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McGraw-Hill/Irwin

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Why Study Accounting ?

1. First of All you need financial information to make significant decision For example
when you decide between Buying a Car or get one on Lease, Making Monthly Budgets of Income & Expenditure, Investing your Savings or Financing your Childs Education.

2. 3.

Accounting information helps you to evaluate your Employers Short and Long Term Potential. It helps you in your Job Responsibilities of :

Sales- where U need information about availability of product and costs. Production- Where information required about cost of materials, Labor & Over Heads. Quality Control Where U need information about Variances between expected and Actual production. Human Resources- Where you need information regarding Cost of Employees. It gives you a competitive advantage over others who dont know anything about The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin it.

ACCOUNT
An account is a record of something. When you keep track of your finances, you keep them safely recorded somewhere. You note your income so you can report. You can keep account of your time. You can schedule yourself to make most efficient use of your time. The point is, the purpose of an account is to manage your resources. Your life has plenty to do with accounting.

ACCOUNTING
Traditionally accounting has been defined as : . the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character and interpreting the results therefore.

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ACCOUNTING
It means that Accounting is an information system that identifies ( the relevant financial transactions records, analyses, classifies (into five transactions), pillars of Accounting ), summarizes ( in the form of Financial Statements, Statements interprets and then communicates the results ( in the form of an information ) of Financial transactions to the users of Financial Statements. Accounting is often called the Language of business because it provides the means of recording and communicating business activities and the results of those activities. Accounting is based upon a double entry recording system called DOUBLE ENTRY ACCOUNTING SYSTEM. SYSTEM

BOOK KEEPING
It is the clerical side of accounting the recording of routine transactions and day-to-day record keeping. It is the preservation of a systematic, quantitative record of an activity.
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WHO USES ACCOUNTING INFORMATION ?

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Management including Directors, Managers and Executives. Shareholders / Members. Employees. Government Agencies. Lenders / Financial Institutions. Creditors. Investors. Suppliers & Customers Competitors. Stock Exchanges Corporate Law Authority or Securities & Exchange Commission (SEC) The Press. Central Board of Revenue (CBR) Etc. Students for various Analysis.
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DOUBLE ENTRY ACCOUNTING SYSTEM

The double-entry accounting system is based on recording debit and credit parts of transaction so that the total dollar amounts of debits and credits equal each other. Each transaction affects at least two general ledger accounts. A system of recording transactions in a way that maintains the equality of the accounting equation. Also discuss Arms Length Transactions Transactions.

SEPARATE ENTITY CONCEPT

The idea that the activities of an entity are to be separated from those of the individual owners. The companys money and property belong to the company although they finance its activities and own the company. So a company has a corporate personality which separates it from its members / owners/ shareholders.

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ACCOUNTING:
Information for Decision Making

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The accounting process

Economic activities

Accounting links decision makers with economic activities and with the results of their decisions.
Decision makers

Accounting information

Actions (decisions)
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Types of Accounting Information

Financial

Tax

Managerial

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Information System

Information Users Investors Creditors Managers Owners Customers Employees Regulators -SEC -IRS -EPA
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Financial Information Provided Profitability Financial Position Cash Flows

Decisions Supported Performance evaluations Stock Investments Tax strategies Labor relations Resource allocations Lending decisions Borrowings
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Basic Functions of an Accounting System

Interpret and record business transactions.
Payment

Car
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Basic Functions of an Accounting System

Interpret and record business transactions. Classify similar transactions into useful reports.

Summarize and communicate information to decision makers.

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Financial Reporting and Financial Statements

Income Statement Balance Sheet Statement of Cash Flows

Other Information: Industry Competitors Economy-wide

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Characteristics of Externally Reported Information

A Means to an End Usefulness Enhanced via Explanation Broader than Financial Statements

Based on General Purpose Assumption Results from Inexact and Approximate Measures
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Historical in Nature

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Users of Internal Accounting Information

 Board of Directors  Chief Executive Officer  Chief Financial Officer  Vice Presidents  Business Unit Managers  Plant Managers  Store Managers  Line Supervisors

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Characteristics of Internal Accounting Information

Timeliness A Means to an End Identify DecisionMaking Authority

Measures of Efficiency and Effectiveness

Oriented Toward Future

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Integrity of Accounting Information

Institutional Features Generally Accepted Accounting Principles (GAAP) Financial Accounting Standards Board Securities and Exchange Commission Internal Control Structure Audits

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Integrity of Accounting Information

Professional Organizations American Institute of Certified Public Accountants Institute of Management Accountants Institute of Internal Auditors American Accounting Association

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Integrity of Accounting Information

Competence, Judgment and Ethical Behavior Certified Public Accountants (CPAs) Certificate in Management Accounting (CMA) Certificate in Internal Auditing (CIA) Code of Professional Conduct

CPA
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Any Question

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THE ACCOUNTING CYCLE:

Capturing Economic Events

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The Accounting Cycle

Journalize transactions.

Post entries to the ledger accounts.

Prepare trial balance.

Make end-ofyear adjustments.

Prepare after closing Journalize and post closing trial balance. McGraw-Hill/Irwin entries.

Prepare Prepare adjusted financial trial balance. The McGraw-Hill Companies, Inc., 2002 statements.

