1.

Financial Statements
a. Balance sheet
Balance sheet shows company’s financial position at given point of time.

Assets = Liabilities + Owner’s Equity

Sample of Balance sheet.

Definition

Assets Assets are things that company owns and are sometimes referred
to as the resource of company. Companies Vehicles, Offices, Cash
in Bank, Goods in inventory are examples of Assets
Liabilities Liabilities are obligations of the company; they are amounts
owed to others as of the balance sheet date. Loans, Loan
interests Amounts own to the supplier are examples of liabilities
Owner’s Equity Difference between Assets and liabilities are known as owner’s
equity. When new business starts this the amount injected by
company’s owners/promotors.
Accounts

Assets Liabilities Owner’s Equity

Current Current Retained Earnings
 Cash  Accounts Payables Account
 Accounts Receivable  Interest Payable
 Accrued  Accrued Payble/Expense
Receivable/Revenue  Unearned Revenue or
 Inventory Deferred Revenue
 Prepaid Expense or (Received in Advance)
deferred Expense
(Insurance) Non Current
 Loans
Non Current  Bonds
 Land
 Buildings
 Equipment
 Vehicals

Credit/Debit Rule
Assets Liabilities Owner’s Equity
Debit Credit Debit Credit Debit Credit
Increase Decrease Decrease Increase Decrease Increase
 Tips
 Asset is on left side of formula and Debit is also on left side of accounting entries
so Debit increases the Assets value and Credit decreases the Asset value.
 Liabilities and Owner’s equity is on right side of the accounting formula and
credit is also on right side of accounting entries so credit increases the liabilities
and owner’s equity
 Any cash received is debited and any cash paid is credited

b. Income Statement
Income statement shows company’s performance and profit or loss for specific period
of time.

Net Income/Lose = Revenue – Expense

Revenue Under the accrual basis of accounting Revenues are earned by

providing the services or by sale of goods to the customer.
Revenues are earned even though cash is not received
Expense Expenses are the costs incurred to generate revenues. In other
words, a firm records an expense when it disburses cash or
promises to disburse cash for an asset or service used to generate
income.
 Credit/Debit Rule
Expense/Loss Revenue/Gains
Debit Credit
Increase Increase

Tips
 At the end of financial year difference of revenue and expense goes to retained
earing account which is Owner’s equity and so expense decrease’s owner’s
equity so debit increases expense
 At the end of financial year difference of revenue and expense goes to retained
earing account which is Owner’s equity and so revenue increases owner’s equity
so Credit increases revenue

Accounts

Expense Revenue
Cost of Goods Sold Sales
Rent Service Revenue
Depreciation Interest Revenue
Loan Interest Gain of Sale of Assets

2. Retained Earnings Account

 Retained Earnings Account is Owner’s Equity account every year as part of closing process net
income/loss is calculated and income statement accounts (Revenue, Expense) zeroed out and
closed and net income is transferred to retained earnings account.

Permanent Accounts Temporary Accounts

Asset, liability, and owner equity accounts are
referred to as "permanent accounts" they are
not closed at the end of the accounting year;
their balances are automatically carried
forward to the next accounting year
Revenue, expense accounts are temporary
accounts the balances in temporary accounts
increase throughout the accounting year and
are "zeroed out" and closed at the end of the
accounting year.

Closing process works as below as part of closing process total of all the revenue accounts is
credit income summary account.

Similarly total of all expense accounts is debited from income summary account

Debit Credit
Income Summary Account = Total from all Total from all
Expense account Revenue account

Transfer amount from Income Summary account to Retained Earnings Account

Debit Credit
Next year balance sheet Income Summary Retained Earnings
Account Account

3. Suspense & Clearing Account

Suspense Account
A suspense account is temporary account
used because the proper account could not be
determined at the time that the transaction
was recorded.
When the proper account is determined, the
amount will be moved from the suspense
account to the proper account.
Example
Cash received in bank but it is not known from
which customer it is received
A suspense account can be
asset, liability, revenue, expense and it is hard
to find when it is recorded
Clearing Account
Clearing Account is temporary intermediate
account for later posting to a paramagnet
account.
When transaction is verified and confirmed
it is moved to permanent account
Example
Cash received in bank and customer is
known but do not know for which invoice
4. Adjusting Entries

Adjusting entries are accounting journal entries that convert a company's accounting records to
the accrual basis of accounting. An adjusting journal entry is typically made just prior to issuing a
company's financial statements.

Below two scenarios required Adjusting Entries to Occure

Accrual Deferral
Nothing has been entered in the accounting Something has already been entered in the
records for certain expenses and/or accounting records, but the amount needs
revenues, but those expenses and/or to be divided up between two or more
revenues did occur and must be included in accounting periods
the current period's income statement and
balance sheet.
Example Example
Accrued Expense Deferred Expense
Prepaid Insurance
Prepaid Rent
Deferred Revenue
Advanced Received for Monthly Service

Adjusting entries almost always involve a

 balance sheet account (Interest Payable, Prepaid Insurance, Accounts Receivable, etc.)
and an
 income statement account (Interest Expense, Insurance Expense, Service Revenues,
etc.)

