review of the accounting process chapter 2 © 2009 the mcgraw-hill companies, inc

REVIEW OF THE REVIEW OF THE ACCOUNTING PROCESSACCOUNTING PROCESS

Chapter 2

© 2009 The McGraw-Hill Companies, Inc.

McGraw-Hill /Irwin

Slide 2

The Accounting EquationThe Accounting Equation

A = L + OE- Owner Withdrawals+ Owner Investments

- Expenses- Losses

+ Revenue+ Gains

McGraw-Hill /Irwin

Slide 3

Accounting Equation for a CorporationAccounting Equation for a Corporation

A = L + SE+ Retained Earnings+ Paid-in Capital

- Expenses- Losses

+ Revenues+ Gains

- Dividends

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Slide 4

Account RelationshipsAccount Relationships

Debits and credits affect the Balance Sheet Model as follows:

Debits and credits affect the Balance Sheet Model as follows:

A = L + PIC + REAssets

Dr.+

Cr.-

LiabilitiesDr.-

Cr.+

Paid-inCapital

Dr.-

Cr.+

Retained EarningsDr.-

Cr.+

Revenues and GainsDr.-

Cr.+

Expenses and Losses

Dr.+

Cr.-

Permanent Accounts

Temporary Accounts

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Slide 5

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

During the Accounting Period

At the End of the Accounting Period

At the End of the Year

McGraw-Hill /Irwin

Slide 6

Accounting Processing CycleAccounting Processing Cycle

On January 1, $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.

McGraw-Hill /Irwin

Slide 7

General LedgerGeneral Ledger

The “T” account is a shorthand format of an account used by accountants to analyze transactions.

It is not part of the bookkeeping system.

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Slide 8

Posting Journal EntriesPosting Journal Entries

On July 1, the owners invest $60,000 in a new business, Dress Right Clothing Corporation.

GENERAL JOURNAL Page 1

Date DescriptionPost. Ref. Debit Credit

July 1 Cash 60,000Common Stock 60,000

Post the debit portion of the entry to the Cash ledger account.

Post the debit portion of the entry to the Cash ledger account.

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Slide 9


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Slide 10


We follow the same procedure to post the credit portion of the entry to the Common Stock account.

We follow the same procedure to post the credit portion of the entry to the Common Stock account.

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After recording all entries for the period, Dress Right’s Unadjusted Trial Balance would be as follows:

After recording all entries for the period, Dress Right’s Unadjusted 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.

McGraw-Hill /Irwin

Slide 12

Prepaym ents(Deferrals)

Accruals Estimates

Adjusting Entries

Transactions where cash is paid or received

before a related expense or revenue is

recognized.

Transactions where cash is paid or received after a related expense

or revenue is recognized.

McGraw-Hill /Irwin

Slide 13

Asset Expense

UnadjustedBalance

CreditAdjustment

DebitAdjustment

Prepaid ExpensesPrepaid Expenses

Today, I will payfor my first

6 months’ rent. Prepaid Expenses

Items paid for in advance of receiving their benefits

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Slide 14

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

Straight-LineDepreciationExpense

= Asset Cost - Salvage Value

Useful Life

DepreciationDepreciation

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Slide 15


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, 2009.

Asset Cost 12,000$ Salvage Value - Useful Life 60 months

McGraw-Hill /Irwin

Slide 16

JulyDepreciation

Expense=

$12,000 - $0

60 months= $200 per month

Recall the Furniture and Fixtures for $12,000 listed on Dress Right’s unadjusted trial balance.

Asset Cost 12,000$ Salvage Value - Useful Life 60 months

GENERAL JOURNAL Page 2Date Description PR Debit Credit

July 31 Depreciation Expense 200Accumulated Depr. - Furniture & Fixtures 200

To record depreciation


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Slide 17

After posting, the accounts look like this:


Beg. bal. - 12,000

Bal. 12,000

Furniture and FixturesBeg. bal. -

200 Bal. 200

Depreciation Expense

- Beg. bal.200 200 Bal.

Accumulated Depreciation

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Slide 18

Liability RevenueUnadjusted

BalanceCredit

AdjustmentDebit

Adjustment

Unearned RevenuesUnearned Revenues

“Go Big Blue”

Buy your season tickets forall home basketball games NOW! Unearned Revenue

Cash received in advance of performing

services

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Slide 19

Alternative Approach to Record PrepaymentsAlternative Approach to Record Prepayments

Unearned RevenueRecord initial cash receipts

as follows:

Cash $$$ Revenue $$$

Adjusting EntryRecord the amount for the

unearned liability as follows:

Revenue $$$ Unearned revenue $$$

Prepaid ExpensesRecord initial cash

payments as follows:

Expense $$$ Cash $$$

Adjusting EntryRecord the amount for the

prepaid expense as follows:

Prepaid expense $$$ Expense $$$

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Slide 20

Expense LiabilityCredit

AdjustmentDebit

Adjustment

Accrued LiabilitiesAccrued Liabilities

I won’t pay youuntil the job is done!

