Intermediate Financial Accounting I
The Accounting Information System
Accounting Cycle 2
Objectives of the Chapter
I. Learning the accounting process in preparing financial statements.
II. Introduce the accrual accounting concept and the adjusting entries.
III.Introduce the worksheet (including the trial balance, the adjustments and the adjusted trial balance, the I/S and the B/S columns), the preparation of financial statements from the worksheet and the closing entries.
Accounting Cycle 3
I. Accounting Process
1.Identification and measurement of business transactions and other events;
2.Journalization (general or special journals);
3.Post (to ledger accounts and subsidiaries);
4.Prepare worksheet (including unadjusted T/B, adjustments; adjusted T/B, I/S, B/S…);
5.Prepare financial statements;
Accounting Cycle 4
Accounting Process (contd.)
6. Prepare and post adjusting entries;
7. Prepare and post closing entries;
8. Prepare post-closing trial balance (T/B) (optional);
9. Prepare and post reversing entries.
The Accounting Cycle (Source: Kieso, et al., 14th E, Illustration 3-6)
Accounting Cycle 5
Accounting Cycle 6
1. Identifying Accounting Events
External Events: Purchase of assets, sales of goods, loss from flood, …
Internal Events: Consumption of prepaid rent, use of depreciable assets, transfer of raw material to W-I-P, …
Accounting Cycle 7
1. Identifying Accounting Events (contd.)
Events are recognized as accounting events and would be recorded if:
a. have occurred;
b. affect the financial position of the business;
c. can be measured in monetary terms (measurable);
d. relevant, reliable.
Accounting Cycle 8
Examples
1. Two months of prepaid insurance expired.2. Purchase of a machine.3. Sales of merchandise.4. Changes in managerial policies.5. Value of human resources.6. The development of a new product.7. Sign a contract to buy a building.8. Investment from owners.9. Distribution to owners.
Accounting Cycle 9
2. Journalization
Introduction of the Double-Entry System and Journal Entries:
A. Double-entry system;
B. T-account;
C. Increases and decrease in the accounts.
Accounting Cycle 10
A. Double-Entry System
Each transaction affects at least two accounts and the balance of the accounting equation must be maintained.
Example: Purchases inventory and charges to accounts payable.
Assets = Liabilities + EquityInventory Accounts Payable + +
Accounting Cycle 11
A. Double-Entry System (contd.)
Assets = Liabilities + Equity Revenues Expenses1 + -2 + +3 + +4 - -5 - -6 + +7 - -89
10
Accounting Cycle 12
B. Introduction of the T-account
Inventory
Debit Credit
Accounts Payable
Debit Credit
Accounting Cycle 13
DebitA Credit
CreditRevenue
Debit
DebitExpense
Credit
C. Increases and Decreases in the Accounts
CreditL Debit
CreditE Debit
Accounting Cycle 14
Examples of the Journal Entries:
Journal Page 1
Date Accounts andExplanation
Ref. Debit Credit
Apr. 2 Cash…………………Common stock….
Issued common stock to owners
50,00050,000
Apr. 3 Land………………...Cash……………..
Paid Cash for Land
40,00040,000
Accounting Cycle 15
Special Journals (Cash Disbursements and Receipts)
Cash Disbursements Journal
Acct Title Ref. Debit Credit9 4 246 G. Winkle 80.00 80.009 7 247 Stephens
Wholesale 163.00 163.009 16 248 Harris
Insurance 96.00Prepaid Insurance 96.00
9 22 249 City of Norwich 62.00 62.00
9 28 250 Burkett Supply 105.00 105.00
506.00 225.00 185.00 96.00
DateCheck
No.
Selling & Administra-tive Exp. Dr.
Other AccountsPayee
A/P Dr.
Cash Cr.
Accounting Cycle 16
Special Journals (Cash Disbursements and Receipts)
Cash Receipts Journal
Acct Title Ref. Debit Credit9 1 Collection from R.
