Chapter Two LIC.ppt

FinancialandManagementAccounting
ChapterTwo:TheAccountingCycle
Courseleader:SitinaAkmel(Asst.prof.)

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what an account is and how it helps in the recording process.
[2] Define debits and credits and explain their use in recording business
transactions.
[3] Identify the basic steps in the recording process.
[4] Explain what a journal is and how it helps in the recording process.
[5] Explain what a ledger is and how it helps in the recording process.
[6] Explain what posting is and how it helps in the recording process.
[7] Prepare a trial balance and explain its purposes.
[8] Prepare adjusting entry, worksheet and financial statements.
[9] Prepare closing entry and post closing trial balance

 Record of increases and decreases
in a specific asset, liability, equity,
revenue, or expense item.
 Debit = “Left”
 Credit = “Right”
Account
An account can be
illustrated in a T-
account form.
The Account

Double-entry system
► Each transaction must affect two or more accounts to
keep the basic accounting equation in balance.
► Recording done by debiting at least one account and
crediting another.
► DEBITS must equal CREDITS.
The Account
Debits and Credits

Account Name
Debit / Dr. Credit / Cr.
If Debit amounts are greater than Credit amounts, the
account will have a debit balance.
$10,000 Transaction #2
$3,000
$15,000
8,000
Transaction #3
Balance
Transaction #1
Debits and Credits

Account Name
$10,000 Transaction #2
$3,000
Balance
Transaction #1
$1,000
8,000 Transaction #3
If Debit amounts are less than Credit amounts, the
account will have a credit balance.
Debits and Credits

 Assets - Debits should exceed
credits.
 Liabilities – Credits should
exceed debits.
 Normal balance is on the
increase side.
Chapter
3-23
Assets
Assets
Normal Balance
Normal Balance
Chapter
3-24
Liabilities
Liabilities
Normal Balance
Normal Balance
Debits and Credits

 Issuance of share capital and
revenues increase equity (credit).
 Dividends and expenses
decrease equity (debit).
Chapter
3-25
Normal Balance
Normal Balance
Share Capital
Share Capital
Chapter
3-23
Dividends
Dividends
Normal Balance
Normal Balance
Chapter
3-25
Normal Balance
Normal Balance
Equity
Equity
Chapter
3-25
Normal Balance
Normal Balance
Retained Earnings
Retained Earnings
Debits and Credits

Chapter
3-27
Normal Balance
Normal Balance
Expense
Expense
Chapter
3-26
Normal Balance
Normal Balance
Revenue
Revenue
Debits and Credits
 The purpose of earning
revenues is to benefit the
shareholders.
 The effect of debits and credits
on revenue accounts is the
same as their effect on equity.
 Expenses have the opposite
effect: expenses decrease
equity.

Chapter
3-23
Assets
Assets
Normal Balance
Normal Balance
Chapter
3-27
Normal Balance
Normal Balance
Expense
Expense
Normal
Balance
Credit
Normal
Balance
Debit
Debit/Credit Rules
Chapter
3-24
Liabilities
Liabilities
Normal Balance
Normal Balance
Chapter
3-25
Normal Balance
Normal Balance
Equity
Equity
Chapter
3-26
Normal Balance
Normal Balance
Revenue
Revenue

Income Statement
= + -
Asset Liability Equity Revenue Expense
Debit
Credit
Debit/Credit Rules
Statement of
Financial Position

Summary of Debit/Credit Rules
Relationship among the assets, liabilities and equity of a
business:
The equation must be in balance after every transaction.
For every Debit there must be a Credit.

Business documents, such as a sales slip, a check, a bill, or
a cash register tape, provide evidence of the transaction.
Analyze each transaction Enter transaction in a journal
Transfer journal information to
ledger accounts
Steps in the Recording Process

 Book of original entry.
 Transactions recorded in chronological order.
 Contributions to the recording process:
1. Discloses the complete effects of a transaction.
2. Provides a chronological record of transactions.
3. Helps to prevent or locate errors because the debit and
credit amounts can be easily compared.
The Journal

Journalizing - Entering transaction data in the journal.
Illustration: On September 1, shareholders’ invested €15,000 cash
in the corporation in exchange for share of stock, and Softbyte
purchased computer equipment for €7,000 cash.
Account Title Ref. Debit Credit
Date
Cash
Share capital-ordinary
Sept. 1 15,000
15,000
General Journal
Equipment
Cash
7,000
7,000

Simple and Compound Entries
Illustration: On July 1, Tsai Company purchases a delivery truck
costing $420,000. It pays $240,000 cash now and agrees to pay
the remaining $180,000 on account.
Account Title Ref. Debit Credit
Date
Equipment
Cash
July 1 420,000
240,000
General Journal
180,000
Accounts payable

