2. Recap Accounting Process Prepared by Mubashar majeed

3. Introduction to Financial Statements Companies prepare interim financial statements and annual financial statements.

4. Introduction to Financial Statements Three primary financial statements. Income Statement Balance Sheet Statement of Cash Flows We will use a corporation to describe these statements.

5. © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Describes where the enterprise stands at a specific date. Income Statement Balance Sheet Statement of Cash Flows Depicts the revenue and expenses for a designated period of time.

6. The Concept of the Business Entity Vagabond Travel Agency A business entity is separate from the personal affairs of its owner.

7. Assets and Liabilities Assets are economic resources that are owned by the business and are expected to provide positive future cash flows. Liabilities are debts that represent negative future cash flows for the enterprise. Owners’ equity represents the owner’s claim to the assets of the business.

8. The Accounting Equation Assets = Liabilities + Owners’ Equity $300,000 = $80,000 + $220,000 Assets = Liabilities + Owners’ Equity $300,000 = $80,000 + $220,000

9. ALOE A = L + OEASSETS Debit for Increase Credit for DecreaseEQUITIES Debit for Decrease Credit for IncreaseLIABILITIES Debit for Decrease Credit for Increase Debits and credits affect accounts as follows: Debit and Credit Rules

10. ALOE A = L + OE Debit balances Credit balances = In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits. Double Entry Accounting  The Equality of Debits and Credits

11. ¶ May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Will Cash increase or decrease? Will Capital Stock increase or decrease?

12. ¶ May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Cash increases $8,000 with a debit. Capital Stock increases $8,000 with a credit.

13. · May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Will Cash increase or decrease? Will Tools & Equipment increase or decrease?

14. · May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Cash decreases $2,500 with a credit. Tools & Equipment increases $2,500 with a debit.

15. ¸ May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. Will Truck increase or decrease? Will Cash and Notes Payable increase or decrease?

16. ¸ May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. Truck increases $15,000 with a debit. Cash decreases $2,000 with a credit. Notes Payable increases $13,000 with a credit.

17. In an actual accounting system, transactions are initially recorded in the journal. The Journal

18. Posting involves copying information from the journal to the ledger accounts. Posting Journal Entries to the Ledger Accounts

19. The Ledger The entire group of accounts is kept together in an accounting record called a ledger. Cash Accounts Payable Capital Stock Accounts are individual records showing increases and decreases.

20. The Use of Accounts Increases are recorded on one side of the T- account, and decreases are recorded on the other side. Left or Debit Side Right or Credit Side Title of Account

21. Receipts are on the debit side. Payments are on the credit side. The balance is the difference between the debit and credit entries in the account. Debit and Credit Entries

22. Posting Journal Entries to the Ledger Accounts

24. This ledger format is referred to as a running balance (as opposed to simple T accounts). Ledger Accounts After Posting

25. Net income is not an asset  it’s an increase in owners’ equity from profits of the business. ALOE A = L + OE IncreaseDecreaseIncrease Either (or both) of these effects occur as net income is earned...... but this is what “net income” really means. What is Net Income?

26. ALOE A = L + OE Retained Earnings Capital Stock Retained Earnings The balance in the Retained Earnings account represents the total net income of the corporation over the entire lifetime of the business, less all amounts which have been distributed to the stockholders as dividends.

27. Revenue and Expenses The price for goods sold and services rendered during a given accounting period. Increases owner’s equity. The costs of goods and services used up in the process of earning revenue. Decreases owner’s equity.

28. The Realization Principle: When To Record Revenue Realization Principle Revenue should be recognized at the time goods are sold and services are rendered.

29. The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up.

30. Debits and Credits for Revenue and ExpenseEQUITIES Debit for Decrease Credit for Increase REVENUES Debit for Decrease Credit for Increase EXPENSES Credit for Decrease Debit for Increase Expenses decrease owner’s equity. Revenues increase owner’s equity.

31. Let’s analyze the revenue, and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction. Let’s analyze the revenue, and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction.

32. ½ May 29: JJ’s provided lawn care services for a client and received $750 in cash. Will Cash increase or decrease? Will Sales Revenue increase or decrease?

33. ½ May 29: JJ’s provided lawn care services for a client and received $750 in cash. Cash increases $750 with a debit. Sales Revenue increases $750 with a credit.

