The purpose of this chapter is to review the fundamental accounting process used to produce the financial statements. This review establishes a framework for the study of the concepts covered in intermediate accounting. Actual accounting systems differ significantly from company to company. This chapter focuses on the many features that tend to be common to any accounting system.
Chapter REVIEW OF THE ACCOUNTING PROCESS © 2013 The McGraw-Hill Companies, Inc Slide The Accounting Equation A = L + OE + Owner Investments - Owner Withdrawals + Revenue + Gains - Expenses - Losses Slide Accounting Equation for a Corporation A = L + SE + Issued Capital + Retained Earnings + Revenues - Expenses - Dividends + Gains - Losses Slide Account Relationships Debits Debits and and credits credits affect affect the the Statement Statement of of Financial Financial Position Position Model Model as as follows: follows: A = L + PIC + RE Assets Dr Cr + - Liabilities Dr Cr + Permanent Accounts Temporary Accounts Issued Capital Dr Cr + Retained Earnings Dr Cr + Revenues and Gains Dr Cr + Expenses and Losses Dr Cr + - During the Accounting Period Source documents Transaction Analysis Record in Journal Slide Post to Ledger At the End of the Accounting Period Financial Statements Adjusted Trial Balance Record & Post Adjusting Entries At the End of the Year Close Temporary Accounts Post-Closing Trial Balance Unadjusted Trial Balance The Accounting Processing Cycle Slide Accounting Processing Cycle On January 1, $40,000 was borrowed from a bank and a note payable was signed Two accounts are affected: Cash (an asset) increases by $40,000 Notes Payable (a liability) increases by $40,000 Prepare the journal entry Slide General 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 Slide Posting Journal Entries On July 1, the owners invest $60,000 in a new business, Dress Right Clothing Corporation GENERAL JOURNAL Date July Description Cash Page Post Ref Debit Credit 60,000 Ordinary Share Capital 60,000 Post Post the the debit debit portion portion of of the the entry entry to to the the Cash Cash ledger ledger account account Slide Posting Journal Entries Slide 10 Posting Journal Entries We Wefollow followthe thesame sameprocedure procedure to topost postthe thecredit credit portion portionof of the theentry entryto tothe theOrdinary OrdinaryShare ShareCapital Capital account account Slide 27 Dress Right Clothing Corporation Statement of Financial Position At July 31, 2013 Assets Current assets: Cash Accounts receivable Less: Allowance for uncollectible accounts Supplies Inventory Prepaid rent Total current assets Property and equipment: Furniture and fixtures Less: Accumulated depreciation Total assets $ $ 2,000 500 68,500 1,500 1,200 38,000 22,000 131,200 12,000 200 $ 11,800 143,000 The Statement of Financial Position presents the financial position of the company on a particular date Slide 28 Dress Right Clothing Corporation Statement of Financial Position At July 31, 2013 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Salaries payable Unearned rent revenue Interest payable Note payable Total current liabilities Long-term liabilities: Note payable Shareholders' equity: Ordinary share captal $ Retained earnings Total shareholders' equity Total liabilities and shareholders' equity $ 35,000 5,500 750 333 10,000 51,583 30,000 60,000 1,417 $ 61,417 143,000 Notice that assets of $143,000 equal total liabilities plus shareholders’ equity of $143,000 Slide 29 Dress Right Clothing Corporation Statement of Cash Flows For the Month of July 2013 Cash flows from operating activities: Cash inflows: From customers From rent Cash outflows: For rent For supplies To suppliers for merchandise To employees Net cash used by operating activities Cash flows from investing activities: Purchase of furniture and fixtures Cash flows from financing activities: Issue of ordinary shares Increase in notes payable Payment of cash dividend Net cash provided by financing activities Net increase in cash $ 36,500 1,000 (24,000) (2,000) (25,000) (5,000) $ (18,500) (12,000) $ 60,000 40,000 (1,000) $ 99,000 68,500 The statement of cash flows discloses the changes in cash during a period Slide 30 Dress Right Clothing Corporation Statement of Changes in Equity For the Month of July 2013 Balance at July 1, 2013 Issue of ordinary shares Net income for July 2013 Less: Dividends Balance at July 31, 2013 Total Ordinary Share Retained Shareholders' Capital Earnings Equity $ $ $ 60,000 60,000 2,417 