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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Review of the Accounting Process 2 Insert Book Cover Picture.

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Presentation on theme: "Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Review of the Accounting Process 2 Insert Book Cover Picture."— Presentation transcript:

1 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Review of the Accounting Process 2 Insert Book Cover Picture

2 2-2 The Basic Model Economic events cause changes in the financial position of a company. External events involve an exchange between the company and another entity. Internal events do not involve an exchange transaction but do affect the company’s financial position.

3 2-3 Learning Objectives Analyze routine economic events— transactions—and record their effects on a company’s financial position using the accounting equation format.

4 2-4 The Accounting Equation A = L + OE - Owner Withdrawals+ Owner Investments - Expenses - Losses + Revenue + Gains

5 2-5 Accounting Equation for a Corporation A = L + SE + Retained Earnings+ Paid-in Capital - Expenses - Losses + Revenues + Gains - Dividends

6 2-6 Account Relationships Debits and credits affect the Balance Sheet Model as follows: A = L + PIC + RE Assets Dr. + Cr. - Liabilities Dr. - Cr. + Paid-in Capital Dr. - Cr. + Retained Earnings Dr. - Cr. + Revenues and Gains Dr. - Cr. + Expenses and Losses Dr. + Cr. -

7 2-7 Account Relationships A = L + PIC + RE + R + G- E - L Permanent accounts represent the basic financial position elements of the accounting equation. Temporary accounts keep track of the changes in the retained earnings component of shareholders’ equity. Debits and credits affect the Balance Sheet Model as follows:

8 2-8 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

9 2-9 Learning Objectives Record transactions using the general journal format.

10 2-10 Accounting Processing Cycle On January 1, 2007, $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. Account numbers are references for posting to the General Ledger.

11 2-11 General Ledger The “T” account is a shorthand used by accountants to analyze transactions. It is not part of the bookkeeping system.

12 2-12 Learning Objectives Post the effects of journal entries to T-accounts and prepare an unadjusted trial balance.

13 2-13 Posting Journal Entries On July 1, 2006, the owners invest $60,000 in a new business, Dress Right Clothing Corporation. Post the debit portion of the entry to the Cash ledger account.

14 2-14 Posting Journal Entries 1

15 2-15 Posting Journal Entries 23

16 2-16 Posting Journal Entries 45

17 Posting Journal Entries

18 2-18 Posting Journal Entries Post the credit portion of the entry to the Common Stock ledger account. 1

19 2-19 Posting Journal Entries 23

20 2-20 Posting Journal Entries 45

21 Posting Journal Entries

22 2-22 After recording all entries for the period, Dress Right’s 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.

23 2-23 Additional Consideration Perpetual Inventory System Inventory account is continually updated to reflect purchases and sales. Cost of goods sold account is continually updated to reflect sales. Periodic Inventory System Purchases account reflects purchases of inventory. Cost of goods sold and inventory are adjusted at period end. Discussed in more depth in Chapters 8 & 9.

24 2-24 Adjusting Entries At the end of the period, some transactions or events remain unrecorded. Because of this, several accounts in the ledger need adjustments before their balances appear in the financial statements.

25 2-25 Learning Objectives Identify and describe the different types of adjusting journal entries. Determine the required adjustments, record adjusting journal entries in general journal format, and prepare an adjusted trial balance.

26 2-26 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.

27 2-27 Asset Expense Unadjusted Balance Credit Adjustment Debit Adjustment Prepaid Expenses Today, I will pay for my first 6 months’ rent. Prepaid Expenses Items paid for in advance of receiving their benefits

28 2-28 Prepaid Expenses Assume that on July 31, 2006, Dress Right determines that at the end of July $1,200 of supplies remains. Let’s look at the adjusting journal entry needed on July 31, Prepare the adjusting entry. $2,000 - $1,200 = $800 supplies used

29 2-29 After posting, the accounts look like this: Prepaid Expenses

30 2-30 Depreciation is the process of computing expense by allocating the cost of plant and equipment over their expected useful lives. Straight-Line Depreciation Expense = Asset Cost - Salvage Value Useful Life Depreciation

31 2-31 Depreciation 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, 2006.

32 Depreciation Expense = $12,000 - $0 60 months =$200 Recall the Furniture and Fixtures for $12,000 listed on Dress Right’s unadjusted trial balance. Assume the following: Depreciation Now, prepare the adjusting entry for July 31, 2006.

33 2-33 Contra Asset Depreciation Let’s see how the accounts would look after posting!

34 2-34 After posting, the accounts look like this: Depreciation

35 2-35 Liability Revenue Unadjusted Balance Credit Adjustment Debit Adjustment Unearned Revenues “Go Big Blue” Buy your season tickets for all home basketball games NOW! Unearned Revenue Cash received in advance of performing services

36 2-36 For Dress Right Corporation, the only unearned revenue in the trial balance is unearned rent revenue. On July 16 Dress Right received $1,000 in advance for the first two months’ rent. First, let’s prepare the entry for July 16. Unearned Revenues Liability Account

37 2-37 Unearned Revenues For Dress Right Corporation, the only unearned revenue in the trial balance is unearned rent revenue. On July 16 Dress Right received $1,000 in advance for the first two months’ rent. Now, let’s prepare the adjusting entry for July 31.

