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Dr Cr. Chapter 2. The Accounting Process. Chapter 2--Learning Objectives. 1. Analyze transactions based upon the accounting equation. Accounting Equation. Assets = Liabilities + Equity or Assets - Liabilities = Equity. Accounting Equation. Assets = Liabilities + Equity. Assets

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chapter 2

Dr Cr

Chapter 2

The Accounting Process

slide2

Chapter 2--Learning Objectives

1. Analyze transactions based upon the accounting equation

slide3

Accounting Equation

Assets = Liabilities + Equity

or

Assets - Liabilities = Equity

slide4

Accounting Equation

Assets = Liabilities + Equity

Assets

Have value

Will generate future cash flows

slide5

Accounting Equation

Assets = Liabilities + Equity

Assets

Factory building

Equipment

Accounts receivable

slide6

Accounting Equation

Assets = Liabilities + Equity

Liabilities

Obligations

Incurred to Acquire Assets

slide7

Accounting Equation

Assets = Liabilities + Equity

Liabilities

Accounts Payable

Salaries Payable

Bonds Payable

slide8

Accounting Equation

Assets = Liabilities + Equity

Equity

Owner Claim to Assets

Assets - Liabilities

the accounting equation
The Accounting Equation

Investments by Owners

Distributions to Owners

Assets = Liabilities + Equity

Revenues - Expenses

Gains - Losses

transactions events
Transactions & Events
  • Affect Balance Sheet only
  • Affect Balance Sheet & Earnings
transactions affecting the balance sheet
Transactions affecting the balance sheet
  • Investments by owners
  • Distributions to owners
  • Use assets to acquire other assets
  • Use assets to extinguish debt
  • Acquire assets by incurring debt
slide12

Accounting Equation

Assets = Liabilities + Equity

Example

Purchased a Car for $22,000

Paid $5,000 down

Signed a note for the balance

slide13

Effect on Accounting Equation

Assets = Liabilities + Equity

Car $22,000 Note $17,000

Cash ( 5,000)

Assets $17,000 = Liab $17,000

transactions affecting earnings
Transactions affecting Earnings
  • Earnings = Change in net assets, excluding investments by and distributions to owners
  • Equity = Net assets
  • Earnings increase equity
  • Earnings = Revenues - Expenses + Gains - Losses
  • Earnings increase equity through revenues, expenses, gains & losses
slide15

Chapter 2--Learning Objectives

2. Interpret the four traditional financial statements

financial statements
Financial Statements

1. Income statement

2. Statement of changes in shareholders’ equity

3. Balance sheet

4. Statement of cash flows

income statement elements
Income StatementElements
  • Revenues
  • Expenses
  • Gains
  • Losses

}

For the accounting period

statement of changes in shareholders equity
Statement of changes in shareholders’ equity
  • Investments by owners
  • Distributions to owners
  • Net income or loss

}

For the accounting period

balance sheet elements
Balance SheetElements
  • Assets
  • Liabilities
  • Equity

}

At the end of the accounting period

statement of cash flows
Statement of cash flows
  • Investing activities
  • Financing activities
  • Operating activities