34. ¾ May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Will Cash increase or decrease? Will Gasoline Expense increase or decrease?

35. ¾ May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Cash decreases $50 with a credit. Gasoline Expense increases $50 with a debit.

36. ¿ May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Will Cash increase or decrease? Will Dividends increase or decrease?

37. ¿ May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Cash decreases $200 with a credit. Dividends increase $200 with a debit.

38. Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May.

39. All balances are taken from the ledger accounts on May 31 after considering all of JJ’s transactions for the month. Proves equality of debits and credits.

40. Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Make end-of- year adjustments. Prepare adjusted trial balance. Prepare financial statements. Prepare after closing trial balance. Journalize and post closing entries. The Accounting Cycle

41. Adjusting Entries THE ACCOUNTING CYCLE: Accruals and Deferrals

42. At the end of the period, we need to make adjusting entries to get the accounts up to date for the financial statements.

43. Adjusting entries are needed whenever revenue or expenses affect more than one accounting period. Every adjusting entry involves a change in either a revenue or expense and an asset or liability. Adjusting Entries

44. Types of adjustment Two types of adjustment 1- Deferrals Result from prepayments made or received E.g. Payment of six month rent paid or received 2- Accrual These are items are unrecorded, unpaid or not yet received E.g. Salaries payable, Services revenue receivable

45. Adjustment Deferral Prepaid Expense Expense ……….Prepaid Depreciation Expense Dep. Exp. Accumulated Dep. Unearned Revenue Revenue Accrual Accrued Expenses Expenses Payable Accrued Revenue A/R Revenue

46. Rules for Adjusting Entries Affect 1 Income statement account Affect 1 balance sheet account Cash account is never be involved

47. Jan. 1Dec. 31 $2,400 Insurance Policy Coverage for 12 Months $200 Monthly Insurance Expense On January 1, Webb Co. purchased a one- year insurance policy for $2,400. Converting Assets to Expenses

48. Initially, costs that benefit more than one accounting period are recorded as assets. Converting Assets to Expenses

49. The costs are expensed as they are used to generate revenue. Converting Assets to Expenses

50. Income Statement Cost of assets used this period to generate revenue. Income Statement Cost of assets used this period to generate revenue. Balance Sheet Cost of assets that benefit future periods. Balance Sheet Cost of assets that benefit future periods. Converting Assets to Expenses

51. Depreciation is the systematic allocation of the cost of a depreciable asset to expense. Depreciable assets are physical objects that retain their size and shape but lose their economic usefulness over time. The Concept of Depreciation

52. On May 2, 2003, JJ’s Lawn Care Service purchased a lawn mower with a useful life of 50 months for $2,500 cash. Using the straight-line method, calculate the monthly depreciation expense. $2,500 50 = $50 Depreciation expense (per period) = Cost of the asset Estimated useful life Depreciation Is Only an Estimate

53. JJ’s Lawn Care Service would make the following adjusting entry. Contra-asset Depreciation Is Only an Estimate

54. JJ’s $15,000 truck is depreciated over 60 months as follows: $15,000  60 months = $250 per month Depreciation Is Only an Estimate

55. Accumulated depreciation would appear on the balance sheet as follows:

56. Prior PeriodsCurrent PeriodFuture Periods Transaction Collected from customers in advance (creates a liability). Transaction Collected from customers in advance (creates a liability). End of Current Period Adjusting Entry  Recognize portion earned as revenue, and  Reduce balance of liability account. Adjusting Entry  Recognize portion earned as revenue, and  Reduce balance of liability account. Converting Liabilities to Revenue

57. Examples Include: Airline Ticket Sales Sports Teams’ Sales of Season Tickets Converting Liabilities to Revenue

58. Jan. 1Dec. 31 $6,000 Rental Contract Coverage for 12 Months $500 Monthly Rental Revenue On January 1, Webb Co. received $6,000 in advance for a one-year rental contract. Converting Liabilities to Revenue

59. Initially, revenues that benefit more than one accounting period are recorded as liabilities. Converting Liabilities to Revenue

60. Over time, the revenue is recognized as it is earned. Converting Liabilities to Revenue

61. Income Statement Revenue earned this period. Income Statement Revenue earned this period. Balance Sheet Liability for future periods. Balance Sheet Liability for future periods. Converting Liabilities to Revenue