Wood on Account 150.00 150.009 5 Sale of Merchandise
to Customers 250.00 250.009 12 Collection from J.
Smith on Account 75.00 75.009 19 Receipt of Dividend
from Ford Motor Co. 120.00Dividend Rev. 120.00
9 25 Sale of Merchandise to Customers 400.00 400.00
995.00 225.00 650.00 120.00
DateSales
Cr.Other Accounts
Explanation A/R Cr.Cash Dr.
Accounting Cycle 17
3. Posting(to ledger accounts and subsidiaries)
Date Item Jrnl. Ref. Debit Credit Debit CreditApr. 2 J.1 50,000 50,000
3 J.1 40,000 10,000
BalanceAccount: Cash Account No. 101
The Ledger: all individual accounts (assets, liability, and stockholder’s equity accounts) combined make up the ledger.
Another Example of Posting (Kieso, et al., 14th edition, Illustration 3-8)
Accounting Cycle 18
Accounting Cycle 19
Accounts ReceivableNo. 3
20x1Mar 31 Balance 672.00Apr 30 CR8
1,136.00Apr 30 S6 2,662.00
General Ledger (T-Account Format)
Examples of Posting using T-accounts (Kieso, et al., 14th edition, Illustrations 3-9 and 3-10)
Accounting Cycle 20
Accounting Cycle 21
Accounts ReceivableSUBSIDIARY LEDGER Ellen Odom202
20x1Mar 31 Balance 520Apr 2 S6 910
Nita Doty204
20x1Mar 31 Balance 30 Apr 18 CR8 750Apr 6 S6 750
Joe Leo206
20x1Mar 31 Balance 122 Apr 16 CR8 200Apr 4 S6 816
Rex Road208
20x1Apr 1 S6 186 Apr 7 CR8
186
Subsidiary Ledger
21
Accounting Cycle 22
Examples of Controlling Accounts
General LedgerControlling Acct. Type of Subsidiary Record
Accounts Receivable
Accounts Payable
Capital Stock
Notes Receivable
Individual customers’ ledger accounts, or a file of uncollected sales invoices.
Individual ledger accounts, or a file of unpaid purchase invoices.
A record of the stock certificates and number of shares held by each shareholder.
A file of uncollected N/R, or a “register” or book in which the notes are listed.
Accounting Cycle 23
Examples of Controlling Accounts (contd.)
General LedgerControlling Acct. Type of Subsidiary Record
Raw Material on Hand
Equipment
Land
Separate record card for each item of material used in manufacturing.
Separate record card for each item of equipment. This is often known as a plant ledger.
Separate record card for each parcel of land owned.
Accounting Cycle 24
The Flows of Accounting Data
TransactionOccurs
Source Documents Prepared
Transaction Analysis
Takes Place
Transaction Entered in Journal
Amounts Posted to Ledger
Accounting Cycle 25
XYZ Corp.Trail Balance
4/30/20x1Cash 33,300Accounts receivable 2,000Office supplies 500Land 18,000Accounts payable 100Common Stock 50,000Dividends 2,100Service revenue 8,500Rent Expense 1,100Salary Expense 1,200Utilities Expense 400 .
Total 58,600 58,600 .
25
Accounting Cycle 26
II. Accrual Accounting
The time-period concept, the revenue recognition and matching principles.
Accrual versus cash basis accounting.
Adjusting entries.
Accounting Cycle 27
The Time-Period Concept, the Revenue Recognition & Matching Principles
The time-period concept:
Income and financial position of a business are reported periodically, not until the end of life of a business.
Income Measurement And Profit Analysis 28
Revenue Recognition Principle (SFAS No. 5) (-An Accrual Basis) Revenue is recognized when it is earned and
realized or realizable (SFAC 5, par. 83). Earned : the entity has substantially accomplished
what it must do to be entitled to compensation. Realized: goods are exchanged for cash or claims. Realizable: assets received as compensation are
readily convertible into cash or claims to cash. In general, these conditions are met at time of sale (delivery) or
when services are rendered regardless whether cash is collected or not (SFAC 5, par. 84).
