Review of the Accounting Process

1. Chapter 2 Review of the Accounting Process

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

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

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

5. During the Accounting Period Source documents Transaction Analysis Record in Journal Post to Ledger At the End of the Accounting Period Financial Statements Adjusted Trial Balance Record & Post Adjusting Entries Unadjusted Trial Balance The Accounting Processing Cycle At the End of the Year Close Temporary Accounts Post-Closing Trial Balance

6. 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.

7. General Ledger The “T” account is a shorthand format of an account used by accountants to analyze transactions. It is notpart of the bookkeeping system.

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

9. Posting Journal Entries

10. Posting Journal Entries We follow the same procedure to post the credit portion of the entry to the Common Stock account.

11. After recording all entries for the period, Dress Right’s Unadjusted Trial Balance would be as follows: A Trial Balance is a listing of all accounts and their balances at a point in time. Debits = Credits

12. Transactions where cash is paid or received beforea related expense or revenue is recognized. Transactions where cash is paid or received after a related expense or revenue is recognized.

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

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

15. 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, 2009.

16. Depreciation Recall the Furniture and Fixtures for $12,000 listed on Dress Right’s unadjusted trial balance. July Depreciation Expense $12,000 - $0 60 months = = $200 per month

17. Depreciation After posting, the accounts look like this:

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

19. Alternative Approach to Record Prepayments Prepaid ExpensesRecord initial cash payments as follows: Expense $$$ Cash $$$ Adjusting EntryRecord the amount for the prepaid expense as follows: Prepaid expense $$$ Expense $$$ Unearned RevenueRecord initial cash receipts as follows: Cash $$$ Revenue $$$ Adjusting EntryRecord the amount for the unearned liability as follows: Revenue $$$ Unearned revenue $$$

20. Accrued Liabilities Liability Expense Debit Adjustment Credit Adjustment I won’t pay you until the job is done! Accrued Liabilities Liabilities recorded when an expense has been incurred prior to cash payment.

21. Accrued Receivables Revenue Asset Debit Adjustment Credit Adjustment Yes, you can pay me in May for your April 15 tax return. Accrued Receivables Revenue earned in a period prior to the cash receipt.

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

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

24. 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.

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

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

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

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

29. The statement of shareholders’ equity presents the changes in permanent shareholder accounts.

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

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

32. 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.

33. 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 1 and the unadjusted account balances in columns 2 and 3. • Determine end-of-period adjusting entries and enter them in columns 4 and 5. • Add or deduct the effects of the adjusting entries on the account balances and enter in columns 6 and 7. • Transfer the temporary retained earnings account balances to columns 8 and 9. • Transfer the balances in the permanent accounts to columns 10 and 11. Let’s look at the completed worksheet for Dress Right.

35. 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.

36. 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.

37. 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.

38. 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.

39. 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.

40. End of Chapter 2