recorded when earned.
Expenses are recorded when incurred.
Matching Principle
Because transactions occur over time, ADJUSTMENTS
are required at the end of each fiscal period to
get the revenues and expenses in the right
period.
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Now that we have covered the trial balance,
lets discuss adjusting entries.
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Adjusting Entries

• There are two types of adjusting entries.

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Deferrals
End of accounting period.
Examples include rent received in advance (an
unearned revenue) or insurance paid in advance (a
prepaid expense).
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Accruals
End of accounting period.
Examples include interest earned during the
period (accrued revenue) or wages earned by
employees but not yet paid (accrued expense).
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The Closing Process

• Even though the balance sheet account balances
  carry forward from period to period, the income
  statement accounts do not.

• Closing entries
• Transfer net income (or loss) to Retained
  Earnings.
• Establish a zero balance in each of the temporary
  accounts to start the next accounting period.

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The Closing Process

• The following accounts are called temporary or
  nominal accounts and are closed at the end of the
  period . . .

• Revenues
• Expenses
• Gains,
• Losses, and
• Dividends declared.

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The Closing Process

• Assets, liabilities, and stockholders equity
  are permanent, or real accounts, and are never
  closed.

• Assets
• Liabilities
• Stockholders Equity

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The Closing Process

• Two steps are used in the closing process . . .
• Close revenues and gains to Retained Earnings.
• Close expenses and losses to Retained Earnings.

How to Close the Books!
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The Closing Process
To close Papa Johns Restaurant Sales Revenue
account, the following entry is required
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The Closing Process

• If we close the other revenue accounts in a
  similar fashion, the retained earnings account
  looks like this . . .

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The Closing Process
To close Papa Johns Cost of Sales -
Restaurants account, the following entry is
required
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The Closing Process

• If we close the other expense accounts in a
  similar fashion, the retained earnings account
  looks like this . . .

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The Conceptual Framework
Objective of External Financial Reporting To
provide useful economic information to external
users for decision making and for assessing
future cash flows.

• Primary Characteristics
• Relevancy predictive value,
• feedback value, and timeliness.
• Reliability verifiability,
• representational faithfulness, and
• neutrality (objectiveness).
• Secondary Characteristics
• Comparability across
• companies.
• Consistency over time.

Elements of Statements Asset Liability Stockholder
s Equity Revenue Expense Gain Loss
Qualitative Characteristics Relevancy Reliability
Comparability Consistency