Financial Accounting

ACCOUNTING CYCLE
The sequence of Accounting procedures applied every period in recording transactions and preparing Financial Statements. These procedures begin with journalizing transactions including adjusting and closing accounts and conclude with preparation of an after-closing trial balance.
1. 2. 3. 4. 5. 6. 7. 8.

Recording of Business Transactions. Posting of Transactions in Ledger Accounts. Prepare Trial Balance. Make Year End Adjustments. Make Adjusted Trial Balance. Make Closing Entries. Prepare After-Closing Trial Balance. Prepare Financial Statements.

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Financial Accounting

CONSERVATISM
The traditional accounting practice of resolving uncertainty by choosing the solution which leads to the lower ( more conservative ) amount of income being recognized in the current accounting period. This concept is designed to avoid over statement of financial strength or earnings.

MATCHING PRINCIPLE
The generally accepted accounting principle that determines when expenses should be recorded in the accounting records. The revenue earned during an accounting period is matched (offset) with the expenses incurred in generating this revenue.

REALIZATION PRINCIPLE
The generally accepted accounting principle that determines when Revenue should be recorded in the accounting records. Revenue is realized when services are rendered to customers or when goods are sold or delivered to customers.
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FUNDAMENTAL ACCOUNTING ASSUMPTIONS

The following are recognized as fundamental accounting assumptions : 1. 2. 3. Going Concern. Consistency. Accrual.

Where fundamental accounting assumptions are followed in financial statements, disclosure of such assumptions is not required. If the fundamental accounting assumption is not followed, the fact should be disclosed together with the reasons.

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FUNDAMENTAL ACCOUNTING ASSUMPTIONS

Going Concern
The enterprise is viewed as a going concern. It means that it is assumed that the business will exist for a long time and transactions are recorded from this point of view. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations.

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FUNDAMENTAL ACCOUNTING ASSUMPTIONS

Consistency
It is assumed that accounting policies are consistent from one period to another. The accounting practices should remain the same from one year to another for instance It would be improper to value stocks-in-trade according to one method one year and according to another method next year. If the change becomes necessary, the change and its effects should be stated clearly.

Accrual
Revenue and costs are accrued, that is, recognized as they are earned or incurred ( and not as money is received or paid ) and recorded in the financial statements of the periods to which they relate.

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ACCOUNTING POLICIES / CONVENTIONS

The selection and application of the appropriate accounting policies and the preparation of financial statements should be govern by the three main accounting conventions : 1. 2. 3. Prudence Substance Over Form Materiality

Prudence
Means carefulness, care, caution, cautiousness, discretion and good sense. Uncertainties inevitably surround many transactions. This should be recognized by exercising prudence / rational judgment in preparing financial statements. Prudence does not justify the creation of secret / hidden reserves.
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ACCOUNTING POLICIES / CONVENTIONS

Materiality
The relative importance of an amount or item. An item which is not significant enough to influence the decisions of users of financial statements is considered to be not material. Financial statements should disclose all items, which are material enough to affect evaluations or decisions.

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ACCOUNTING POLICIES / CONVENTIONS

Substance Over Form

In dictionary substance means matter, material, stuff or body. Similarly, Form means shape, appearance, outward appearance, figure, outline or structure. It means that the financial transactions ( for which the entries are made in the books of accounts ) should be accounted for and presented (means that these are analyzed and recorded in the GL - general ledger ) in accordance with their substance and financial reality and not merely with their legal form. In other words the transactions should be recorded considering their impact (or the materiality of impact) on the financial position of the company and not on the basis of their existence in the form of legal or statutory grounds.
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ACCOUNTING POLICIES / CONVENTIONS

Substance Over Form

Example
Suppose, if A sells some equipment to B on the basis that A will use that equipment for a period of three years after the sale of that equipment to B then the ownership to the equipment has been transferred to B at the time of Sale. The equipment after the sale belongs to Mr. B but Mr. A is still entitled to use that equipment for a period of three years as per the clauses of the Sale Deed. Similarly, In the case of Leasing, the ownership of the property remains with the Lessor but Lessee is entitled to use that Asset for a predefined period.
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CLASSIFICATION
FIVE PILLARS OF ACCOUNTING
1. 2. 3. 4. 5.

A S S E T S. L I A B I L I T I E S. E Q U I T I E S. E X P E N S E S. R E V E N U E S.

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ASSETS
TYPES OF ASSETS
1. INTANGIBLE ASSETS. 2. TANGIBLE ASSETS.

A ) INTANGIBLE ASSETS
1. Goodwill. 2. Copyrights. 3. Patents.

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B) TANGIBLE ASSETS
1. 2.

Current Assets. Non Current Assets / Fixed Assets . CURRENT ASSETS

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Cash / Bank. Accounts Receivables / Sundry Debtors. Notes Receivables / Bills Receivables. Prepaid Expenses / Prepayments. Inventories / Stocks / Stores Spares & Loose Tools. Office Supplies. Stock in Trade. Short Term Loans & Advances. Short Term Investments. Short Term Deposits.

A S S E T S

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B) TANGIBLE ASSETS
1. 2.

Current Assets. Non Current Assets / Fixed Assets . NON CURRENT ASSETS 1. 2. 3. 4. FIXED ASSETS. Long Term Deposits. Long Term Loans & Advances. Long Term Investments.