.
Income Measurement And Profit Analysis 29
Revenue Recognition Principle
Other conditions for revenue recognition (Staff Accounting Bulletin No. 101(1999)):
Persuasive evidence of a sale. Price is fixed or determinable. Collectibility is reasonably assured. Delivery has occurred or services
have been rendered.
Accrual Accounting and the Financial Statements 30
The Expense Recognition (Matching) Principle
If revenues are recognized in a period, all related expenses should be recognized in the same period regardless whether expenses are paid or not.
The related expenses include traceable costs (e.g. product costs), period costs, (e.g. interest and rent expenses) and estimated expenses (e.g. depreciation expense and bad debt expense).
Accrual Accounting and the Financial Statements 31
Accrual vs. Cash Basis Accounting Accrual-basis accounting:
Revenues are recognized based on revenue recognition principle (i.e., recognized when realized and earned regardless whether cash is collected or not).
Expenses are recognized based on matching principle (i.e., recognized when incur regardless whether they are paid or not).
Note: revenue and expense recognize before cash settlement.
Accrual vs. Cash Basis Accounting (contd.) Cash-basis accounting:
The accountant does not record a transaction until cash is received or paid.
Cash-basis accounting is NOT acceptable for financial reporting.
Accrual Accounting and the Financial Statements 32
Accrual Accounting and the Financial Statements 33
Adjusting Entries
Due to the periodicity concept, financial reports are prepared periodically.
Based on revenue recognition principle, adjusting entries are prepared at the end of a period to recognize revenues earned during the period but not yet recorded (i.e., accrued revenues).
Accrual Accounting and the Financial Statements 34
Adjusting Entries (contd.)
Based on the matching principle, the accrued expenses (i.e., expenses incurred but not yet paid/recorded) and estimated expenses (i.e., depreciation expense and bad debt expense) are recorded at the end of a period.
Types of Adjusting Entries (Kieso, et al. textbook, 14th edition, illustration 3-20)
Accounting Cycle 35
Accounting Cycle 36
Adjusting Entries and Reversing Entries
Types of Adjusting Entries
Can or Cannot Have Reversing Entries
1. Accruals 2. Deferrals 3. Estimated Expenses
Can B/S approach: Cannot I/S approach: Can Cannot (except for I/T Exp.)
Adjusting Entries for Accruals (Kieso, et al. 14th edition, illustration 3-27)
Accounting Cycle 37
Accounting Cycle 38
1. Accruals: Unrecorded Revenue or Expenses
a. Accrued expense: A one-year note payable was issued on 11/1/x1
to purchase an equipment. The face amount of the note is $2,400. The annual interest rate is 10% and interests are paid on 4/30/x2 and 11/1/x2.
11/1/x1Equipment 2,400
Notes Payable 2,400
Adj. Entry12/31/x1
Accounting Cycle 39
Accruals: (contd.) b. Accrued revenue:
A one year note was received from a credit sale with a face amount of $3,000 and an annual interest rate of 12% on 9/1/x1. Interests are received on 3/1/x2 and 9/1/x2.
9/1/x1N/R 3,000
Sales 3,000
Adj. Entry12/31/x1
Adjusting Entries for Deferrals (Kieso, et al. textbook, 14th edition, illustration 3-21)
Accounting Cycle 40
Accounting Cycle 41
2. Deferrals: Postponing the Recognition of Revenues or Expenses
a. Unearned revenues Receiving $2,400 for one-year
advanced rent payment from tenant on 12/1/x1
(B/S Approach) (I/S Approach)12/1/x1 Cash 2400
Unearned Rent240012/31/x1
Unearned Rent 200Rent Revenue
200
12/1/x1 Cash 2400
Rent Revenue240012/31/x1
Rent Revenue 2200Unearned Rent
2200
Accounting Cycle 42
Deferrals (contd.)
b. Prepaid expenses Prepaid 12 month insurance of $1,200
on 11/1/x1(B/S Approach) (I/S Approach)
11/1/x1 Prepaid Ins. 1200
Cash120012/31/x1
Ins. Exp. 200Prepaid Ins.