2,417 (1,000) (1,000) $ 60,000 $ 1,417 $ 61,417 The statement of changes in equity presents the changes in permanent shareholder accounts Slide 31 Temporary and Permanent Accounts Income Summary Liabilities Permanent Accounts Shareholders’ Equity Temporary Accounts Assets Dividends Expenses Revenues The closing process applies only to temporary accounts Slide 32 Post-Closing Trial Balance DRESS RIGHT CLOTHING CORPORATION Post-Closing Trial Balance July 31, 2013 Account Title Debits Credits Cash $ 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 Ordinary share capital 60,000 Retained earnings 1,417 Totals $ 143,700 $ 143,700 Lists permanent accounts and their balances Total debits equal total credits Slide 33 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 Balance, 1/1 Plus: Cash paid Less: Insurance expense Balance, 12/31 Prepaid Insurance $ 5,000 20,000 (22,000) $ 3,000 Slide 34 Appendix 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: Enter account titles in column and the unadjusted account balances in columns and Determine end-of-period adjusting entries and enter them in columns and Add or deduct the effects of the adjusting entries on the account balances and enter in columns and Transfer the temporary retained earnings account balances to columns and Transfer the balances in the permanent accounts to columns 10 and 11 Let’s look at the completed worksheet for Dress Right Worksheet, Dress Right Clothing Corporation, July 2013 Unadjusted Trial Balance Adjusting Entries Account Title Dr Cr Dr Cr Cash 68,500 Accounts receivable 2,000 Allowance for uncollectible accounts (7) 500 Supplies 2,000 (1) 800 Prepaid rent 24,000 (2) 2,000 Inventory 38,000 Furniture and fixtures 12,000 Accumulated depr.furniture & fixtures (3) 200 Accounts payable 35,000 Note payable 40,000 Unearned rent revenue 1,000 (4) 250 Salaries payable (5) 5,500 Interest payable (6) 333 Ordinary share capital 60,000 Retained earnings 1,000 Sales revenue 38,500 Rent revenue (4) 250 Cost of goods sold 22,000 Salaries expense 5,000 (5) 5,500 Supplies expense (1) 800 Rent expense (2) 2,000 Depreciation expense (3) 200 Interest expense (6) 333 Bad debt expense (7) 500 Totals 174,500 174,500 9,583 9,583 Net income Totals Adjusted Trial Balance Dr Cr 68,500 2,000 Income Statement Dr Cr Statement of Financial Position Dr Cr 68,500 2,000 500 500 1,200 22,000 38,000 12,000 1,200 22,000 38,000 12,000 200 35,000 40,000 750 5,500 333 60,000 200 35,000 40,000 750 5,500 333 60,000 1,000 1,000 38,500 250 22,000 10,500 800 2,000 200 333 500 181,033 38,500 250 22,000 10,500 800 2,000 200 333 500 181,033 2,417 38,750 38,750 144,700 2,417 144,700 Slide 36 Appendix 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 Slide 37 Appendix 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 Slide 38 Appendix 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: Journalizing the effects of a particular transaction is made more efficient through the use of specifically designed formats 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 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 Slide 39 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 SALES JOURNAL Date 2013 Aug 18 22 29 Accounts Receivable Subsidiary Account No 801 812 813 803 805 Customer Name Leland High School Mr John Smith Greystone School Ms Barbara Jones Hart Middle School Sales Invoice Number 10-221 10-222 10-223 10-224 10-225 Page Cr Sales Revenue (400) Dr Accounts Receivable (110) 1,500 200 825 120 650 3,295 Other columns capture information needed for updating the accounts receivable subsidiary ledger Slide 40 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 CASH RECEIPTS JOURNAL Explanation or Account Name Date Dr Cash (100) Page Cr Accounts Receivable (110) Cr Sales Revenue (400) Cr Other Other Accounts 10,000 Notes payable (220) 2013 Aug Cash sale 11 Borrowed cash 500 500 10,000 17 Leland High School 750 20 Cash sale 300 25 Mr John Smith 200 11,750 750 300 200 950 800 10,000 End of Chapter © 2008 The McGraw-Hill Companies, Inc ... Posting Journal Entries We Wefollow followthe thesame sameprocedure procedure to topost postthe thecredit credit portion portionof of the theentry entryto tothe theOrdinary OrdinaryShare ShareCapital... advance of receiving their benefits Slide 14 Depreciation Depreciation is the process of computing expense by allocating the cost of plant and equipment over their expected useful lives Straight-Line... 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