A S S E T S

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TANGIBLE ASSETS
FIXED ASSETS ( Property, Plant & Equipment )
According to IAS-16, a class of Property, Plant and Equipment is a grouping of assets of a similar nature and use in an enterprises operations. The following are examples of separate classes (mainly due to their Capitalization policy ) :
1. 2. 3. 4. 5. 6. 7. 8.

Land ( Agricultural and Non-Agricultural both ). Land and Buildings. Machinery. Ships. Aircrafts. Motor vehicles. Furniture and Fixtures. Office Equipment.

A S S E T S

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LIABILITIES
TYPES OF LIABILITIES
1. 2.

CURRENT LIABILITIES. NON- CURRENT LIABILITES.

A ) CURRENT LIABILITIES
1. 2. 3. 4. 5. 6. 7. 8. 9.

Bank Overdraft / Running Finance. Accounts Payable / Sundry Creditors. Notes Payable / Bills Payable. Salaries Payable. Income Tax Payable. Dividend Payable. Interest Payable. Short Term Portion of the Long Term Loan & Redeemable Capital. Short Term Portion of Liabilities against assets subject to Finance Lease.
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B ) NON - CURRENT LIABILITIES

1. 2. 3. 4.

Long Term Loans. Long Term Deposits. Long Term Liabilities against Assets subject to Finance Lease. Deferred Liabilities ( Gratuity / PF / Taxation ).

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EQUITIES
1. 2. 3. 4. 5. 6.

Issued Subscribed and Paid-up Capital. Share Premium. Capital Reserves. General Reserves. Retained Earnings / Un-Appropriated Profit. Redeemable Capital.

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The Role of Accounting Records

Establishes accountability for assets and transactions. Keeps track of routine business activities. Obtains detailed information about a particular transaction. Evaluates efficiency and performance within company. Maintains evidence of companys business activities.
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The Ledger
Cash Accounts Payable Capital Stock

Accounts are individual records showing increases and decreases. The entire group of accounts is kept together in an accounting record called a ledger.
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The Use of Accounts

Increases are recorded on one side of the Taccount, and decreases are recorded on the other side.
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Title of Account
Left or Debit Side Right or Credit Side

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RULES OF DEBIT & CREDIT

Debit and Credit are not clearly defined in any of the Accounting book. Most of the renowned books encompass the following definition : Debit is a phenomenon that deals with the five pillars of Accounting and describes the treatment of these pillars under the following rules : 1. 2. 3. 4. 5. Increase in Assets; Decrease in Liabilities; BALANCE SHEET Decrease in Equities; Increase in Expenses; INCOME STATEMENT Decrease in Income / Revenues.

Credit denotes the above in the reverse manner .

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Lets see how debits and credits are recorded in the Cash account for JJs Lawn Care Service.

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Debit and Credit Entries

Receipts are on the debit side.

5/1 5/25 5/29 5/31 Bal.

Cash 8,000 5/2 2,500 Payments 75 5/8 2,000 are on the credit 750 5/28 150 side. 5/31 50 4,125 The balance is the
difference between the debit and credit entries in the account.
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Debit and Credit Rules

Debits and credits affect accounts as follows:

A = L + OE
ASSETS Debit Credit for for Increase Decrease LIABILITIES Debit Credit for for Decrease Increase EQUITIES Debit Credit for for Decrease Increase
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Double Entry AccountingThe Equality of Debits and Credits

Debit balances

A = L + OE =
Credit balances
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In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.
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Lets record selected transactions for JJs Lawn Care Service in the accounts.
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May 1: Jill Jones and her family invested $8, in JJs Lawn Care Service and received 8 shares of stock.

Will Cash increase or decrease?

Will Capital Stock increase or decrease?

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

May 1: Jill Jones and her family invested $8, in JJs Lawn Care Service and received 8 shares of stock.

Cash increases with a debit. $8,

Capital Stock increases $8, with a credit.

Cash 5/1 8,000

Capital Stock 5/1 8,000

McGraw-Hill/Irwin

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May 2: JJs purchased a riding lawn mower for $2,5 cash.

Will Cash increase or decrease?

Will Tools & Equipment increase or decrease?

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

May 2: JJs purchased a riding lawn mower for $2,5 cash.

ash decreases $2,5 wi h a credi .

ools uipmen increases $2,5 wi h a debi .

ash 5/ , 5/2 2,5

ools 5/2 2,5

uipmen

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

Will Truck increase or decrease?

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The McGraw-Hill Companies, Inc., 2002

May 8: JJs purchased a $15, truck. JJs paid $2, down in cash and issued a note . payable for the remaining $13,
ash decreases with a credit. $2, otes ayable increases $13, with a credit.
ash
ruck 5 8 15,

ruck increases with a debit. $15,

5 1 8,

5 2 2,5 5 8 2,

otes ayable 5 8 13,

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May 11: JJs purchased some repair parts for $3 on account.

Will Tools & Equipment increase or decrease?

Will Accounts Payable increase or decrease?

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The McGraw-Hill Companies, Inc., 2002

May 11: JJs purchased some repair parts for $3 on account.

Tools & Equipment increases $3 with a debit.

Accounts Payable increases $3 with a credit.