 General Ledger contains the entire group of accounts
maintained by a company.
The Ledger

Standard Form of Account

Posting –
process of
transferring
amounts from
the journal to
the ledger
accounts.
Steps

Accounts and account numbers arranged in sequence in which
they are presented in the financial statements.
Chart of Accounts

Follow these steps:
1. Determine what
type of account is
involved.
2. Determine what
items increased or
decreased and by
how much.
3. Translate the
increases and
decreases into
debits and credits.
The Recording Process Illustrated

The Recording Process Illustrated

34
1. Cecil Jameson, Attorney-at-Law, is a proprietorship owned and
operated by Cecil Jameson. On July 1, 2005, Cecil Jameson,
Attorney-at-Law, has the following assets and liabilities: cash,
$1,000; accounts receivable, $3,200; supplies, $850; land, $10,000;
accounts payable, $1,530. Office space and office equipment are
currently being rented, pending the construction of an office
complex on land purchased last year.
Business transactions during July are summarized as follows:
a. Received cash from clients for services, $3,928.
b. Paid creditors on account, $1,055.
c. Received cash from Cecil Jameson as an additional investment,
$3,700.
Exercise

35
d. Paid office rent for the month, $1,200.
e. Charged clients for legal services on account, $2,025.
f. Purchased office supplies on account, $245.
g. Received cash from clients on account, $3,000.
h. Received invoice for paralegal services from Legal Aid Inc. for
July (to be paid on August 10), $1,635.
i. Paid the following: wages expense, $850; answering service
expense, $250; utilities expense, $325; and miscellaneous expense,
$75.
j. Determined that the cost of office supplies on hand was $980;
therefore, the cost of supplies used during the month was $115.
k. Jameson withdrew $1,000 in cash from the business for personal
use.

 Generally a month, a quarter, or a year.
 Also known as the “Periodicity Assumption”
Timing Issues
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).
Jan. Feb. Mar. Apr. Dec.
. . . . .

 Monthly and quarterly time periods are called interim
periods.
 Most large companies must prepare both quarterly and
annual financial statements.
 Fiscal Year = Accounting time period that is one year in
length.
 Calendar Year = January 1 to December 31.
Timing Issues
Fiscal and Calendar Years

Accrual-Basis Accounting
 Transactions recorded in the periods in which the
events occur.
 Revenues are recognized when the services are
performed, rather than when cash is received.
 Expenses are recognized when incurred, rather than
when paid.
Accrual- vs. Cash-Basis Accounting
Timing Issues

Cash-Basis Accounting
 Revenues recognized when cash is received.
 Expenses recognized when cash is paid.
 Cash-basis accounting is not in accordance with
International Financial Reporting Standards (IFRS).
Accrual- vs. Cash-Basis Accounting
Timing Issues

Revenue Recognition Principle
Recognizing Revenues and Expenses
Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
In a service enterprise,
revenue is considered to be
earned at the time the service
is performed.
Timing Issues

Expense Recognition Principle
Recognizing Revenues and Expenses
Match expenses with
revenues in the period when
the company makes efforts to
generate those revenues.
“Let the expenses follow
the revenues.”
Timing Issues

Adjusting Entries
 Ensure that the revenue recognition and expense
recognition principles are followed.
 Necessary because the trial balance may not contain
up-to-date and complete data.
 Required every time a company prepares financial
statements.
 Will include one income statement account and one
statement of financial position account.
The Basics of Adjusting Entries

1. Prepaid Expenses.
Expenses paid in cash before
they are used or consumed.
Deferrals
3. Accrued Revenues.
Revenues for services
performed but not yet
received in cash or recorded.
4. Accrued Expenses.
Expenses incurred but not yet
paid in cash or recorded.
2. Unearned Revenues.
Cash received before services
are performed.
Accruals
Types of Adjusting Entries

Trial Balance –
Each account is
analyzed to
determine whether
it is complete and
up-to-date.
Types of Adjusting Entries

Deferrals are either:
 Prepaid expenses
OR
 Unearned revenues.
Adjusting Entries for Deferrals

Payment of cash, that is recorded as an asset because service or
benefit will be received in the future.
 insurance
 supplies
 advertising
Cash Payment Expense Recorded
BEFORE
 rent
 equipment
 buildings
Prepayments often occur in regard to:
Prepaid Expenses

 Expire either with the passage of time or through use.
 Adjusting entry:
► Increase (debit) to an expense account and
► Decrease (credit) to an asset account.
Prepaid Expenses