}

For the accounting period

slide22

Statement of Owner’s Equity

Income Statement

Balance Sheet

Revenue

+ Gains

- Expenses

-Losses

Net Income

slide23

Revenue

+ Gains

- Expenses

-Losses

Net Income

Statement of Owner’s Equity

Income Statement

Balance Sheet

}

R/E Beginning Balance

+ Net Income

- Dividends

R/E Ending Balance

slide24

Revenue

+ Gains

- Expenses

-Losses

R/E BB

+ Net Income

- Dividends

R/E EB

Net Income

Statement of Owner’s Equity

Income Statement

Balance Sheet

slide25

Revenue

+ Gains

- Expenses

-Losses

R/E BB

+ Net Income

- Dividends

R/E EB

Net Income

Statement of Owner’s Equity

Income Statement

Balance Sheet

Assets

Liabilities

Equity

slide26

Statement of Owner’s Equity

Income Statement

Balance Sheet

Assets

Liabilities

Equity

R/E BB

+ Net Income

- Dividends

Revenue

+ Gains

- Expenses

-Losses

R/E EB

Net Income

slide27

Statement of Owner’s Equity

Income Statement

Balance Sheet

Assets

Liabilities

Equity

R/E BB

+ Net Income

- Dividends

Revenue

+ Gains

- Expenses

-Losses

R/E EB

Net Income

slide28

Statement of Owner’s Equity

Income Statement

Balance Sheet

Assets

Liabilities

Equity

R/E BB

+ Net Income

- Dividends

Revenue

+ Gains

- Expenses

-Losses

R/E EB

Net Income

slide29

Statement of Owner’s Equity

Income Statement

Balance Sheet

Assets

Liabilities

Equity

R/E BB

+ Net Income

- Dividends

Revenue

+ Gains

- Expenses

-Losses

R/E EB

Net Income

slide30

Statement of Owner’s Equity

Income Statement

Balance Sheet

Assets

Liabilities

Equity

R/E BB

+ Net Income

- Dividends

Revenue

+ Gains

- Expenses

-Losses

R/E EB

Net Income

slide31

Chapter 2--Learning Objectives

3. Understand the accounting model including the purpose of journals and ledgers

journals
Journals
  • Journals - Books of Original Entry
    • Record transactions or events
      • i.e, Journal entries
    • In chronological order
    • Complete record of effects of transaction on accounts
    • Accounts and amounts debited /credited
sample transaction
Sample Transaction

Paid $1,000 on Account to XYZ Supplies

Journal Entry

Accounts Payable 1,000

Cash 1,000

ledgers
Ledgers
  • Ledgers - Contain Accounts
    • General Ledger
      • Contains accounts for financial statement elements
posting
Posting
  • From Journal to General Ledger Account
slide36

Journal Entry

Accounts Payable 1,000

Cash 1,000

Accounts Payable

Debit

Credit

10,000

1,000

9,000

types of journal
Types of Journal
  • General Journals
  • Special Journals
special journals
Special Journals
  • Cash Receipts Journal
  • Cash Disbursements Journal
  • Purchases Journal
  • Sales Journal
cash receipts journal
Cash Receipts Journal
  • Record All receipts of Cash
    • ie, deposits to the bank
  • Examples:
    • Cash sales
    • Received Cash on account
    • Sold company truck for cash
cash disbursements journal
Cash Disbursements Journal
  • Record All payments of Cash
    • ie, checks written
  • Examples:
    • Paid supplier on account
    • Purchased truck for cash
    • Made mortgage payment
sales journal
Sales Journal
  • Record All Sales on Account
    • When sale is made and no cash is received
purchases journal
Purchases Journal
  • Record All Purchases of merchandise on Account
    • When purchases are made and no cash is paid
    • Purchases of items other than merchandise are recorded in the general journal
general journal
General Journal
  • For All other Journal Entries
  • Examples:
    • Adjusting
    • Closing
    • Sales & purchase returns
slide44

Chapter 2--Learning Objectives

4. Perform the steps in the accounting process

accounting cycle
Accounting Cycle

Transactions Events

Record

Accumulate in Accounts

Outputs

Financial Statements

Inputs

Source Docs

during the accounting period
During the Accounting Period
  • Identify transactions & events to record
  • Journalize transactions & events
  • Post from journals to ledgers
at the end of the accounting period
At the end of the accounting period
  • Prepare Unadjusted Trial Balance
  • Journalize & Post adjusting entries
  • Prepare Adjusted Trial Balance
  • Prepare Financial Statements
  • Journalize & Post closing entries
  • Prepare Post Closing Trial Balance
at beginning of next accounting period
At beginning of next accounting period

10 Journalize & Post reversing entries

adjusting entries types
Adjusting Entries - Types
  • Deferrals
  • Accruals
  • Estimated Items
  • Inventory
deferrals
Deferrals
  • Prepaid Expenses
  • Unearned revenues
typical deferred expenses
Typical Deferred Expenses
  • Supplies
  • Prepaid Rent
  • Bookkeeping Approaches
  • Record transaction as expense
  • Record transaction as asset
accounting approach
Accounting Approach
  • Original debit to expense
    • Adjusting Entry

Debit Prepaid

Credit Expense

example
Example:
  • 12/1/x1: Paid 3 month rent in advance, $3,000
  • Journal Entry

Rent Expense 3,000

Cash 3,000

year end 12 31
Year End - 12/31
  • $1,000 has expired = Expense
  • $2,000 is unexpired = Asset
slide55