Tools & Equipment 11 3

Accounts Payable 11 3

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May 18: JJs sold half of the repair parts to ABC Lawns for $15 , a price equal to JJs cost. ABC Lawns agrees to pay JJs within 3 days.

Will Tools & Equipment increase or decrease?

Will Accounts Receivable increase or decrease?

McGraw-Hill/Irwin

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May 18: JJs sold half of the repair parts to ABC Lawns for $15 , a price equal to JJs cost. ABC Lawns agrees to pay JJs within 3 days.

Tools & Equipment decreases $15 with a credit.

Tools & Equipment 5 ,5 5 18 15 5 11 3

Accounts Receivable increases $15 with a debit.

Accounts Receivable 5 18 15

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

ate ay ash

ccount itles and

lanation

e it ,

redit

a ital

toc usiness.

,
The McGraw-Hill Companies, Inc., 2002

ners in est cash in the

McGraw-Hill/Irwin

Posting Journal Entries to the Ledger Accounts

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

GENERAL JOURNAL
Date 2003 May 1 Cash Capital Stock Owners invest cash in the business. General Ledger 8,000 8,000 Account Titles and Explanation Debit Credit

Date 2003 May 1

McGraw-Hill/Irwin

Cash Debit Credit 8,000

Balance 8,000
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Posting Journal Entries to the Ledger Accounts

GENERAL JOURNAL
Date 2003 May 1 Cash Capital Stock Owners invest cash in the business. General Ledger 8,000 8,000 Account Titles and Explanation Debit Credit

Date 2003 May 1

McGraw-Hill/Irwin

Capital Stock Debit Credit 8,000

Balance 8,000
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Posting Journal Entries to the Ledger Accounts

GENERAL JOURNAL
Date 2003 May 2 Tools & Equipment Cash Purchased lawn mower. 2,500 2,500 Account Titles and Explanation Debit Credit

Lets see what the cash account looks like after posting the cash portion of this transaction for JJs Lawn Care Service.
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Ledger Accounts After Posting

General Ledger Cash Debit Credit ,000 2, 00

Date 2003 May 1 2

Balance ,000 , 00

This ledger format is referred to as a running balance (as opposed to simple T accounts).
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What is Net Income?

Net income is not an asset its an increase in owners equity from profits of the business.

Increase

A = L + OE
Decrease Increase . . . but this is what net income really means.
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Either (or both) of these effects occur as net income is earned . . .

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Retained Earnings

A = L + OE
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.
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Revenue and Expenses

The price for goods sold and services rendered during a given accounting period. Increases owners equity.

The costs of goods and services used up in the process of earning revenue.
McGraw-Hill/Irwin

Decreases owners equity.

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The Realization Principle: When To Record Revenue

Realization Principle Revenue should be recognized at the time goods are sold and services are rendered.

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The Matching Principle: When To Record Expenses

Matching Principle Expenses should be recorded in the period in which they are used up.

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Debits and Credits for Revenue and Expense

Expenses decrease owners equity.
EQUITIES Debit Credit for for Decrease Increase

Revenues increase owners equity.

EXPENSES Debit Credit for for Increase Decrease

REVENUES Debit Credit for for Decrease Increase

The McGraw-Hill Companies, Inc., 2002

McGraw-Hill/Irwin

Investments by and Payments to Owners

Payments to owners decrease owners equity.
DIVIDENDS Debit Credit for for Increase Decrease EQUITIES Debit Credit for for Decrease Increase

Owners investments increase owners equity.

CAPITAL STOCK

Debit Credit for for Decrease Increase

The McGraw-Hill Companies, Inc., 2002

McGraw-Hill/Irwin

Lets analyze the revenue, and expense transactions for JJs Lawn Care Service for the month of May. We will also analyze a dividend transaction.
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May 29: JJs provided lawn care services for a client and received $75 in cash.

Will Cash increase or decrease?

Will Sales Revenue increase or decrease?

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

May 29: JJs provided lawn care services for a client and received $75 in cash.

Cash increases $75 with a debit.

Sales Revenue increases $75 with a credit.

Cash 5 5 29 75 52 25 5 2

Sale Revenue /29 7

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The McGraw-Hill Companies, Inc., 2002

May 31: JJs purchased gasoline for the lawn mower and the truck for $5 cash.

Will Cash increase or decrease?

Will Gasoline Expense increase or decrease?

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

May 31: JJs purchased gasoline for the lawn mower and the truck for $5 cash.

Cash decreases $5 with a credit.

Gasoline Expense increases $5 with a debit.

Gasoline Expense 5/ 50

Cash 51 5 5 5 5 5 31 5 5

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May 31: JJs Lawn Care paid Jill Jones and her family a $2 dividend.

Will Cash increase or decrease?

Will Dividends increase or decrease?

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

May 31: JJs Lawn Care paid Jill Jones and her family a $2 dividend.

Cash decreases $2 with a credit.

Dividends increase $2 with a debit.

Cash 1 2 2 2 2 31 31 2 5/31

Divid 00

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Now, lets look at the Trial Balance for JJs Lawn Care Service for the month of May.

