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The Accounting Equation

A = L + OE
+ Owner Investments

- Owner Withdrawals

+ Revenues
+ Gains

- Expenses
- Losses

Accounting Equation for a


Corporation

A = L + SE
+ Paid-in Capital

+ Retained Earnings

+ Revenues - Expenses - Dividends


+ Gains
- Losses

Accounting Equation, Debits and


Credits, Increases and Decreases

Permanent Accountsassets, liabilities, paid-in capital, retained earnings


Temporary Accounts-revenues, gains, expenses, losses

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

At the End
of the Year
Close Temporary
Accounts

Post-Closing
Trial Balance

Unadjusted
Trial Balance

The
Accounting
Processing
Cycle

The Accounting Cycle

C3

Start

Prepare
post-closing
trial balance

Analyze
transactions

POST

Closing
Entries

Journalize
Post

Prepare
statements

Prepare
unadjusted
trial balance

Prepare
adjusted
trial balance

Adjusting
Entries

POST

3-5

The Accounting Processing


Cycle
On July 1, two individuals each invested $30,000 in a new
business, Dress Right Clothing Corporation. Each
investor was issued 3,000 shares of common stock.

Two accounts are affected:


Cash

(an asset) increases by $60,000.


Common stock (a shareholders equity) increases
by $60,000.
July 1
Cash
Common stock

60,000
60,000

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.

Posting Journal Entries

After
Afterrecording
recording all
all entries
entriesfor
forthe
theperiod,
period,Dress
DressRights
Rights
Unadjusted
UnadjustedTrial
TrialBalance
Balance would
would be
be as
asfollows:
follows:

AATrial
Trial
Balance
Balance is
isaa
list
list of
of all
all
accounts
accounts
and
andtheir
their
balances
balancesat
at
aaparticular
particular
date.
date.

Debits = Credits

The Adjustment Process


Accounts are adjusted at the end of a period to
record internal transactions and events that are
not yet recorded.
Two basic principles for recognizing Revenues
and Expenses:
1. The revenue recognition principle requires
revenue be recorded when earned, not before
and not after.
2. The matching principle requires expenses be
recorded in the same period as the revenues
earned as a result of these expenses.

Accrual Basis versus Cash Basis


Accrual basis accounting uses the adjusting
process to recognize revenue when earned and to
match expenses with revenues. This means the
economic effects of revenues and expenses are
recorded when earned or incurred, not when cash is
received or paid. Accrual basis is consistent with
GAAP.
Cash basis accounting revenues are recognized
when cash is received and expenses are recognized
when cash paid. Cash basis is not consistent with
GAAP.
Accrual accounting also increases the comparability
of financial statements from one period to another.

Adjusting Accounts
An adjusting entry is recorded to bring an asset
or liability account balance to its proper amount.
The adjusting process is based on ACCRUAL
ACCOUNTING of Revenue Recognition and
Matching Principle.
Adjusting accounts is a 3-step process:
(1) Determine the current account balance,
(2) Determine what the current account balance
should be, and
(3) Record adjusting entry to get from step 1
to step 2.

P1

Supplies
During 2009, Scott Company purchased $15,500 of
supplies. Scott recorded the expenditures as
Supplies (Asset). On December 31, a count of the
supplies indicated $2,655 on hand.
What adjustment is required?

126

652

3-13

Adjusting Entries
At the end of the period, adjusting entries are
required to satisfy the realization principle and
the matching principle.

Prepayments

Accruals

Estimates

Transactions where
cash is paid or received
before a related
expense or revenue is
recognized.

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

Accountants must often


make estimates in order
to comply with the
accrual accounting
model.

C2, P1

Adjusting Accounts
Framework for
Adjustments
Adjustments

Paid
Paid (or
(or received)
received) cash
cash before
before
expense
expense (or
(or revenue)
revenue) recognized
recognized

Prepaid
Unearned
Prepaid
Unearned
(Deferred)
(Deferred)
(Deferred)
(Deferred)
expenses*
revenues
expenses*
revenues
*including depreciation

Paid
Paid (or
(or received)
received) cash
cash after
after
expense
expense (or
(or revenue)
revenue) recognized
recognized

Accrued
Accrued
expenses
expenses

Accrued
Accrued
revenues
revenues

3-15

Prepaid (Deferred) Expenses


P1

Supplies
During 2009, Scott Company purchased $15,500 of
supplies. Scott recorded the expenditures as
Supplies. On December 31, a count of the supplies
indicated $2,655 on hand.
What adjustment is required?

