review of the accounting process chapter 2 © 2009 the mcgraw-hill companies, inc
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REVIEW OF THE REVIEW OF THE ACCOUNTING PROCESSACCOUNTING PROCESS
Chapter 2
© 2009 The McGraw-Hill Companies, Inc.
McGraw-Hill /Irwin
Slide 2
The Accounting EquationThe Accounting Equation
A = L + OE- Owner Withdrawals+ Owner Investments
- Expenses- Losses
+ Revenue+ Gains
McGraw-Hill /Irwin
Slide 3
Accounting Equation for a CorporationAccounting Equation for a Corporation
A = L + SE+ Retained Earnings+ Paid-in Capital
- Expenses- Losses
+ Revenues+ Gains
- Dividends
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Slide 4
Account RelationshipsAccount Relationships
Debits and credits affect the Balance Sheet Model as follows:
Debits and credits affect the Balance Sheet Model as follows:
A = L + PIC + REAssets
Dr.+
Cr.-
LiabilitiesDr.-
Cr.+
Paid-inCapital
Dr.-
Cr.+
Retained EarningsDr.-
Cr.+
Revenues and GainsDr.-
Cr.+
Expenses and Losses
Dr.+
Cr.-
Permanent Accounts
Temporary Accounts
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Slide 5
Source documents
Record in Journal
Financial Statements
Transaction Analysis
Post to Ledger
Unadjusted Trial Balance
Record & Post Adjusting
Entries
Adjusted Trial Balance
Close Temporary Accounts
Post-Closing Trial Balance
The Accounting Processing
Cycle
During the Accounting Period
At the End of the Accounting Period
At the End of the Year
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Accounting Processing CycleAccounting Processing Cycle
On January 1, $40,000 was borrowed from a bank and a note payable was signed.
Prepare the journal entry.
Two accounts are affected:Cash (an asset) increases by $40,000.Notes Payable (a liability) increases by $40,000.
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General LedgerGeneral 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.
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Posting Journal EntriesPosting Journal Entries
On July 1, the owners invest $60,000 in a new business, Dress Right Clothing Corporation.
GENERAL JOURNAL Page 1
Date DescriptionPost. Ref. Debit Credit
July 1 Cash 60,000Common Stock 60,000
Post the debit portion of the entry to the Cash ledger account.
Post the debit portion of the entry to the Cash ledger account.
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Posting Journal EntriesPosting Journal Entries
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Slide 10
Posting Journal EntriesPosting Journal Entries
We follow the same procedure to post the credit portion of the entry to the Common Stock account.
We follow the same procedure to post the credit portion of the entry to the Common Stock account.
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After recording all entries for the period, Dress Right’s Unadjusted Trial Balance would be as follows:
After recording all entries for the period, Dress Right’s Unadjusted Trial Balance would be as follows:
Debits = Credits
A Trial Balance is a listing of all
accounts and their
balances at a point in
time.
A Trial Balance is a listing of all
accounts and their
balances at a point in
time.
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Slide 12
Prepaym ents(Deferrals)
Accruals Estimates
Adjusting Entries
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.
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Slide 13
Asset Expense
UnadjustedBalance
CreditAdjustment
DebitAdjustment
Prepaid ExpensesPrepaid Expenses
Today, I will payfor my first
6 months’ rent. Prepaid Expenses
Items paid for in advance of receiving their benefits
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Slide 14
Depreciation is the process of computing expense by allocating the cost of plant and equipment over their expected useful lives.
Straight-LineDepreciationExpense
= Asset Cost - Salvage Value
Useful Life
DepreciationDepreciation
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Slide 15
DepreciationDepreciation
Recall the Furniture and Fixtures for $12,000 listed on Dress Right’s unadjusted trial balance. Assume the
following:
Let’s calculate the depreciation expense for the month ended July 31, 2009.
Asset Cost 12,000$ Salvage Value - Useful Life 60 months
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Slide 16
JulyDepreciation
Expense=
$12,000 - $0
60 months= $200 per month
Recall the Furniture and Fixtures for $12,000 listed on Dress Right’s unadjusted trial balance.