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JJ's Lawn Care Service Unadjusted Trial Balance May 31, 2003 Cash $ 3,925 Accounts receivable 75 Tools & equipment 2,650 Truck 15,000 Notes payable Accounts payable Capital stock ividends 200 Sales revenue Gasoline expense 50 Total $ 21,900
McGraw-Hill/Irwin

$ 13,000 150 8,000 750 $ 21,900

All balances are taken from the ledger accounts on May 31 after considering all of JJs transactions for the month. Proves equality of debits and credits.
The McGraw-Hill Companies, Inc., 2002

Another COMPREHENSIVE Q/S :

Preparation of Trial Balance
GIVEN :
The following are some of the transactions of HAQQANI Stores for the month of January 2004.

DATES TRANSACTIONS
JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN JAN

01 Haqqani invested Rs. 280,000 cash for his business. 01 Purchased shop building for cash Rs. 100,000. 02 Purchased shop furniture for cash Rs. 20,000. 04 Purchased merchandise for cash Rs. 15,000. 05 Paid Transportation Expense Rs. 150. 07 Purchased merchandise on account from Jamali & Sons for Rs. 17,800 and paid transport Rs. 160. 10 Sold merchandise for cash Rs. 14,350. 13 Sold merchandise on account to Patel & Co. for Rs. 8,500. 16 Purchased shop equipment for cash Rs. 8,000. 19 Paid for merchandise purchased Rs. 13,600. 22 Received on account of cash sales Rs. 4,500. 26 Paid for Transportation Rs. 120. 27 Received cash from Patel & Co. Rs. 5,000. 28 Paid cash to Jamali & Sons Rs. 15,000. 30 Paid Salaries to employees for the month Rs. 4,500.

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Financial Accounting

SOLUTION TO THE QUESTION :

HAQQANI STORES
GENERAL JOURNAL
DATE

ACCOUNT TITLES & DESCRIPTION

Post Ref

DEBIT

CREDIT

2004 Ca h
Jan 01

280,000

Haqqan ' Cap a

( To record Haqqan 's Inves men n h e bus ness )

280,000

Jan 01 Shop Bu d ng

100,000 100,000

Ca h
( To record h e purchase of Shop bu d ng for cash )

Jan 02 Shop Fu n u e

20,000 20,000

Ca h
( To record h e purchase of Shop urn u re for cash )

Jan 04 Pu cha e

15,000 15,000

Ca h
( To record h e purchase of merchand se for cash )

Jan 05

an po a on Ca h

xpen e

150 150

( To record h e paymen of Transpor a on )

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Financial Accounting

HAQQANI STORES
GENERAL JOURNAL
DATE

ACCOUNT TITLES & DESCRIPTION

Post Ref

DEBIT

CREDIT

Jan 07 Pu cha e

17,800 17,800

ccoun Payab e - a a & Son

( To record h e purchase of merchand se on accoun )

an po a on xpen e Ca h
( To record h e paymen of Transpor a o n )

Jan 10 Ca h

Sa e
( To record h e sa e of merchand se for cash )

Jan 13

ccoun ece vab e - Pa e & Co.' Sa e

( To record h e sa e of merchand se on accoun )

Jan 16 Shop

qu p en Ca h

( To record h e purchase of shop equ p men for Cash )

McGraw-Hill/Irwin

160 160

14,350 14,350

8,500 8,500

8,000 8,000

The McGraw-Hill Companies, Inc., 2002

Financial Accounting

H QQ
G
O Jan 19 Pu cha e I S

I STO
JO
S IPTIO

S
I

13,600 13,600
 

Ca h
( To record h e purchase of merchand se for Cash )

Jan 22 Ca h

4,500

Sa e
( To record Cash Sa es )


Jan 26

an po a on xpen e Ca h
( To record paymen of Transpor a o n )
  

120 120

Jan 27 Ca h

5,000

ccoun

ece vab e - Pa e & Co.'

   

( To record rece p of Cash from Pa e & Co. )

Jan 28

ccoun Payab e - a a & Son Ca h

( To record h e paymen of Cash o Jama & Sons. )
   

15,000 15,000

Jan 30 Sa a e

xpen e Ca h
     

4,500 4,500

( To record h e paymen of Sa a r es for h e mon h )

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

 

 

Post f

4,500

5,000

Financial Accounting

H QQ
GE E
( ebi )
2004 Jan - 01 Jan - 01 Jan - 10 Jan - 22 Jan - 27 Opening Balance Haqqani's apital a/c Sales a/c Sales a/c Accounts Rec-Patel & o. a/c
 

I STO ES
L LE GE
(Credi )
Shop Building a/c Shop Furniture a/c urchases a/c ransportation Expense a/c Transportation Expense a/c Shop Equipment a/c Purchases a/c Transportation Expense a/c Accounts Pay-Jamali & o. a/c Salaries Expense a/c Closing Balance


CASH (Asse )
s NIL 280,000 14,350 4,500 5,000 2004 Jan - 01 Jan - 02 Jan - 04 Jan - 05 Jan - 07 Jan - 16 Jan - 19 Jan - 26 Jan - 28 Jan - 30 Jan - 31

T
Account Form of Ledger
303,850

s 100,000 20,000 15,000 150 160 8,000 13,600 120 15,000 4,500 127,320 303,850

(Debi )
2004

CAPITAL
s.


2004 Jan - 01 Jan - 01

Jan -31

Closing Balance

280,000 280,000

( ebi )
pening alan e a h a/
" " !