Illustration: Pioneer Advertising Agency
purchased supplies costing $2,500 on
October 5. Pioneer recorded the payment
by increasing (debiting) the asset
Supplies. This account shows a balance
of $2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
$1,000 of supplies are still on hand.
Supplies 1,500
Supplies expense 1,500
Oct. 31

Illustration: On October 4, Pioneer
Advertising paid $600 for a one-year fire
insurance policy. Coverage began on
October 1. Pioneer recorded the payment
by increasing (debiting) Prepaid
Insurance. This account shows a balance
of $600 in the October 31 trial balance.
Insurance of $50 ($600 ÷ 12) expires
each month.
Prepaid insurance 50
Insurance expense 50
Oct. 31

Depreciation
 Buildings, equipment, and vehicles (assets with long
lives) are recorded as assets, rather than an expense,
in the year acquired.
 Depreciation allocates a portion of the asset’s cost as
an expense during each period of the asset’s useful life.
 Depreciation does not attempt to report the actual
change in the value of the asset.

40
Illustration: For Pioneer Advertising, assume
that depreciation on the equipment is $480 a
year, or $40 per month.
Accumulated depreciation 40
Depreciation expense
Oct. 31
Accumulated Depreciation is called a contra
asset account.

Statement Presentation
 Accumulated Depreciation is a contra asset account
(credit).
 Appears just after the account it offsets (Equipment) on
the statement of financial position.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.

Receipt of cash that is recorded as a liability because service has not
be performed.
 Rent
 Airline tickets
Cash Receipt Revenue Recorded
BEFORE
 Magazine subscriptions
 Customer deposits
Unearned revenues often occur in regard to:
Unearned Revenues

 Adjusting entry is made to record the revenue for
services performed and to show the liability that remains.
 Results in a decrease (debit) to a liability account and
an increase (credit) to a revenue account.
Unearned Revenues

Illustration: Pioneer Advertising received $1,200 on October 2
from R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
$1,200 in the October 31 trial balance. Analysis reveals that the
company earned $ 400 of those fees in October.
Service revenue 400
Unearned service revenue 400
Oct. 31

Accruals are made to record
 Revenues for services performed
OR
 Expenses incurred
in the current accounting period that have not been
recognized through daily entries.
Adjusting Entries for Accruals

Revenues for services performed but not yet received in cash or
recorded.
 Interest
 Services performed
 Rent
Accrued revenues often occur in regard to:
Accrued Revenues
BEFORE Cash Receipt
Revenue Recorded

 Adjusting entry shows the receivable that exists and
records the revenues for services performed.
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
Accrued Revenues

Illustration: In October Pioneer Advertising
Agency recognized $200 for advertising
services performed but not recorded.
Accounts receivable 200
Cash 200
Nov. 10
200
Service revenue 200
Accounts receivable
Oct. 31
On November 10, Pioneer receives cash of $
200 for the services performed.

Expenses incurred but not yet paid in cash or recorded.
 Rent
 Interest
 Taxes
 Salaries
Accrued expenses often occur in regard to:
Accrued Expenses
BEFORE Cash Payment
Expense Recorded

 Adjusting entry records the obligation and recognizes the
expense.
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Accrued Expenses

Illustration: Pioneer Advertising signed a three-month note
payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.
Interest payable 50
Interest expense 50
Oct. 31

Illustration: Pioneer Advertising last paid salaries on October 26;
the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($ 400 x 3 days).

Summary of Basic Relationships

 Prepared after all adjusting entries are journalized and
posted.
 Purpose is to prove the equality of debit balances and
credit balances in the ledger.
 Is the primary basis for the preparation of financial
statements.
The Adjusted Trial Balance
Adjusted Trial Balance

Financial Statements are prepared directly from the
Adjusted Trial Balance.
Statement
of Financial
Position
Income
Statement
Retained
Earnings
Statement
Preparing Financial Statements

 Multiple-column form used in preparing financial
statements.
 Not a permanent accounting record.
 Five step process.
 Use of worksheet is optional.
Preparing a Worksheet
Using a Worksheet

Steps in Preparing a Worksheet

Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Prepaid Insurance 600
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200
Share Capital-Ordinary 10,000
Dividends 500
Service Revenue 10,000
Salaries and Wages Exp. 4,000
Rent Expense 900
Totals 28,700 28,700
Financial Position
Adjusted Income
Trial Balance Adjustments Trial Balance Statement
Statement of
1. Prepare a Trial Balance on the Worksheet
Trial balance amounts come
directly from ledger accounts.
Include all accounts
with balances.