126

652

3-16

P1

Depreciation
Depreciation is the process of computing
expense from allocating the cost of plant and
equipment over their expected useful lives.

Straight-Line
Asset Cost - Salvage Value
Depreciation =
Useful Life
Expense

3-17

Depreciation
Recall the Furniture and Fixtures for $12,000 listed on
Dress Rights unadjusted trial balance. Assume the
following:
Asset Cost
$
12,000
Salvage Value
Useful Life
60 months

Lets calculate the depreciation expense for the month


ended July 31, 2011.

Depreciation

Recall the Furniture and Fixtures for $12,000 listed on


Dress Rights unadjusted trial balance.
Asset Cost
$
12,000
Salvage Value
Useful Life
60 months
July
Depreciation
Expense

$12,000 - $0
=

$200 per month

60 months

July 31
Depreciation expense
200
Accumulated depreciationfurniture and fixtures
200

Depreciation
After posting, the accounts look like this:
Furniture and Fixtures
Beg. bal.
12,000
Bal.
12,000

Depreciation Expense
Beg. bal.
200
Bal.
200

Accumulated Depreciation
Beg. bal.
200
200 Bal.

P1

Unearned (Deferred) Revenues


Cash
Cash received
received in
in
advance
advance of
of
providing
providing
products
products or
or
services.
services.

Liability
Debit
Adjustment

Unadjusted
Balance

Buy your season tickets for


all home basketball games NOW!

Go Big Blue

Revenue
Credit
Adjustment

3-21

P1

Unearned (Deferred) Revenues


On October 1, 2009, Ox University sold 1,000 season
tickets to its 20 home basketball games for $100 each.
Ox University makes the following entry:

3-22

P1

Unearned (Deferred) Revenues


On December 31, Ox University has
played 10 of its regular home games,
winning 2 and losing 8.

3-23

Accrued Expenses

P1

Costs
Costs incurred
incurred in
in aa
period
period that
that are
are
both
both unpaid
unpaid and
and
unrecorded.
unrecorded.

Expense
Debit
Adjustment

Were about one-half


done with this job and
want to be paid for
our work!

Liability
Credit
Adjustment

3-24

Accrued Expenses

P1

Barton,
Barton, Inc.
Inc. pays
pays its
its employees
employees every
every Friday.
Friday. Year-end,
Year-end,
12/31/09,
12/31/09, falls
falls on
on aa Wednesday.
Wednesday. As
As of
of 12/31/09,
12/31/09, the
the
employees
employees have
have earned
earned salaries
salaries of
of $47,250
$47,250 for
for Monday
Monday
through
through Wednesday.
Wednesday.

Last pay
date
12/26/09
12/1/09

Next pay
date

12/31/09
Year end

Record
Record adjusting
adjusting
journal
journal entry.
entry.
3-25

P1

Accrued Expenses
Barton,
Barton, Inc.
Inc. pays
pays its
its employees
employees every
every Friday.
Friday. Year-end,
Year-end,
12/31/09,
12/31/09, falls
falls on
on aa Wednesday.
Wednesday. As
As of
of 12/31/09,
12/31/09, the
the
employees
employees have
have earned
earned salaries
salaries of
of $47,250
$47,250 for
for Monday
Monday
through
through Wednesday.
Wednesday.

3-26

P1

Accrued Revenues
Smith
Smith &
& Jones,
Jones, CPAs,
CPAs, had
had $31,200
$31,200 of
of work
work
completed
completed but
but not
not yet
yet billed
billed to
to clients.
clients.
Lets
Lets make
make the
the adjusting
adjusting entry
entry necessary
necessary on
on
December
December 31,
31, 2009,
2009, the
the end
end of
of the
the companys
companys fiscal
fiscal
year.
year.

3-27

Estimates
Accountants often must make estimates of
future events to comply with the accrual
accounting model.

Examples

Depreciation
Uncollectible accounts

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.