SHOP BUIL I G ( sse )

2004 NIL 100 000 100,000
%

100,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

$ #

2004 Jan - 01 Jan - 01

Jan - 31

(Credi )
s. Opening Balance ash a/c 280,000 280,000

( redi )

losing Balance

100 000

Financial Accounting

H QQ
GE E
( ebi )
p ening alan e a h a/
( ( ' &

I STO ES
L LE GE
( redi )
s.
1

SHOP FURNITURE ( sse )

s. NIL 20 000 20,000
1 0 )

2004 Jan - 01 Jan - 02

2004 Jan -31 Closing Balance

20 000 20,000

( ebi )
p ening alan e a h a/ A o unt Pay - Jamil & Son a h a/
( 0 ( ( (( 0 ) 0 ) & '

PURCH SE
Rs. NIL 15,000 17,800 13,600 46,400 2004

(Credi )
Rs.

( ebi )
( 0

TR NSPORT TION EXPENSE (Expense)

Rs.
(

McGraw-Hill/Irwin

2004 Jan - 05 Jan - 07 Jan - 26

Ca h a/ Ca h a/ Ca h a/

2004 Jan - 01 Jan - 04 Jan - 07 Jan - 19

T
Account Form of Ledger

Jan - 31

Closing Balance

46,400 46,400

(Credi )
Rs.

2004 150 160 120 Jan -31 430

Closing Balance

430 430

The McGraw-Hill Companies, Inc., 2002

Financial Accounting

H QQ
GE E

I STO ES
L LE GE

( e it
4332

O
as a/c l si B lance
T SR 5 H G

TS P Y BLE
s.
777 33U F 77 E 8

( re it
F 8 77 I DC 5

17,

( e it

S LES ( evenue )
s.
Y V Y XW

( re it
X

( e it)
V c eV V d WX

O
e i Bala ce Sales a/c

TS

E EIV BLES ( sset)

s.
XX

( re it)
XXX

as a/c l sing Balance

8,5

,500

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

XX

Ja - 3
V

hgf

2004 Ja Ja - 3
W V V

2004 Ja -

s. 5,

3,5 8,500

XX

l sing Balance

Ja - 3
V

,35 7,35

XX

Ja Ja - 3 Ja aa W V V

as a/c Accou ts Rec - Patel & o. as a/c

s. 4,35 8,5 4,5 27,35

33U

Q P

Ja Ja -3
6

5, , 17,

Ja Ja 6

e i Bala ce as a/c

A 6 6 @9

I7 8 7

4332 6

s. ,

Financial Accounting

H QQ
GE E
( ebi )
p ening alance ash a/c
q p

I STO ES
L LE GE
(Credi )
s.

SHOP EQUIPME T ( sse )

s. NIL 8,000 Jan - 31 8,000 Closing Balance
i

2004 Jan - 01 Jan - 16

2004

8,000 8,000

( ebi )
i

S L
ash a/c

IES EXPE SE ( Expense )

s. 4,500 4,500 2004 Jan - 31 Closing Balance

(Credi )
s. 4,500 4,500

2004 Jan - 30

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Financial Accounting

HAQQANI S
IAL BALAN E
AS ON JANUARY 31, 2004

S
Post Ref DEBIT in Rupees REDIT in Rupees

S No.

OUNT TITLES

Cash 2 Haqqani's Capital 3 hop Building hop Furniture 4 5 Purchases 6 Transportation Expenses 7 Accounts Payables 8 ales 9 Accounts Receivables 10 hop Equipment 11 alaries Expenses
1 TOTAL

12 ,320 2 0,000 100,000 20,000 4 ,400 430 2,800 2 ,3 0 3,500 8,000 4,500

310,150

310,150

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

H AQ Q ANI ST R S
I NCOM STAT M NT
Rup Rup

Financial Accounting

For th p r od nd d MAY 31, 1994.

Sales Revenue
L : Sales return and Allownaces Sales Discount

27,3 -

NET SALES L : COST OF OODS SOLD Merchandise Inventory (Opening - 01-01-2004) Add : Purchases

27,3

46,400 46,400 46,400 46,400 46,400

Add : Carriage - In Less : Purchase Discount Purchase Returns Net Purchases

Merchandise available for Sale : Merchandise Inventory (Closing - 31-01-2004) L COST OF GOODS SOLD

GR SS PR FIT
L : OP RATIN XP NS S Salaries Expense Depreciation Expense Transportation Expense Insurance Expense Bad Debt Expense TOTAL OPERATING EXPENSES Rs. 4,500 430 -

(19,

4,930 Rs.