Have on Books

Want on Books

Rent Expense

1,000

Rent Expense

3,000

Prepaid Rent

2,000

slide56

Adjustment

Rent Expense

Prepaid Rent

3,000

2,000

2,000

1,000

Adjusting Entry

Prepaid Rent 2,000

Rent Expense 2,000

accounting approach57
Accounting Approach
  • Original debit to Asset
    • Adjusting Entry

Debit Expense

Credit Prepaid

example58
Example:
  • 12/1/x1: Paid 3 month rent in advance, $3,000
  • Journal Entry

Prepaid Rent 3,000

Cash 3,000

year end 12 3159
Year End - 12/31
  • $1,000 has expired = Expense
  • $2,000 is unexpired = Asset
slide60

Have on Books

Want on Books

Rent Expense

1,000

Prepaid Rent

3,000

Prepaid Rent

2,000

slide61

Adjustment

Prepaid Rent

Rent Expense

3,000

1,000

1,000

2,000

Adjusting Entry

Rent Expense 1,000

Prepaid Rent 1,000

unearned revenues
Unearned Revenues
  • Obligations to perform services for which money has already been received
typical unearned revenues
Typical Unearned Revenues
  • Rent Received in Advance
  • Subscriptions Received in Advance
  • Bookkeeping Approaches
  • Record transaction as revenue
  • Record transaction as liability
accounting approach64
Accounting Approach
  • Original credit to Revenue
    • Adjusting Entry

Debit Revenue

Credit Unearned Revenue

example65
Example:
  • 12/1/x1: Received 3 month rent in advance, $3,000
  • Journal Entry

Cash 3,000

Rental Revenue 3,000

year end 12 3166
Year End - 12/31
  • $1,000 is earned = Revenue
  • $2,000 is unearned = Liability
slide67

Have on Books

Want on Books

Rental Revenue

1,000

Rental Revenue

3,000

Rent Received in Advance

2,000

slide68

Adjustment

Rent Received in Advance

Rental Revenue

3,000

2,000

2,000

1,000

Adjusting Entry

Rental Revenue 2,000

Rent Rec’d in Adv 2,000

accounting approach69
Accounting Approach
  • Original credit to Liability
    • Adjusting Entry

Debit Liability

Credit Revenue

example70
Example:
  • 12/1/x1: Received 3 month rent in advance, $3,000
  • Journal Entry

Cash 3,000

Rent Received in Advance 3,000

year end 12 3171
Year End - 12/31
  • $1,000 in earned = Revenue
  • $2,000 is unearned = Liability
slide72

Have on Books

Want on Books

Rental Revenue

1,000

Rent Rec’d in Advance

3,000

Rent Rec’d in Advance

2,000

slide73

Adjustment

Rent Rec’d in Advance

Rental Revenue

3,000

1,000

1,000

2,000

Adjusting Entry

Rent Rec in Adv 1,000

Rental Revenue 1,000

accruals
Accruals
  • Accrued Expenses
    • Payables
  • Accrued Revenues
    • Receivables
typical accrued expenses
Typical Accrued Expenses
  • Salaries Payable
  • Interest payable
  • Taxes Payable
most common accrued revenue
Most Common Accrued Revenue
  • Interest Receivable
typical estimated items
Typical Estimated Items
  • Depreciation
  • Bad Debt Expense
  • Pension Expense
inventory adjustment
Inventory Adjustment
  • Close Beginning Inventory
  • Close Purchases
  • Insert Ending Inventory
  • Difference = Cost of Goods Sold
cost of goods sold
Cost of Goods Sold

Beginning Inventory

  • Purchases

Goods available for Sale

- Ending Inventory

Cost of Goods Sold

example80
Example
  • Beginning Inventory 10,000
  • Purchases 95,000
  • Ending Inventory 7,000
cost of goods sold81
Cost of Goods Sold