200
11/1/x1 Ins. Exp. 1200
Cash120012/31/x1
Prepaid Ins. 1000Ins. Exp. 1000
Accounting Cycle 43
3. Estimated Expenses (no reversing entry except for I/T)
Examples - Depreciation Exp.:
12/31 Depreciation Exp. XXXAccumulated Depr. XXX
Bad Debt Exp.:12/31 B/D Exp. XXX
Allowance for B/D XXX
Income Tax12/31 Income Tax Exp. XXX
Income Tax Payable XXX
Accounting Cycle 44
III. Worksheet Example
A. The adjusting entries information for the worksheet example.
B. Preparing financial statements from a worksheet.
C. Closing and reversing entries.
Accounting Cycle 45
A. Adjusting Entries Information The following items are the adjusting entries
information for the worksheet example (source: Kieso, et al. textbook):
(a) Furniture and equipment is depreciated at the rate of 10% per year based on original cost of $67,000.
Depreciation Expense --Furniture and Equipment 6,700
Accumulated Depreciation --Furniture and Equipment
6,700
Accounting Cycle 46
A. Adjusting Entries Information (contd.)
(b) Estimated bad debts, one-quarter of 1% of sales ($400,000).
Insurance Expense 360Prepaid Insurance
360
Bad Debts Expense 1,000Allowance for Doubtful Accounts
1,000(c) Insurance expired during the year, $360.
Accounting Cycle 47
A. Adjusting Entries Information (contd.)
(d) Interest accrued on notes receivable as of December 31, $800.
Interest Receivable 800Interest Revenue
800(e) The Rent Expense account contains
$500 rent paid in advance, which is applicable to next year.
Prepaid Rent Expense 500Rent Expense
500
Accounting Cycle 48
A. Adjusting Entries Information (contd.)
(f) Property taxes accrued December 31, $2,000.
Property Tax Expense 2,000 Property Tax Payable 2,000
(g) Income taxes accrued December 31, $3,440
Income tax expense 3,440 Income tax payable 3,440
Accounting Cycle 49
Uptown Cabinet Corp.(source: Kieso, et al. Illu. 3C-1)TEN-COLUMN WORK SHEET (with Periodic Inventory System)
For the Year Ended December 31, 2010
Accounts
CashN/RA/RAllow. for double Accounts
Inventory, 1/1/12
Prepaid insurance
Furniture & equip.
Accu. Depr. -- furniture & equip.
Dr. Cr. Dr. Cr. Dr. Cr. 1200 120016000 1600041000 41000
2000 (b) 1000 300036000 36000900 (c) 360540
67000 67000
12000 (a)670018700
Adjusted Trial Balance Adjustments Trial Balance
49
Accounting Cycle 50
TEN-COLUMN WORK SHEET (contd.)
Accounts
N/PA/PB/PCommon stock
R/E, 1/1/12SalesPurchasesSales Salaries exp.
Advertising exp.
Traveling exp.
Office Sal. exp.
T&T exp.
Dr. Cr. Dr. Cr. Dr. Cr.
2000020000
1350013500
3000030000
5000050000
1420014200
400000400000320000 32000020000 200002200 22008000 800019000 19000600 600
Trial Balance Adjustments Adj. T-B
50
Accounting Cycle 51
TEN-COLUMN WORK SHEET (contd.)
Accounts
Rent exp.Property tax exp.
Interest exp.
TotalsDep. Exp-fur. & equ.
Bad debts exp.
Insurance exp.
Int. receivable
Int. revenue
Prepaid rent exp.
Property tax pay.
Totals
Dr. Cr. Dr. Cr. Dr. Cr. 4800 (e) 50043003300 (f) 2000 5300 1700 1700541700541700
(a) 6700 6700(b) 1000 1000(c) 360 360(d) 800 800
(d) 800 800(e) 500 500
(f) 2000 2000 2000
11360 11360552200552200
Trial Balance Adjustments Adj. T-B
51
Accounting Cycle 52
TEN-COLUMN WORK SHEET (contd.)