TOTAL N T LOSS
McGraw-Hill/Irwin

(23,980)

The McGraw-Hill Companies, Inc., 2002

Financial Accounting

H AQ Q AN S
BALANCE
AS ON

S
4 Rupees

SHEET
EQUITIES

JANUARY 31 2

ASSETS
Rupees URRENT ASSETS Cash A oun s Re e vables 35 Less All for Bad Debts Merchandise Inventory - Closing Prepaid Insurance Investments Office Supplies NON CURRENT ASSETS Shop Building 1 Less All for Depreciation Shop Furniture Shop Equipment TOTAL 127,320 3,500 -

CURRENT LIABILITIES A oun s Payable N es payables Salaries payable Sundry Creditors PROPRIETORSHIP Riaz's Capital

Rs

2,800 -

Rs

256,020

100,000 20,000 8,000

258 82

258 82

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Financial Accounting

H AQ Q AN S O
A
F r
HA A ANI's Ne a i al r fi / ss ( fr m INC
A

S
A I A
4
280 000 (23 980) 256 2

N
e m e

HAN
e
Rs
N

IN

JANUARY 31 2

ess HA

Ria 's Dra i gs ANI's a i al l si g Ja ary 31 2 Rs

256 2

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

THE ACCOUNTING CYCLE:

Accruals and Deferrals

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

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

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Adjusting Entries
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.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Types of Adjusting Entries

Converting assets to expenses Converting liabilities to revenue

Accruing unpaid expenses

McGraw-Hill/Irwin

Accruing uncollected revenues

The McGraw-Hill Companies, Inc., 2002

Converting Assets to Expenses

End of Current Period Prior Periods Current Period Future Periods

Transaction Paid future expenses in advance (creates an asset).

McGraw-Hill/Irwin

Adjusting Entry Recognize portion of asset consumed as expense, and Reduce balance of asset account.
The McGraw-Hill Companies, Inc., 2002

Converting Assets to Expenses

Examples Include: Depreciation Supplies Expiring Insurance Policies

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Converting Assets to Expenses

$2,4 Insurance Policy Coverage for 12 Months $2 Monthly Insurance Expense

Jan. 1

Dec. 31

On January 1, Webb Co. purchased a oneyear insurance policy for $2,4 .

McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Converting Assets to Expenses

Initially, costs that benefit more than one accounting period are recorded as assets.

GENERAL JOURNAL
Date Jan. Account Titles and Explanation 1 Unexpired Insurance Cash urchase a one-year insurance policy.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Debit 2,400

Credit 2,400

Converting Assets to Expenses

The costs are expensed as they are used to generate revenue.

E E A
ate an.

A
e it redit

Account Titles and Explanation Monthly Ad usting Entry or nsurance nsurance Expense nexpired nsurance nsurance expense or anuary.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Converting Assets to Expenses

Bala e Sheet I ome Stateme t Cost of assets that be efit f t re erio s. Cost of assets se this erio to ge erate reve e.

ire I s r 1/1 2, 00 1/31 Bal. 2,200

McGraw-Hill/Irwin

e 200

I s r 1/31 200

e se

The McGraw-Hill Companies, Inc., 2002

The Concept of Depreciation

Depreciable assets are physical objects that retain their size and shape but lose their economic usefulness over time.

Depreciation is the systematic allocation of the cost of a depreciable asset to expense.

McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

The Concept of Depreciation

The portion of an assets utility that is used up must be expensed in the period used.
Fixed Asset (debit) On date when initial payment is made . . . Cash (credit)
McGraw-Hill/Irwin

The assets usefulness is partially consumed during the period.

Accumulated Depreciation (credit)

At end of period . . .
Depreciation Expense (debit)
The McGraw-Hill Companies, Inc., 2002

Depreciation Is Only an Estimate

On May 2, 2 3, JJs Lawn Care Service purchased a lawn mower with a useful life of 5 months for $2,5 cash. Using the straight-line method, calculate the monthly depreciation expense.
Depreciation Cost of the asset expense (per = Estimated useful life period)

$5
McGraw-Hill/Irwin

$2,5 5

The McGraw-Hill Companies, Inc., 2002

Depreciation Is Only an Estimate

JJs Lawn Care Service would make the following adjusting entry.
GENERAL JOURNAL
Date Account Titles and Explanation Accumulated Depreciation: Tools & Eq. To record one month s depreciation. Debit 5 5 Credit May 31 Depreciation Expense: Tools & Eq.

McGraw-Hill/Irwin

Contra-asset

The McGraw-Hill Companies, Inc., 2002

Depreciation Is Only an Estimate

JJs $15, truck is depreciated over 6 months as follows:
J
ate ay 1 ccount itles and epreciation pense: ccumulated planation ruck ruck e it 5 5 redit

epreciation:

o record one month s depreciation.

McGraw-Hill/Irwin

$15,

z6 months = $25 per McGraw-Hill Companies, Inc., 2002 month The

JJ's Lawn Care Service Partial Balance Sheet Accumulated depreciation would May 31, 2001 appear on the balance sheet as Assets L Cash $ 3,925 N follows: Accounts receivable 75 A Tools & equipment $ 2,650 Less: Accum. depr. 50 2,600 Truck $ 15,000 Ow Less: Accum. depr. 250 14,750 J To

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Converting Liabilities to Revenue

End of Current Period Prior Periods Current Period Future Periods

Transaction Collected from customers in advance (creates a liability).

McGraw-Hill/Irwin

Adjusting Entry Recognize portion earned as revenue, and Reduce balance of liability account.
The McGraw-Hill Companies, Inc., 2002

Converting Liabilities to Revenue

Examples Include: Airline Ticket Sales Sports Teams Sales of Season Tickets

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Converting Liabilities to Revenue

$6, Rental Contract Coverage for 12 Months $5 Jan. 1 Monthly Rental Revenue Dec. 31

On January 1, Webb Co. received $6, in advance for a one-year rental contract.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Converting Liabilities to Revenue

Initially, revenues that benefit more than one accounting period are recorded as liabilities.