Beg Inv 10,000

  • Purchases 95,000

Available 105,000

- End Inv 7,000

CGS 98,000

slide82

Have on Books

Want on Books

Inventory

Inventory

7,000

10,000

Cost of Goods Sold

Purchases

98,000

95,000

slide83

Inventory

Purchases

CGS

10,000

95,000

Step 1

Close beginning Inventory

slide84

Inventory

Purchases

CGS

10,000

95,000

Step 1

Close beginning Inventory

slide85

Inventory

Purchases

CGS

10,000

95,000

Step 2

Close Purchases

slide86

Inventory

Purchases

CGS

95,000

10,000

Step 2

Close Purchases

slide87

Inventory

Purchases

CGS

10,000

95,000

Step 2

Close Purchases

slide88

Inventory

Purchases

CGS

10,000

7,000

95,000

7,000

Step 3

Insert Ending Inventory

slide89

Inventory

Purchases

CGS

10,000

7,000

95,000

7,000

98,000

The Difference

Cost of Goods Sold

slide90

Inventory

Purchases

CGS

10,000

95,000

Account

Debit

Credit

Inventory

10,000

slide91

Inventory

Purchases

CGS

95,000

Inventory

10,000

Account

Debit

Credit

Purchases

95,000

slide92

Inventory

Purchases

CGS

Purchases

95,000

Inventory

10,000

98,000

7,000

Account

Debit

Credit

Inventory

7,000

Cost of Goods Sold

98,000

slide93

Inventory

Purchases

CGS

Purchases

95,000

Inventory

10,000

95,000

95,000

10,000

10,000

7,000

98,000

7,000

98,000

Account

Debit

Credit

Inventory

7,000

Cost of Goods Sold

98,000

slide94

Balance Sheet

Closing the Books

The only thing left

Permanent Accounts

Assets

Liabilities

Equity

slide95

Revenue

+ Gains

- Expenses

-Losses

Net Income

Temporary

Statement of Owner’s Equity

Income Statement

R/E BB

+ Net Income

- Dividends

R/E EB

slide96

Revenue

+ Gains

- Expenses

-Losses

Net Income

Statement of Owner’s Equity

Income Statement

Close

to

R/E

R/E BB

+ Net Income

- Dividends

R/E EB

closing
Closing
  • Close all income statement accounts to the Income Summary
  • Close Income Summary to R/E
  • Close Dividends to R/E
adjusted trial balance
Adjusted Trial Balance

Debits

Current Assets 40,000

Investments 15,000

Plant Assets 90,000

Dividends 2,000

CGS 45,000

Adm Expenses 11,000

Selling Expense 14,000

Interest Expense 4,000

Total 221,000

Credits

Current Liabs 15,000

Long Term Liabs 65,000

Common Stock 27,000

Retained Earnings 6,000

Net Sales 100,000

Interest Revenue 8,000

Total 221,000

Close to IS

close income statement accounts
Close Income Statement Accounts

Debit

Credit

Net Sales

100,000

Interest Revenue

8,000

CGS

45,000

Admin Expenses

11,000

Selling Expense

14,000

Interest Expense

4,000

Income Summary

34,000

close income summary account
Close Income Summary Account

Debit

Credit

Income Summary

34,000

Retained Earnings

34,000

close dividends
Close Dividends

Debit

Credit

Retained Earnings

2,000

Dividends

2,000

slide102

Income Summary

Retained Earnings

6,000

34,000

38,000

34,000

2,000

0

38,000

Dividends

2,000

2,000

reversing entries
Reversing Entries
  • Reverse certain adjusting entries
  • Dated: Beginning of next accounting period
  • Facilitate the bookkeeping process
what entries to reverse
What entries to reverse?
  • All Accruals
  • Those deferrals that increased balance sheet accounts
    • i.e., returns amounts to expense & revenue accounts
accrual example
Accrual Example
  • Salaries are $1,000/day. The year ended on Tuesday. Salaries are paid each Monday for the previous week.
  • Year end adjustment (for 2 days)

Salary Expense 2,000

Salaries Payable 2,000

accounting approaches
Accounting Approaches
  • Make reversing entry
  • Don’t make reversing entry
payment of the salaries assume no reversing entry is made
Payment of the Salaries:Assume no reversing entry is made
  • When the salaries are paid the following Monday

Salaries Payable 2,000

Salary Expense 3,000

Cash 5,000

slide108

At year end

Salary Expense

Salaries Payable

2,000

2,000

Adjusting Entry

slide109

Salary Expense

Salaries Payable

2,000

2,000

2,000

Closing Entry

slide110

Beginning of next accounting period

Salary Expense

Salaries Payable

2,000

slide111

Salary Expense

Salaries Payable

3,000

2,000

2,000

Pay Salaries

slide112

Account balances after payment

Salary Expense

Salaries Payable

3,000

assume instead the following reversing entry was made
Assume instead:The following reversing entry was made