Examples

Asset

Accrued Revenue If invoice not Generated

Service is provided but invoice is not Accrued Accounts Receivable(A) Debit
generated in that accounting period and will Accrued Revenue(R) Credit
be generated in next accounting period
If invoice not Generated
Accounts Receivable(A) Debit
Revenue(R) Credit
Deferred Expense On Purchase
Purchase of service/goods in advance for Prepaid Services(A) Debit
which expense is spanning to multiple Cash(A) Credit
accounting year Expense in current financial year
Insurance (E) Debit
 Prepaid Service(A) Credit
Equipment Depreciation Depreciation Expense(E) Debit
Equipment Depreciation spanning in multiple Equipment Cost(A) Credit
accounting year

Asset Account Scenarios.

i. Prepaid Expense / Deferred Expense
Under the accrual method of accounting, any payments for future expenses
must be deferred to an asset account until the expenses are used up or have
expired.

Example
Company Purchases 6 month insurance and paid 600$ in advance

Purchase of Insurance
Account Debit Credit
Cash (Asset) 600
Prepaid Expense (Asset) 600

First Month Installment

Account Debit Credit
Installment (Expense) 100
Prepaid Expense (Asset) 6 100

Second Month installment

Account Debit Credit

Installment (Expense) 100
Prepaid Expense (Asset) 100

Liabilities

Example

Accrued Expense If invoice not Generated

Service is received but invoice is not Accrued Expense(E) Debit
received/generated in that accounting period Accrued Accounts Payable(L) Credit
and will be generated in next accounting
period If Invoice Generated
Accrued Expense(E) Debit
Accrued Accounts Payable(L) Credit
Deferred/Unearned Revenue On sell
 Sell or Service with advance receipt for which Cash(A) Debit
revenue spanning in multiple year Deferred Revenue(L) Credit

Current Year Revenue

Deferred Revenue(L) Debit
Revenue(R) Credit

Liability Account Scenarios.

i. Unearned Revenue or Deferred Revenue
Under the accrual method of accounting, the amounts received in advance of
being earned must be deferred to a liability account until they are earned.

Let's assume that Company receives $4,000 on December 10 for services it

will provide at a later date.

Account Debit Credit

Unearned Revenue (Liability) 4000
Cash (Asset) 4000

Let's assume that Company provides service on January 10

Account Debit Credit

Unearned Revenue (Liability) 4000
Revenue 4000

5. Reversal Entries
Reversing entries are made on the first day of an accounting period in order to remove
certain adjusting entries that were made in the previous accounting period. Reversing entries
are most often used with accrual type adjusting entries.

Two benefits of reversing entries are:

 The chance of double-counting revenues and/or expenses will be greatly reduced, and
 The processing of subsequent documents will be more efficient

Accrued Revenue reversing Entry

Service is provided in Month of December but invoice is presented in Month of January

Service Provided but no invoice

presented (Accrued Revenue in Accrued Accounts Receivable(A) Debit - 500
December) Revenue(R) Credit - 500
 Year End process Income Revenue(R) - 500
Statement Generated
Year End process Income Accrued Accounts Receivable(A) - 500
accounts moved to REA and Revenue(R) -0
made it Zero

Reversing Entry Accrued Accounts Receivable(A) Credit - 500

Revenue(R) Debit - 500
Balance After reversing Entries Accrued Accounts Receivable(A) -0
Revenue(R) - Negative 500

Invoice Presented Accounts Receivable(A) Debit - 500

Revenue(R) Credit - 500
Balance After Invoice Presented Accounts Receivable(A) - 500
Revenue(R) -0

Accrued Expense reversing Entry

Service is received in Month of December but invoice is presented in Month of January

Service received but no invoice Expense Account Debit - 500

presented (Accrued Expense in Accrued Accounts Payables(L) Credit - 500
December)

Year End Process Income Expense - 500

Statement Generated
Year End process Income Accrued Accounts Payable (L) - 500
accounts moved to REA and Expense Account -0
made it Zero

Reversing Entry Accrued Accounts Payables(L) Debit - 500

Expense Account Credit - 500
Balance After reversing Entries Accrued Accounts Payables(L) -0
Expense A - (+)500

Invoice Presented Expense Account Debit - 500

Accounts Payables(L) Credit - 500
Balance After Invoice Presented Accounts Payables(L) - 500
Expense Account -0

6. Accounts Payable
 PO Receipt Inventory Receiving (A) Debit
Accrued Expense (L) Credit

PO Delivery Inventory Material (A) Debit

Inventory Receiving (A) Credit

AP Invoice Accrued Expense (L) Debit

Accounts Payables(L) Credit

AP Payment Accounts Payable (L) Debit

Cash(A) Credit

7. Accounts Receivable

Sales Order Issue COGS (E) Debit

Inventory Material (A) Credit

Sales Invoice Account Receivable (A) Debit

Sales Revenue (R) Credit

AR Receipt Cash (A) Debit

Accounts Receivable (A) Credit