Asset Cost 12,000$ Salvage Value - Useful Life 60 months
GENERAL JOURNAL Page 2Date Description PR Debit Credit
July 31 Depreciation Expense 200Accumulated Depr. - Furniture & Fixtures 200
To record depreciation
DepreciationDepreciation
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Slide 17
After posting, the accounts look like this:
DepreciationDepreciation
Beg. bal. - 12,000
Bal. 12,000
Furniture and FixturesBeg. bal. -
200 Bal. 200
Depreciation Expense
- Beg. bal.200 200 Bal.
Accumulated Depreciation
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Slide 18
Liability RevenueUnadjusted
BalanceCredit
AdjustmentDebit
Adjustment
Unearned RevenuesUnearned Revenues
“Go Big Blue”
Buy your season tickets forall home basketball games NOW! Unearned Revenue
Cash received in advance of performing
services
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Slide 19
Alternative Approach to Record PrepaymentsAlternative Approach to Record Prepayments
Unearned RevenueRecord initial cash receipts
as follows:
Cash $$$ Revenue $$$
Adjusting EntryRecord the amount for the
unearned liability as follows:
Revenue $$$ Unearned revenue $$$
Prepaid ExpensesRecord initial cash
payments as follows:
Expense $$$ Cash $$$
Adjusting EntryRecord the amount for the
prepaid expense as follows:
Prepaid expense $$$ Expense $$$
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Slide 20
Expense LiabilityCredit
AdjustmentDebit
Adjustment
Accrued LiabilitiesAccrued Liabilities
I won’t pay youuntil the job is done!
Accrued Liabilities
Liabilities recorded when an expense has been incurred
prior to cash payment.
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Slide 21
Asset Revenue
CreditAdjustment
DebitAdjustment
Accrued ReceivablesAccrued Receivables
Yes, you can pay mein May for your April
15 tax return.Accrued Receivables
Revenue earned in a period prior to the cash
receipt.
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Slide 22
EstimatesEstimates
Uncollectible accounts and depreciation of fixed assets are estimated.
An estimated item is a function of future events and developments.
$$
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Slide 23
EstimatesEstimatesThe estimate of bad debt expense at the end of the
period is an example of an adjusting entry that requires an estimate.
Assume that Dress Right’s management determines that of the $2,000 of accounts receivable recorded at July 31,
only $1,500 will ultimately be collected. Prepare the adjusting entry for July 31.
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DRESS RIGHT CLOTHING CORPORATIONAdjusted Trial Balance
July 31, 2009Account Title Debits CreditsCash 68,500$ Accounts receivable 2,000 Allowance for uncollectible accounts 500$ Supplies 1,200 Prepaid rent 22,000 Inventory 38,000 Furniture and fixtures 12,000 Accumulated depr.-furniture & fixtures 200 Accounts payable 35,000 Note payable 40,000 Unearned rent revenue 750 Salaries payable 5,500 Interest payable 333 Common stock 60,000 Retained earnings 1,000 Sales revenue 38,500 Rent revenue 250 Cost of goods sold 22,000 Salaries expense 10,500 Supplies expense 800 Rent expense 2,000 Depreciation expense 200 Interest expense 333 Bad debt expense 500 Totals 181,033$ 181,033$
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.
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Slide 25
The income statement summarizes the results of operating activities of the company.
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Slide 26
Current assets: Cash 68,500$ Accounts receivable 2,000$ Less: Allowance for uncollectible accounts 500 1,500 Supplies 1,200 Inventory 38,000 Prepaid rent 22,000 Total current assets 131,200 Property and equipment: Furniture and fixtures 12,000 Less: Accumulated depreciation 200 11,800 Total assets 143,000$
Dress Right Clothing CorporationBalance SheetAt July 31, 2009
Assets
The balance sheet presents the financial position of the company on a particular date.
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Slide 27
Current liabilities: Accounts payable 35,000$ Salaries payable 5,500 Unearned rent revenue 750 Interest payable 333 Note payable 10,000 Total current liabilities 51,583 Long-term liabilities: Note payable 30,000 Shareholders' equity: Common stock 60,000$ Retained earnings 1,417 Total shareholders' equity 61,417 Total liabilities and shareholders' equity 143,000$
Dress Right Clothing CorporationBalance SheetAt July 31, 2009
Liabilities and Shareholders' Equity
Notice that assets of $143,000 equal total liabilities plus shareholders’ equity of $143,000.