38 2-38 Unearned Revenues After posting, the accounts look like this:

39 2-39 Alternative Approach to Record Prepayments Unearned Revenue Record initial cash receipts as follows: Cash $$$ Revenue $$$ Adjusting Entry Record the amount for the unearned liability as follows: Revenue $$ Unearned revenue $$ Prepaid Expenses Record initial cash payments as follows: Expense $$$ Cash $$$ Adjusting Entry Record the amount for the prepaid expense as follows: Prepaid expense $$ Expense $$

40 2-40 Expense Liability Credit Adjustment Debit Adjustment Accrued Liabilities I won’t pay you until the job is done! Accrued Liabilities Costs incurred in a period that are both unpaid and unrecorded

41 2-41 7/1/06 7/31/06 Month end Last pay date 7/20/06 Next pay date 8/2/06 Record adjusting journal entry. Accrued Liabilities On July 31, 2006, the employees have earned salaries of $5,500.

42 2-42 Accrued Liabilities After posting, the accounts look like this:

43 2-43 Asset Revenue Credit Adjustment Debit Adjustment Accrued Receivables Yes, you can pay me in May for your April 15 tax return. Accrued Receivables Revenues earned in a period that are both unrecorded and not yet received

44 2-44 Assume that Dress Right loaned another corporation $30,000 at the beginning of August. Terms of the note call for the payment of principal, $30,000, and interest at 8% in three months. First, let’s determine the amount of interest to accrue at August 31, Accrued Receivables P × R × T $30, / 12 Interest = $200

45 2-45 Assume that Dress Right loaned another corporation $30,000 at the beginning of August. Terms of the note call for the payment of principal, $30,000, and interest at 8% in three months. Now, let’s prepare the adjusting entry for August 31, Accrued Receivables

46 2-46 Accrued Receivables After posting, the accounts look like this:

47 2-47 Estimates  Uncollectible accounts and depreciation of fixed assets are estimated.  An estimated item is a function of future events and developments. $ $

48 2-48 Estimates The 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, 2006, only $1,500 will ultimately be collected. Prepare the adjusting entry for July 31, 2006.

49 2-49 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.

50 2-50 Learning Objectives Describe the four basic financial statements.

51 2-51 The income statement summarizes the results of operating activities of the company.

52 2-52 The balance sheet presents the financial position of the company on a particular date.

53 2-53 The balance sheet presents the financial position of the company on a particular date.

54 2-54 The statement of cash flows discloses the changes in cash during a period.

55 2-55 The statement of shareholders’ equity presents the changes in permanent shareholder accounts.

56 2-56 Learning Objectives Explain the closing process.

57 2-57 The Closing Process  Resets revenue, expense and dividend account balances to zero at the end of the period.  Helps summarize a period’s revenues and expenses in the Income Summary account. Identify accounts for closing. Record and post closing entries. Prepare post-closing trial balance.

58 2-58 Temporary Accounts Revenues Income Summary Expenses Dividends Permanent Accounts Assets Liabilities Shareholders’ Equity The closing process applies only to temporary accounts. Temporary and Permanent Accounts

59 2-59  Close Revenue accounts to Income Summary.  Close Expense accounts to Income Summary.  Close Income Summary account to Retained Earnings. Let’s prepare the closing entries for Dress Right. Closing Entries

60 2-60  Close Revenue accounts to Income Summary.

61 2-61 Now, let’s look at the ledger accounts after posting this closing entry.  Close Revenue Accounts to Income Summary

62 2-62  Close Revenue Accounts to Income Summary

63 2-63  Close Expense accounts to Income Summary.

64 2-64 Now, let’s look at the ledger accounts after posting this closing entry.  Close Expense Accounts to Income Summary

65 2-65  Close Expense Accounts to Income Summary Net Income

66 2-66  Close Income Summary to Retained Earnings.

67 2-67 Now, let’s look at the ledger accounts after posting this closing entry.  Close Income Summary to Retained Earnings

68 2-68  Close Income Summary to Retained Earnings

69 2-69 Post-Closing Trial Balance Lists permanent accounts and their balances. Total debits equal total credits.

70 2-70 Learning Objectives Convert from cash basis net income to accrual basis net income.

71 2-71 Conversion From Cash Basis to Accrual Basis Adjusting entries, for the most part, are conversions from cash to accrual. Let’s look at an example.

72 2-72 Conversion From Cash Basis to Accrual Basis 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. Determine Insurance Expense for the period.

73 2-73 Conversion From Cash Basis to Accrual Basis 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.

74 2-74 Appendix 2A Use of a Worksheet

75 2-75 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 trial 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.

76 2-76

77 2-77 Appendix 2B Reversing Entries

78 2-78 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. Let’s consider the following accrual adjusting entry made by Dress Right.

79 2-79 Reversing Entries If reversing entries are not used, when salaries actually are paid in August, the accountant needs to remember to debit salaries payable and not salaries expense.

80 2-80 Reversing Entries If reversing entries are used, the following reversing entry is made on August 1, This entry reduces the salaries payable account to zero and reduces the salaries expense account by $5,500.

81 2-81 Reversing Entries When salaries actually are paid in August, the debit is to salaries expense, thus increasing the account by $5,500. We can see that the ending balances in the accounts are identical whether or not reversing entries are used.

82 2-82 Appendix 2C Subsidiary Ledgers and Special Journals

83 2-83 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.

84 2-84 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.

85 2-85 Sales 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.

86 2-86 Sales Journal Accounts Receivable Subsidiary Ledger

87 2-87 Cash 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.

88 2-88 Cash Receipts Journal Accounts Receivable Subsidiary Ledger

89 2-89 End of Chapter 2


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