The Income Statement

The income statement summarizes the results


of profit-generating activities of the company.

The Balance Sheet

The balance sheet presents the financial


position of the company on a particular date.

The Balance Sheet

Notice that assets of $143,000 equals total


liabilities plus shareholders equity of $143,000.

C3

The Closing Process: Temporary and


Permanent Accounts
Temporary (nominal) accounts accumulate data related to
one accounting period. They include all income statement
accounts, the dividends account, and the Income Summary
account. These accounts are closed at the end of the period
to get ready for the next accounting period.

Permanent (real) accounts report activities related to one or


more future accounting periods. They carry ending balances
to the next accounting period and are not closed.
3-33

The Statement of Cash Flows

The statement of cash flows discloses the


changes in cash during a period.

The Statement of
Shareholders Equity

The statement of shareholders equity


presents the changes in permanent
shareholder accounts.

The Accounting Cycle

C3

Start

Prepare
post-closing
trial balance

Analyze
transactions

POST

Closing
Entries

Journalize
Post

Prepare
statements

Prepare
unadjusted
trial balance

Prepare
adjusted
trial balance

Adjusting
Entries

POST

3-36

The Closing Process

Income
Summary

Liabilities

Permanent
Accounts

Shareholders
Equity

Temporary
Accounts

Assets

Dividends

Expenses

Revenues

The closing process applies


only to temporary accounts.

P4

1.
2.
3.
4.

Recording Closing Entries


Close revenue accounts to Inc. Summary;
Close expense accounts to Inc. Summary;
Close the income summary to RE;
Close dividends account to RE.

3-38

P4

Recording Closing Entries


Salaries Expenses
$ 18,100

Consulting Revenues

Examine the
accounts
presented.

Income Summary

$ 25,000

Retained Earnings
$ 7,000

3-39

P4

Recording Closing Entries


Salaries Expenses

Consulting Revenues
$ 25,000

$ 18,100

Income Summary
$ 25,000

$ 25,000

Close revenues
with a debit to the
revenue account
and a credit to
Income Summary.
3-40

P4

Recording Closing Entries


Salaries Expenses
$ 18,100

$ 18,100

Income Summary
$ 18,100

$ 25,000

Consulting Revenues
$ 25,000

$ 25,000

Close expense
accounts with a
credit to expenses
and a debit to
Income Summary.
3-41

P4

Recording Closing Entries


Salaries Expenses
$ 18,100

$ 18,100

Income Summary
$ 18,100

$ 25,000
$ 6,900

Consulting Revenues
$ 25,000

$ 25,000

Determine the
balance in the
Income Summary
account.
3-42

P4

Recording Closing Entries


Salaries Expenses
$ 18,100

$ 18,100

Income Summary
$ 18,100
$ 6,900

$ 25,000
$ 6,900

Close the Income


Summary to
Retained Earnings.
Retained Earnings
$ 7,000
$ 6,900

3-43

P4

Recording Closing Entries


The dividends account is closed to
Retained Earnings.
Dividends
$ 2,000

$ 2,000

Retained Earnings
$ 2,000

$ 7,000
6,900

3-44

P4

Recording Closing Entries


The dividends account is closed to
Retained Earnings.
Dividends
$ 2,000

$ 2,000

Retained Earnings
$ 2,000

Determine the ending


balance in Retained
Earnings.

$ 7,000
6,900
$ 11,900

3-45

The Accounting Cycle

C3

Start

Prepare
post-closing
trial balance

Analyze
transactions

POST

Closing
Entries

Journalize
Post

Prepare
statements

Prepare
unadjusted
trial balance

Prepare
adjusted
trial balance

Adjusting
Entries

POST

3-46

Post Closing Trial Balance

P5

Trial Balance prepared after the


closing entries have been posted.
The purpose is to insure that all
nominal or temporary accounts
have been closed.
The only accounts on this trial
balance should be assets,
liabilities, and equity accounts.

3-47

Post-Closing Trial Balance


Lists permanent
accounts and their
balances.

Total debits equal


total credits.

Conversion From Cash Basis to


Accrual Basis

Increases

Decreases

Assets

Add

Deduct

Liabilities

Deduct

Add

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