Accrued Liabilities

Liabilities recorded when an expense has been incurred

prior to cash payment.

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Slide 21

Asset Revenue

CreditAdjustment

DebitAdjustment

Accrued ReceivablesAccrued Receivables

Yes, you can pay mein May for your April

15 tax return.Accrued Receivables

Revenue earned in a period prior to the cash

receipt.

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Slide 22

EstimatesEstimates

Uncollectible accounts and depreciation of fixed assets are estimated.

An estimated item is a function of future events and developments.

$$

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Slide 23

EstimatesEstimatesThe 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,

only $1,500 will ultimately be collected. Prepare the adjusting entry for July 31.

McGraw-Hill /Irwin

DRESS RIGHT CLOTHING CORPORATIONAdjusted Trial Balance

July 31, 2009Account Title Debits CreditsCash 68,500$ Accounts receivable 2,000 Allowance for uncollectible accounts 500$ Supplies 1,200 Prepaid rent 22,000 Inventory 38,000 Furniture and fixtures 12,000 Accumulated depr.-furniture & fixtures 200 Accounts payable 35,000 Note payable 40,000 Unearned rent revenue 750 Salaries payable 5,500 Interest payable 333 Common stock 60,000 Retained earnings 1,000 Sales revenue 38,500 Rent revenue 250 Cost of goods sold 22,000 Salaries expense 10,500 Supplies expense 800 Rent expense 2,000 Depreciation expense 200 Interest expense 333 Bad debt expense 500 Totals 181,033$ 181,033$

This is the Adjusted Trial Balance for

Dress Right after all adjusting entries have

been recorded and posted.

Dress Right will use these balances to

prepare the financial statements.

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Slide 25

The income statement summarizes the results of operating activities of the company.

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Slide 26

Current assets: Cash 68,500$ Accounts receivable 2,000$ Less: Allowance for uncollectible accounts 500 1,500 Supplies 1,200 Inventory 38,000 Prepaid rent 22,000 Total current assets 131,200 Property and equipment: Furniture and fixtures 12,000 Less: Accumulated depreciation 200 11,800 Total assets 143,000$

Dress Right Clothing CorporationBalance SheetAt July 31, 2009

Assets

The balance sheet presents the financial position of the company on a particular date.

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Slide 27

Current liabilities: Accounts payable 35,000$ Salaries payable 5,500 Unearned rent revenue 750 Interest payable 333 Note payable 10,000 Total current liabilities 51,583 Long-term liabilities: Note payable 30,000 Shareholders' equity: Common stock 60,000$ Retained earnings 1,417 Total shareholders' equity 61,417 Total liabilities and shareholders' equity 143,000$

Dress Right Clothing CorporationBalance SheetAt July 31, 2009

Liabilities and Shareholders' Equity

Notice that assets of $143,000 equal total liabilities plus shareholders’ equity of $143,000.

McGraw-Hill /Irwin

Slide 28

The statement of cash flows discloses the changes in cash during a period.

Cash flows from operating activities:Cash inflows: From customers 36,500$ From rent 1,000 Cash outflows: For rent (24,000) For supplies (2,000) To suppliers for merchandise (25,000) To employees (5,000) 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 Net increase in cash 68,500$

Dress Right Clothing CorporationStatement of Cash Flows

For the Month of July 2009

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Slide 29

The statement of shareholders’ equity presents the changes in permanent

shareholder accounts.

Common Stock

Retained Earnings

Total Shareholders'

EquityBalance at July 1, 2009 -$ -$ -$ Issue of capital stock 60,000 60,000 Net income for July 2009 2,417 2,417 Less: Dividends (1,000) (1,000) Balance at July 31, 2009 60,000$ 1,417$ 61,417$

Dress Right Clothing CorporationStatement of Shareholders' Equity

For the Month of July 2009

McGraw-Hill /Irwin

Slide 30

Temporary Accounts

Revenues

Income Summary

Exp

ense

s

Divid

end

s

Permanent Accounts

Assets

Lia

bili

ties

Sh

areho

lders’

Eq

uity

The closing process applies only to temporary accounts.

Temporary and Permanent AccountsTemporary and Permanent Accounts

McGraw-Hill /Irwin

Slide 31

Post-Closing Trial BalancePost-Closing Trial Balance

Lists permanent accounts and their

balances.