62. Prior PeriodsCurrent PeriodFuture Periods Transaction Liability will be paid. Transaction Liability will be paid. End of Current Period Adjusting Entry  Recognize expense incurred, and  Record liability for future payment. Adjusting Entry  Recognize expense incurred, and  Record liability for future payment. Accruing Unpaid Expenses

63. Examples Include: Interest Wages and Salaries Property Taxes Hey, when do we get paid? Accruing Unpaid Expenses

64. Monday, May 29 Friday, June 2 $3,000 Wages Expense On May 31, Webb Co. owes wages of $3,000. Pay day is Friday, June 2. Wednesday, May 31 Accruing Unpaid Expenses

65. Initially, an expense and a liability are recorded. Accruing Unpaid Expenses

66. Income Statement Cost incurred this period to generate revenue. Income Statement Cost incurred this period to generate revenue. Balance Sheet Liability to be paid in a future period. Balance Sheet Liability to be paid in a future period. Accruing Unpaid Expenses

67. Monday, May 29 Friday, June 2 $5,000 Weekly Wages Let’s look at the entry for June 2. Wednesday, May 31 $2,000 Wages Expense $3,000 Wages Expense Accruing Unpaid Expenses

68. The liability is extinguished when the debt is paid. Accruing Unpaid Expenses

69. Prior PeriodsCurrent PeriodFuture Periods Transaction Receivable will be collected. Transaction Receivable will be collected. End of Current Period Adjusting Entry  Recognize revenue earned but not yet recorded, and  Record receivable. Adjusting Entry  Recognize revenue earned but not yet recorded, and  Record receivable. Accruing Uncollected Revenue

70. Examples Include: Interest Earned Work Completed But Not Yet Billed to Customer Accruing Uncollected Revenue

71. Saturday, Jan. 15 Tuesday, Feb. 15 $170 Interest Revenue On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the 15 th day of each month. Monday, Jan. 31 Accruing Uncollected Revenue

72. Initially, the revenue is recognized and a receivable is created. Accruing Uncollected Revenue

73. Income Statement Revenue earned this period. Income Statement Revenue earned this period. Balance Sheet Receivable to be collected in a future period. Balance Sheet Receivable to be collected in a future period. Accruing Uncollected Revenue

74. Saturday, Jan. 15 Tuesday, Feb. 15 $320 Monthly Interest $170 Interest Revenue Let’s look at the entry for February 15. Monday, Jan. 31 $150 Interest Revenue Accruing Uncollected Revenue

75. The receivable is collected in a future period. Accruing Uncollected Revenue

76. As a corporation earns taxable income, it incurs income taxes expense, and also a liability to governmental tax authorities. Accruing Income Taxes Expense: The Final Adjusting Entry

77. Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Make end-of- year adjustments. Prepare adjusted trial balance. Recall from the accounting cycle discussed in Chapter 3, that after the adjusting entries are made, an adjusted trial balance is prepared. Effects of the Adjusting Entries

78. THE ACCOUNTING CYCLE: Reporting Financial Results

79. This is the Adjusted Trial Balance for JJ’s. Now, let’s prepare the financial statements for JJ’s Lawn Care Service for May.

80. Net income also appears on the Statement of Owner’s Equity.

81. Business Earnings Dividends Business Losses This statement summarizes the increases and decreases in Retained Earnings during the period. Statement of Retained Earnings

82. Now, let’s prepare the Balance Sheet.

84. Closing the Temporary Equity Accounts  Close Revenue accounts to Income Summary.  Close Expense accounts to Income Summary.  Close Income Summary account to Retained Earnings.  Close Dividends to Retained Earnings. The closing process gets the temporary accounts ready for the next accounting period.

85. Since Sales Revenue has a credit balance, the closing entry requires a debit to the Sales Revenue account. Closing Entries for Revenue Accounts

87. Since expense accounts have a debit balance, the closing entry requires a credit to the expense accounts. Closing Entries for Expense Accounts

88. Net Income

89. Since Income Summary has a $400 credit balance, the closing entry requires a debit to Income Summary. Closing the Income Summary Account

90. The balance in Income Summary is now zero. Closing the Income Summary Account

91. After all closing entries are made, JJ’s After-Closing Trial Balance looks like this.

92. End of Topic