Accounts
Inv., 12/31/12
TotalsIncome bef. I/T
TotalsIncome bef. I/T
Income tax exp.
Income tax payable
Net income Totals
Dr. Cr. Dr. Cr. Dr. Cr.
(g) 3440(g) 3440
Trial Balance Adjustments Adj. T-B
52
Accounting Cycle 53
Uptown Cabinet Corp.TEN-COLUMN WORK SHEET (contd.)
Accounts
CashN/RA/RAllow. for double Accounts
Inventory, 1/1/12
Prepaid insurance
Furniture & equip.
Accu. Depr. -- furniture & equip.
Dr. Cr. Dr. Cr. Dr. Cr. 1200 120016000 1600041000 41000
3000 300036000 36000540 540
67000 67000
1870018700
Adjusted Income Trial Balance Statement Balance Sheet
53
Accounting Cycle 54
TEN-COLUMN WORK SHEET (contd.)
Accounts
N/PA/PB/PCommon stock
R/E, 1/1/12SalesPurchasesSales Salaries exp.
Advertising exp.
Traveling exp.
Office Sal. exp.
T&T exp.
Dr. Cr. Dr. Cr. Dr. Cr
2000020000
1350013500
3000030000
5000050000
1420014200
400000 400000320000 32000020000 200002200 22008000 800019000 19000600 600
Adj. T-B I/S B/S
54
Accounting Cycle 55
TEN-COLUMN WORK SHEET (contd.)
Accounts
Rent exp.Property tax exp.
Interest exp.
TotalsDep. Exp-fur. & equ.
Bad debts exp.
Insurance exp.
Int. receivable
Int. revenue
Prepaid rent exp.
Property tax pay.
Totals
Dr. Cr. Dr. Cr. Dr. Cr. 4300 43005300 53001700 1700
6700 67001000 1000360 360800 800
800 800500 500
20002000552200552200
Adj. T-B I/S B/S
55
Accounting Cycle 56
TEN-COLUMN WORK SHEET (contd.)
Accounts
Inv., 12/31/12
TotalsIncome bef. I/T
TotalsIncome bef. I/T
Income tax exp.
Income tax payable
Net income Totals
Dr. Cr. Dr. Cr. Dr. Cr
4000040000
425160440800 15640 440800440800
156403440
3440 12200
12200 15640 15640167040
167040
Adj. T-B I/S B/S
56
Accounting Cycle 57
B. Preparing Financial Statements from a Worksheet
Net sales $400,000Cost of goods sold
Inventory, 1/1/x2 $ 36,000Purchases 320,000Cost of goods avail. for sale 356,000Subtract inv., 12/31/x2 40,000
Cost of goods sold 316,000Gross profit on sales 84,000
(Source: Illustration 3-39 of Kieso, et al. 14th edition)Uptown Cabinet Corp.INCOME STATEMENT
For the Year Ended December 31, 2012
Accounting Cycle 58
INCOME STATEMENT (contd.)Selling expenses
Sales salaries exp. 20,000Adv. exp. 2,200Traveling exp. 8,000
Total selling exp. 30,200Administrative exp.
Office Salaries exp. $19,000T&T exp. 600Rent exp. 4,300Property tax exp. 5,300Depr. exp.-fur. & equip. 6,700Bad debts exp. 1,000Insurance exp. 360
Total administrative exp. 37,260
58
Accounting Cycle 59
INCOME STATEMENT (contd.)
Total selling & admin. exp. 67,460
Income from operations16,540
Other revenues and gainsInterest revenue
800
17,340Other exp. And losses
Interest exp. 1,700
Income bef. income taxes15,640
Income taxes 3,440
Net income$12,200
Earnings per share$1.22
59
Accounting Cycle 60
(Source: Illustration 3-40 of KWW textbook, 14th edition)Uptown Cabinet Corp.