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Slide 28
The statement of cash flows discloses the changes in cash during a period.
Cash flows from operating activities:Cash inflows: From customers 36,500$ From rent 1,000 Cash outflows: For rent (24,000) For supplies (2,000) To suppliers for merchandise (25,000) To employees (5,000) Net cash used by operating activities (18,500)$ Cash flows from investing activities: Purchase of furniture and fixtures (12,000) Cash flows from financing activities: Issue of capital stock 60,000$ Increase in notes payable 40,000 Payment of cash dividend (1,000) Net cash provided by financing activities 99,000 Net increase in cash 68,500$
Dress Right Clothing CorporationStatement of Cash Flows
For the Month of July 2009
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Slide 29
The statement of shareholders’ equity presents the changes in permanent
shareholder accounts.
Common Stock
Retained Earnings
Total Shareholders'
EquityBalance at July 1, 2009 -$ -$ -$ Issue of capital stock 60,000 60,000 Net income for July 2009 2,417 2,417 Less: Dividends (1,000) (1,000) Balance at July 31, 2009 60,000$ 1,417$ 61,417$
Dress Right Clothing CorporationStatement of Shareholders' Equity
For the Month of July 2009
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Slide 30
Temporary Accounts
Revenues
Income Summary
Exp
ense
s
Divid
end
s
Permanent Accounts
Assets
Lia
bili
ties
Sh
areho
lders’
Eq
uity
The closing process applies only to temporary accounts.
Temporary and Permanent AccountsTemporary and Permanent Accounts
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Slide 31
Post-Closing Trial BalancePost-Closing Trial Balance
Lists permanent accounts and their
balances.
Total debits equal total credits.
DRESS RIGHT CLOTHING CORPORATIONPost-Closing Trial Balance
July 31, 2009Account Title Debits CreditsCash 68,500$ Accounts receivable 2,000 Allowance for uncollectible accounts 500$ Supplies 1,200 Prepaid rent 22,000 Inventory 38,000 Furniture and fixtures 12,000 Accumulated depr.-furniture & fixtures 200 Accounts payable 35,000 Note payable 40,000 Unearned rent revenue 750 Salaries payable 5,500 Interest payable 333 Common stock 60,000 Retained earnings 1,417 Totals 143,700$ 143,700$
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Slide 32
Conversion From Cash Basis to Accrual BasisConversion From Cash Basis to Accrual Basis
Prepaid Insurance
Balance, 1/1 5,000$ Plus: Cash paid 20,000 Less: Insurance expense (22,000) Balance, 12/31 3,000$
Jeter, Inc. paid $20,000 cash for insurance during the current period. On Jan. 1, Prepaid Insurance was $5,000, and on Dec. 31, the
account balance was $3,000.
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Slide 33
Appendix 2A: Use of a WorksheetAppendix 2A: Use of a Worksheet
A worksheet can be used as a tool to facilitate the preparation of adjusting and closing entries and the
financial statements.
Steps to Follow for Worksheet Completion:
1. Enter account titles in column 1 and the unadjusted account balances in columns 2 and 3.
2. Determine end-of-period adjusting entries and enter them in columns 4 and 5.
3. Add or deduct the effects of the adjusting entries on the account balances and enter in columns 6 and 7.
4. Transfer the temporary retained earnings account balances to columns 8 and 9.
5. Transfer the balances in the permanent accounts to columns 10 and 11.
Let’s look at the completed worksheet for Dress Right.