Salaries Payable 2,000

Salary Expense 2,000

payment of the salaries
Payment of the Salaries
  • When the salaries are paid the following Monday

Salary Expense 5,000

Cash 5,000

slide115

At year end

Salary Expense

Salaries Payable

2,000

2,000

Adjusting Entry

slide116

Salary Expense

Salaries Payable

2,000

2,000

2,000

Closing Entry

slide117

Beginning of next accounting period

Salary Expense

Salaries Payable

2,000

2,000

2,000

Reversing Entry

slide118

Pay Salaries

Salary Expense

Salaries Payable

5,000

2,000

3,000

End result is the same

deferrals119
Deferrals

Adjusting Entry Decreases Asset or Liability

Don’t Reverse

Adjusting Entry Increases Asset or Liability

Reverse

deferrals example deferred expenses
Original =

Debit to Expense

Adjusting Entry

Debit Prepaid

Credit Expense

Reverse

Original =

Debit to Asset

Adjusting Entry

Debit Expense

Credit Prepaid

Don’t Reverse

Deferrals:Example - Deferred Expenses
example121
Example:
  • 12/1/x1: Paid 3 month rent in advance, $3,000
  • Original entry to expense
  • Journal Entry

Rent Expense 3,000

Cash 3,000

slide122

Adjustment

Rent Expense

Prepaid Rent

3,000

2,000

2,000

1,000

Adjusting Entry

Prepaid Rent 2,000

Rent Expense 2,000

slide123

Year End Balances

Rent Expense

Prepaid Rent

1,000

2,000

1,000

Closing Entry

slide124

Beginning of Next Year

Rent Expense

Prepaid Rent

2,000

2,000

2,000

Reversing Entry

example125
Example:
  • 12/1/x1: Paid 3 month rent in advance, $3,000
  • Original entry to asset
  • Journal Entry

Prepaid 3,000

Cash 3,000

slide126

Adjustment

Prepaid

Rent Expense

3,000

1,000

1,000

2,000

Adjusting Entry

Rent Expense 1,000

Prepaid Rent 1,000

slide127

Year End Balances

Rent Expense

Prepaid Rent

1,000

2,000

1,000

Closing Entry

slide128

Beginning of Next Year

Rent Expense

Prepaid Rent

2,000

Don’t Reverse

exercise
Exercise
  • Given: Adjusting Entries
  • Determine whether each AJE relates to
    • Accrual (A)
    • Deferral (D)
  • If a deferral, Did the entry Increase a Balance Sheet Account?
  • Reverse AJE?
slide130

SALARY EXPENSE

SALARIES PAYABLE

Accrual (A) or Deferral (D)

Reverse? Yes or No

slide131

SUPPLIES EXPENSE

SUPPLIES

Accrual (A) or Deferral (D)

Increase Balance Sheet Account?

Yes or No

Reverse? Yes or No

slide132

SUPPLIES

SUPPLIES EXPENSE

Accrual (A) or Deferral (D)

Increase Balance Sheet Account?

Yes or No

Reverse? Yes or No

slide133

INTEREST EXPENSE

INTEREST PAYABLE

Accrual (A) or Deferral (D)

Reverse? Yes or No

slide134

RENT RECEIVED IN ADVANCE

RENTAL REVENUE

Accrual (A) or Deferral (D)

Increase Balance Sheet Account?

Yes or No

Reverse? Yes or No

slide135

RENTAL REVENUE

RENT RECEIVED IN ADVANCE

Accrual (A) or Deferral (D)

Increase Balance Sheet Account?

Yes or No

Reverse? Yes or No

other adjusting entries
Other Adjusting Entries
  • Estimated Items
  • Cost of Goods Sold
  • Should they be reversed?

NEVER

slide137

DEPRECIATION EXPENSE

ACCUMULATED DEPRECIATION

Reverse? Yes or No

Estimated Item

Never Reverse

slide138

INVENTORY

COST OF GOODS SOLD PURCHASES

Reverse? Yes or No

Cost of Goods Sold

Never Reverse