STATEMENT OF RETAINED EARNINGSFor the Year Ended December 31, 2012
B. Preparing Financial Statements from a Worksheet (contd.)
Retained earnings, Jan. 1, 2012
$14,200
Add net income for 20x12
12,200
Retained earnings, Dec. 31, 2012
$26,400 60
Accounting Cycle 61
(Source: Illustration 3-41 of KWW textbook, 14th edition)Uptown Cabinet Corp.
BALANCE SHEETAs of December 31, 2012
B. Preparing Financial Statements from a Worksheet (contd.)
AssetsCurrent assets
Cash$ 1,200
Notes receivable $16,000Accounts receivable 41,000Interest receivable 800 $57,800
Less allow. for doub. acct. 3,00054,800
Merchandise inv. on hand40,000
61
Accounting Cycle 62
BALANCE SHEET (contd.)Prepaid insurance
540Prepaid rent
500Total current assets97,040
Property, plant & equip.Furniture & equipment 67,000Less accu. Depr. 18,700
Total property, plant & equip. 48,300
Total assets$145,340
Liabilities and Stockholders’ EquityCurrent liabilities
Notes payable$ 20,000
Accounts payable13,500
Property tax payable2,000
Income taxes payable 3,440
62
Accounting Cycle 63
BALANCE SHEET (contd.)Total current liabilities38,940
Long-term liabilitiesB/P, due June 30, 20x7
30,000Total liabilities 68,940
Stockholders’ equityCommon stock, $5.00 par value, issued & outstanding, 10,000 shares $50,000Retained earnings 26,400
Total stockholders’ equity 76,400
Total liabilities & stockholders’ equity $145,340
63
Accounting Cycle 64
(Source: p. 98 of Kieso, et al., textbook, 13th edition)General Journal
December 31, 2012
C. Closing and Reversing Entries
Closing Entries
Inventory (12/31) 40,000Cost of Goods Sold 316,000
Inventory (1/1)36,000
Purchases320,000(To record ending inv. bal. & to determine CGS)
Interest Revenue 800Sales 400,000
CGS316,000
Sales Sal. Exp.20,000
Adv. Exp.2,200
64
Accounting Cycle 65
Closing Entries (contd.)Traveling Exp.
8,000Office Salaries Exp.
19,000T&T Exp.
600Rent Exp.
4,300Property Tax Exp.
5,300Depr. Exp. - Fur. & Equip.
6,700Bad Debts Exp.
1,000Insurance Exp.
360Interest Exp.
1,700Income Tax Exp.
3,440Income Summary
12,200(To close revenues and expenses to Income Summary)
Income Summary 12,200Retained Earnings
12,200(To close Income Summary to Retained Earnings)
65
Accounting Cycle 66
January 1, 2012
C. Closing and Reversing Entries
Reversing Entries (Optional)
(D)Interest Revenue 800
Interest Receivable800
(E)Rent Expense 500
Prepaid Rent Expense500
(F)Property Tax Payable 2,000
Property Tax Expense2,000
(G)Income Tax Payable 3,440
Income Tax Expense3,440
66
Accounting Cycle 67
Closing Entries for Periodic Inventory System( with Purchase Returns and Allow): An Example
Inventory & Related Accounts
Inventory Purchases Pur. R&AB.B 12,600 44,650 3,700
Freight-In Income Summary4,350 CGS
Assuming Ending Inv. = 17,200CGS= Beg. Inv + Net Purchases - Endings Inv.Net Purchases = Pur. -Pur. R&A - Pur. Dis + Freight-In
Accounting Cycle 68
IFRS Insights (Source: Kieso, etc. 14th e, p153-155) Companies around the world use the same
accounting process as shown in this chapter.
Despite some differences in standards between IFRS and GAAP, the double entry accounting system is the basis of accounting systems worldwide.
IFRS is growing in acceptance around the world. Approximately 40% of Global Fortune 500 companies use IFRS.