GENERAL JOURNAL
Date Jan. Account Titles and Explanation 1 Cash Unearned Rental Revenue Collected $6,000 in advance for rent.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Debit 6,000

Credit 6,000

Converting Liabilities to Revenue

Over time, the revenue is recognized as it is earned.

GENERAL JOURNAL
Date Account Titles and Explanation onthly Ad usting Entry for Rent Revenue Jan. 31 Unearned Rental Revenue Rental Revenue Rental revenue for January.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Debit 500

Credit

500

Converting Liabilities to Revenue

Balance Sheet Liability for future perio s. Income Statement Revenue earne this perio .

ear e Re tal Reve

1/31

500

1/1 6,000 Bal. 5,500

Re tal Reve e 1/31 500

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Accruing Unpaid Expenses

End of Current Period Prior Periods Current Period Future Periods

Adjusting Entry Recognize expense incurred, and Record liability for future payment.
McGraw-Hill/Irwin

Transaction Liability will be paid.

The McGraw-Hill Companies, Inc., 2002

Accruing Unpaid Expenses

Hey, when do we get paid? Examples Include: Interest Wages and Salaries Property Taxes

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Accruing Unpaid Expenses

$3, Wages Expense

Monday, May 29

Wednesday, May 31

Friday, June 2

On May 31, Webb Co. owes wages of $3, Pay day is Friday, June 2.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Accruing Unpaid Expenses

Initially, an expense and a liability are recorded.

GENERAL JOURNAL
Date Account Titles and Explanation W ages Payable To accrue w ages ow ed to employees.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Debit 3,000

Credit 3,000

May 31 W ages Expense

Accruing Unpaid Expenses

Balance Sheet Liability to be aid in a future eriod. Income Statement Cost incurred this eriod to generate revenue.

Wages ayable 5/31 3,000

Wages 5/31 3,000

ense

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Accruing Unpaid Expenses

$5, Weekly Wages $2, Wages Expense

$3, Wages Expense

Monday, May 29

Wednesday, May 31

Friday, June 2

Lets look at the entry for June 2.

McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Accruing Unpaid Expenses

The liability is extinguished when the debt is paid.

GENERAL JOURNAL
Date Account Titles and Explanation W ages Payable (accrued in May Cash W ee ly payroll for May 29-June 2.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Debit 2,000 3,000

Credit

June 2 W ages Expense (for June

5,000

Accruing Uncollected Revenue

End of Current Period Prior Periods Current Period Future Periods

Adjusting Entry Recognize revenue earned but not yet recorded, and Record receivable.
McGraw-Hill/Irwin

Transaction Receivable will be collected.

The McGraw-Hill Companies, Inc., 2002

Accruing Uncollected Revenue

Examples Include: Interest Earned Work Completed But Not et Billed to Customer

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Accruing Uncollected Revenue

$17 Interest Revenue

Saturday, Jan. 15

Monday, Jan. 31

Tuesday, Feb. 15

On Jan. 31, the bank owes Webb Co. interest of $17 . Interest is paid on the 15th day of each month.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Accruing Uncollected Revenue

Initially, the revenue is recognized and a receivable is created.

GENERAL JOURNAL
Date Account Titles and Explanation Interest Revenue To recognize interest revenue.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Debit 170

Credit 170

Jan. 31 Interest Receivable

Accruing Uncollected Revenue

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

Interest Re eivable 1/31 170

Interest Revenue 1/31 170

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Accruing Uncollected Revenue

$32 Monthly Interest $17 Interest Revenue $15 Interest Revenue

Saturday, Jan. 15

Monday, Jan. 31

Tuesday, Feb. 15

Lets look at the entry for February 15.

McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Accruing Uncollected Revenue

The receivable is collected in a future period.

GENERAL JOURNAL
Date Account Titles and Explanation Interest Revenue (for February) Interest Receivable (accrued Jan. 31) To record interest received.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Debit 320

Credit 150 170

Feb. 15 Cash

Accruing Income Taxes Expense: The Final Adjusting Entry

As a corporation earns taxable income, it incurs income taxes expense, and also a liability to governmental tax authorities.
A
ate ec.

A
ebit redit

Account itles and xplanation ncome axes xpense axes ayable ecember. ncome

stimated income taxes applicable to taxable income earned in

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Adjusting Entries and Accounting Principles

Costs are matched with revenue in two ways: Direct association of costs with specific revenue transactions.

Systematic allocation of costs over the useful life of the expenditure.

McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

The Concept of Materiality

An item is material if knowledge of the item might reasonably influence the decisions of users of financial statements.
Many companies immediately charge the cost of immaterial items to expense.
Supplies
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Lightbulbs

Effects of the Adjusting Entries

Journalize transactions.

Post entries to the ledger accounts.

Prepare trial balance.

Make end-ofyear adjustments.

Recall from the accounting cycle discussed in Chapter 3, that after the adjusting entries are made, an adjusted trial balance is prepared.
McGraw-Hill/Irwin

Prepare adjusted trial balance.

The McGraw-Hill Companies, Inc., 2002

End of Chapter

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002