Total debits equal total credits.

DRESS RIGHT CLOTHING CORPORATIONPost-Closing Trial Balance

July 31, 2009Account Title Debits CreditsCash 68,500$ Accounts receivable 2,000 Allowance for uncollectible accounts 500$ Supplies 1,200 Prepaid rent 22,000 Inventory 38,000 Furniture and fixtures 12,000 Accumulated depr.-furniture & fixtures 200 Accounts payable 35,000 Note payable 40,000 Unearned rent revenue 750 Salaries payable 5,500 Interest payable 333 Common stock 60,000 Retained earnings 1,417 Totals 143,700$ 143,700$

McGraw-Hill /Irwin

Slide 32

Conversion From Cash Basis to Accrual BasisConversion From Cash Basis to Accrual Basis

Prepaid Insurance

Balance, 1/1 5,000$ Plus: Cash paid 20,000 Less: Insurance expense (22,000) 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.

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Slide 33

Appendix 2A: Use of a WorksheetAppendix 2A: 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 account 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.

McGraw-Hill /Irwin

Worksheet, Dress Right Clothing Corporation, July 2009

Account Title Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 68,500 68,500 68,500 Accounts receivable 2,000 2,000 2,000

Allowance for uncollectible accounts - (7) 500 500 500 Supplies 2,000 (1) 800 1,200 1,200 Prepaid rent 24,000 (2) 2,000 22,000 22,000 Inventory 38,000 38,000 38,000 Furniture and fixtures 12,000 12,000 12,000 Accumulated depr.- furniture & fixtures - (3) 200 200 200 Accounts payable 35,000 35,000 35,000 Note payable 40,000 40,000 40,000 Unearned rent revenue 1,000 (4) 250 750 750 Salaries payable - (5) 5,500 5,500 5,500 Interest payable - (6) 333 333 333 Common stock 60,000 60,000 60,000 Retained earnings 1,000 1,000 1,000 Sales revenue 38,500 38,500 38,500 Rent revenue - (4) 250 250 250 Cost of goods sold 22,000 22,000 22,000 Salaries expense 5,000 (5) 5,500 10,500 10,500 Supplies expense - (1) 800 800 800 Rent expense - (2) 2,000 2,000 2,000 Depreciation expense - (3) 200 200 200 Interest expense - (6) 333 333 333 Bad debt expense - (7) 500 500 500 Totals 174,500 174,500 9,583 9,583 181,033 181,033

Net income 2,417 2,417 Totals 38,750 38,750 144,700 144,700

Balance SheetUnadjusted Trial

Balance Adjusting Entries Adjusted Trial Balance Income Statement

McGraw-Hill /Irwin

Slide 35

Appendix 2B: Reversing EntriesAppendix 2B: 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.

McGraw-Hill /Irwin

Slide 36

Appendix 2C: Subsidiary LedgersAppendix 2C: 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.

McGraw-Hill /Irwin

Slide 37

Appendix 2C: Special JournalsAppendix 2C: 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.

McGraw-Hill /Irwin

Slide 38

Sales JournalSales Journal

Sales journals record all credit sales. Every entry in the sales journal has the same effect on the accounts; the sales revenue account

is credited and the accounts receivable control account is debited.

Other columns capture

information needed for

updating the accounts

receivable subsidiary

ledger.

SALES JOURNAL Page 1

Date

Accounts Receivable Subsidiary

Account No. Customer Name

Sales Invoice Number

Cr. Sales Revenue

(400)Dr. Accounts Receivable

(110)

Aug. 5 801 Leland High School 10-221 1,500

9 812 Mr. John Smith 10-222 200

18 813 Greystone School 10-223 825

22 803 Ms. Barbara Jones 10-224 120

29 805 Hart Middle School 10-225 650

3,295

2009

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Slide 39

Cash Receipts JournalCash Receipts Journal

Cash receipts journals record all cash receipts, regardless of the source. Every

entry in the cash receipts journal produces a debit to the cash account with the credit to

various other accounts.CASH RECEIPTS JOURNAL Page 1

DateExplanation or Account Name

Dr. Cash (100)

Cr. Accounts

Receivable (110)

Cr. Sales

Revenue (400)

Cr. Other

Other Accounts

Aug. 7 Cash sale 500 500

11 Borrowed cash 10,000 10,000

Notes payable

(220)

17 Leland High School 750 750

20 Cash sale 300 300

25 Mr. John Smith 200 200

11,750 950 800 10,000

2009

review of the accounting process chapter 2 © 2009 the mcgraw-hill companies, inc

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