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Worksheet, Dress Right Clothing Corporation, July 2009
Account Title Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Cash 68,500 68,500 68,500 Accounts receivable 2,000 2,000 2,000
Allowance for uncollectible accounts - (7) 500 500 500 Supplies 2,000 (1) 800 1,200 1,200 Prepaid rent 24,000 (2) 2,000 22,000 22,000 Inventory 38,000 38,000 38,000 Furniture and fixtures 12,000 12,000 12,000 Accumulated depr.- furniture & fixtures - (3) 200 200 200 Accounts payable 35,000 35,000 35,000 Note payable 40,000 40,000 40,000 Unearned rent revenue 1,000 (4) 250 750 750 Salaries payable - (5) 5,500 5,500 5,500 Interest payable - (6) 333 333 333 Common stock 60,000 60,000 60,000 Retained earnings 1,000 1,000 1,000 Sales revenue 38,500 38,500 38,500 Rent revenue - (4) 250 250 250 Cost of goods sold 22,000 22,000 22,000 Salaries expense 5,000 (5) 5,500 10,500 10,500 Supplies expense - (1) 800 800 800 Rent expense - (2) 2,000 2,000 2,000 Depreciation expense - (3) 200 200 200 Interest expense - (6) 333 333 333 Bad debt expense - (7) 500 500 500 Totals 174,500 174,500 9,583 9,583 181,033 181,033
Net income 2,417 2,417 Totals 38,750 38,750 144,700 144,700
Balance SheetUnadjusted Trial
Balance Adjusting Entries Adjusted Trial Balance Income Statement
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Slide 35
Appendix 2B: Reversing EntriesAppendix 2B: Reversing Entries
Reversing entries remove the effects of some of the adjusting entries made at the end of the
previous reporting period for the sole purpose of simplifying journal entries made during the new period. Reversing entries are optional and are
used most often with accruals.
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Slide 36
Appendix 2C: Subsidiary LedgersAppendix 2C: Subsidiary Ledgers
Subsidiary ledgers contain a group of subsidiary accounts associated with particular general ledger control accounts. Subsidiary ledgers are commonly
used for accounts receivable, accounts payable, plant and equipment, and investments.
For example, there will be a subsidiary ledger for accounts receivable that keeps
track of the increases and decreases in the accounts receivable balance for each of the
company’s customers purchasing goods and services on credit.
After all of the postings are made from the appropriate journals, the balance in the accounts receivable control account should equal the sum of
the balances in the accounts receivable subsidiary ledger accounts.
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Slide 37
Appendix 2C: Special JournalsAppendix 2C: Special Journals
Special journals are used to capture the dual effect of repetitive types of transactions in
debit/credit form.
Special journals simplify the recording process in the following ways:
1. Journalizing the effects of a particular transaction is made more efficient through the use of specifically designed formats.
2. Individual transactions are not posted to the general ledger accounts but are accumulated in the special journals and a summary posting is made on a periodic basis.
3. The responsibility for recording journal entries for the repetitive types of transactions is placed on individuals who have specialized training in handling them.
Let’s look at some special journals.
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Slide 38
Sales JournalSales Journal
Sales journals record all credit sales. Every entry in the sales journal has the same effect on the accounts; the sales revenue account
is credited and the accounts receivable control account is debited.
Other columns capture
information needed for
updating the accounts
receivable subsidiary
ledger.
SALES JOURNAL Page 1
Date
Accounts Receivable Subsidiary
Account No. Customer Name
Sales Invoice Number
Cr. Sales Revenue
(400)Dr. Accounts Receivable
(110)
Aug. 5 801 Leland High School 10-221 1,500
9 812 Mr. John Smith 10-222 200
18 813 Greystone School 10-223 825
22 803 Ms. Barbara Jones 10-224 120
29 805 Hart Middle School 10-225 650
3,295
2009
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Slide 39
Cash Receipts JournalCash Receipts Journal
Cash receipts journals record all cash receipts, regardless of the source. Every
entry in the cash receipts journal produces a debit to the cash account with the credit to
various other accounts.CASH RECEIPTS JOURNAL Page 1
DateExplanation or Account Name
Dr. Cash (100)
Cr. Accounts
Receivable (110)
Cr. Sales
Revenue (400)
Cr. Other
Other Accounts
Aug. 7 Cash sale 500 500
11 Borrowed cash 10,000 10,000
Notes payable
(220)
17 Leland High School 750 750
20 Cash sale 300 300
25 Mr. John Smith 200 200
11,750 950 800 10,000
2009
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End of Chapter 2End of Chapter 2
© 2008 The McGraw-Hill Companies, Inc.