General journal
showing adjusting
entries
Adjusting
Journal
Entries
(Chapter 3)

Cash 15,200
Supplies 2,500 1,500
Prepaid Insurance 600 50
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200 400
Share Capital-Ordinary 10,000
Dividends 500
Service Revenue 10,000 400
200
Salaries and Wages Exp. 4,000 1,200
Rent Expense 900
Totals 28,700 28,700
Supplies Expense 1,500
Insurance Expense 50
Accumulated Depreciation 40
Depreciation Expense 40
Accounts Receivable 200
Interest Expense 50
Interest Payable 50
Salaries and Wages Payable 1,200
Totals 3,440 3,440
Financial Position
Adjusted Income
Statement of
2. Enter the Adjustments in the Adjustments Columns
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Enter adjustment amounts, total
adjustments columns,
and check for equality.
Add additional accounts as needed.
Adjustments Key:
(a) Supplies Used.
(b) Insurance Expired.
(c) Depreciation Expensed.
(d) Service Revenue Earned.
(e) Service Revenue Accrued.
(f) Interest Accrued.
(g) Salaries Accrued.

Cash 15,200 15,200
Supplies 2,500 1,500 1,000
Prepaid Insurance 600 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 400 800
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 400 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200
Rent Expense 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500
Insurance Expense 50 50
Accumulated Depreciation 40 40
Depreciation Expense 40 40
Accounts Receivable 200 200
Interest Expense 50 50
Interest Payable 50 50
Salaries and Wages Payable 1,200 1,200
Totals 3,440 3,440 30,190 30,190
Financial Position
Adjusted Income
Statement of
3. Complete the Adjusted Trial Balance Columns
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Total the adjusted trial balance
columns and check for equality.

Cash 15,200 15,200
Supplies 2,500 1,500 1,000
Prepaid Insurance 600 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 400 800
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 400 10,600 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
Insurance Expense 50 50 50
Accumulated Depreciation 40 40
Depreciation Expense 40 40 40
Accounts Receivable 200 200
Interest Expense 50 50 50
Interest Payable 50 50
Salaries and Wages Payable 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600
Financial Position
Adjusted Income
Statement of
4. Extend Amounts to Financial Statement Columns
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Extend all revenue and expense account
balances to the income statement columns.

Cash 15,200 15,200 15,200
Supplies 2,500 1,500 1,000 1,000
Prepaid Insurance 600 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 400 800 800
Share Capital-Ordinary 10,000 10,000 10,000
Dividends 500 500 500
Service Revenue 10,000 400 10,600 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
Insurance Expense 50 50 50
Accumulated Depreciation 40 40 40
Depreciation Expense 40 40 40
Accounts Receivable 200 200 200
Interest Expense 50 50 50
Interest Payable 50 50 50
Salaries and Wages Payable 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Financial Position
Adjusted Income
Statement of
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Compute Net Income or Net Loss.
5. Total Columns, Compute Net Income (Loss)

 Income statement is prepared from the income
statement columns.
 Statement of financial position and retained earnings
statement are prepared from the statement of financial
position columns.
 Companies journalize and post adjusting entries.
Preparing Statements from a Worksheet
Using a Worksheet

Preparing Statements from a Worksheet

 Adjusting entries are prepared from the adjustments
columns of the worksheet.
 Journalizing and posting of adjusting entries follows the
preparation of financial statements when a worksheet is
used.
Using a Worksheet
Preparing Adjusting Entries from a Worksheet

At the end of the accounting period, the company makes
the accounts ready for the next period.
Closing the Books

Closing entries formally recognize, in the general ledger, the
transfer of
 net income (or net loss) and
 dividends
to retained earnings.
Closing entries are only made at the end of the annual
accounting period.
Closing the Books
Preparing Closing Entries

Retained earnings is a
permanent account; all
other accounts are
temporary accounts.
Dividends are closed directly
to retained earnings and not
to Income Summary because
dividends are not an
expense.
Note:
Closing the Books

Closing
Entries
Illustrated
Closing entries
journalized
Closing the Books

Posting
Closing
Entries
Closing the Books

Purpose is to prove the equality of the permanent account
balances after journalizing and posting of closing entries.
Preparing a Post-Closing Trial Balance

1. Analyze business transactions
2. Journalize the
transactions
6. Prepare an adjusted trial
balance
7. Prepare financial
statements
8. Journalize and post
closing entries
9. Prepare a post-closing
trial balance
4. Prepare a trial balance
3. Post to ledger accounts
5. Journalize and post
adjusting entries
Summary of the Accounting Cycle

Chapter Two LIC.ppt

More Related Content

Similar to Chapter Two LIC.ppt

Recently uploaded

Chapter Two LIC.ppt