Account Name

Debit / Dr.

Credit / Cr.

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Debits and CreditsAccount NameDebit / Dr. Credit / Cr. If Debit entries are greater than Credit entries, the account will have a debit balance.LO 2 Explain double-entry rules.$10,000Transaction #2$3,000$15,0008,000Transaction #3BalanceTransaction #1

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Debits and CreditsIf Credit entries are greater than Debit entries, the account will have a credit balance.LO 2 Explain double-entry rules.$10,000Transaction #2$3,000$1,0008,000Transaction #3BalanceTransaction #1

Account Name

Debit / Dr.

Credit / Cr.

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Debits and Credits SummaryNormal Balance CreditNormal Balance DebitLO 2 Explain double-entry rules.

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Assets

Debit / Dr.

Credit / Cr.

Normal Balance

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Debit / Dr.

Credit / Cr.

Normal Balance

Expense

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Liabilities

Debit / Dr.

Credit / Cr.

Normal Balance

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Debit / Dr.

Credit / Cr.

Normal Balance

Equity

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Debit / Dr.

Credit / Cr.

Normal Balance

Revenue

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Debits and Credits Summary Statement of Financial Position Income Statement=+=-AssetLiabilityEquityRevenueExpenseDebitCreditLO 2 Explain double-entry rules.

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The Accounting EquationRelationship among the assets, liabilities and equity of a business: LO 2 Explain double-entry rules.The equation must be in balance after every transaction. For every Debit there must be a Credit.Illustration 3-3

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Double-Entry System IllustrationAssetsLiabilitiesEquity=+Owners invest $40,000 in exchange for share capital+ 40,000+ 40,000LO 2 Explain double-entry rules.

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Double-Entry System IllustrationAssetsLiabilities=+2. Disburse $600 cash for secretarial wages.- 600- 600 (expense)LO 2 Explain double-entry rules.Equity

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Double-Entry System IllustrationAssetsLiabilities=+3.Purchase office equipment priced at $5,200, giving a 10 percent promissory note in exchange.+ 5,200+ 5,200LO 2 Explain double-entry rules.Equity

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Double-Entry System IllustrationAssetsLiabilities=+4. Received $4,000 cash for services rendered.+ 4,000+ 4,000 (revenue)LO 2 Explain double-entry rules.Equity

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Double-Entry System IllustrationAssetsLiabilities=+5. Pay off a short-term liability of $7,000.- 7,000- 7,000LO 2 Explain double-entry rules.Equity

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Double-Entry System IllustrationAssetsLiabilities=+6. Declared a cash dividend of $5,000.+ 5,000- 5,000LO 2 Explain double-entry rules.Equity

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Double-Entry System IllustrationAssetsLiabilities=+7. Convert a long-term liability of $80,000 into ordinary shares.- 80,000+ 80,000LO 2 Explain double-entry rules.Equity

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Double-Entry System IllustrationAssetsLiabilities=+8. Pay cash of $16,000 for a delivery van.LO 2 Explain double-entry rules.- 16,000+ 16,000Note that the accounting equation equality is maintained after recording each transaction.Equity

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Financial Statements and Ownership StructureOwnership structure dictates the types of accounts that are part of the equity section.Proprietorship or Partnership

Corporation

Share capitalShare premiumDividendsRetained EarningsLO 2 Explain double-entry rules.

Capital accountDrawing account

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Financial Statements and Ownership StructureLO 2 Explain double-entry rules.EquityStatement of Financial PositionRetained Earnings StatementNet income or Net loss (Revenues less expenses)Income StatementDividendsRetained Earnings (Net income retained in business)Share Capital (Investment by shareholders)Illustration 3-4

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The Accounting CycleLO 3 Identify steps in the accounting cycle.Transactions1. Journalization6. Financial Statements7. Closing entries8. Post-closing trail balance9. Reversing entries3. Trial balance2. Posting5. Adjusted trial balance4. AdjustmentsWork SheetIllustration 3-6

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Identify and Recording TransactionsWhat to Record?An item should be recognized in the financial statements if it is an element, is measurable, and is relevant and a faithful representation.LO 3 Identify steps in the accounting cycle.

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1. JournalizingGeneral Journal a chronological record of transactions. Journal Entries are recorded in the journal. LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.September 1: Shareholders invested $15,000 cash in the corporation in exchange for ordinary shares.Illustration 3-7

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2. PostingPosting the process of transferring amounts from the journal to the ledger accounts. LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-7Illustration 3-8

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2. PostingPosting Transferring amounts from journal to ledger. LO 4 Illustration 3-8

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2. PostingExpanded ExampleLO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.The purpose of transaction analysis is to identify the type of account involved, and to determine whether a debit or a credit is required.Keep in mind that every journal entry affects one or more of the following items: assets, liabilities, equity, revenues, or expense.

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2. Posting1. October 1: Shareholders invest $100,000 cash in an advertising venture to be known as Pioneer Advertising Agency Inc.Share capital - ordinary100,000Cash100,000Oct. 1DebitCreditCash100,000100,000DebitCreditShare Capital - OrdinaryLO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-9

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2. Posting2. October 1: Pioneer Advertising purchases office equipment costing $50,000 by signing a 3-month, 12%, $50,000 note payable.Notes payable50,000Office equipment50,000Oct. 1DebitCreditOffice Equipment50,00050,000DebitCreditNotes PayableLO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-10

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2. Posting3. October 2: Pioneer Advertising receives a $12,000 cash advance from KC, a client, for advertising services that are expected to be completed by December 31.Unearned service revenue12,000Cash12,000Oct. 2DebitCreditCash100,00012,000DebitCreditUnearned Service Revenue12,000LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-11

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2. Posting4. October 3: Pioneer Advertising pays $9,000 office rent, in cash, for October.Cash9,000Rent expense9,000Oct. 3DebitCreditCash100,0009,000DebitCreditRent Expense12,0009,000LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-12

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2. Posting5. October 4: Pioneer Advertising pays $6,000 for a one-year insurance policy that will expire next year on September 30.Cash6,000Prepaid insurance6,000Oct. 4DebitCreditCash100,0006,000DebitCreditPrepaid Insurance12,0009,0006,000LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-13

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2. Posting6. October 5: Pioneer Advertising purchases, for $25,000 on account, an estimated 3-month supply of advertising materials from Aero Supply.Accounts payable25,000Advertising supplies25,000Oct. 5DebitCreditAdvertising Supplies25,00025,000DebitCreditAccounts PayableLO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-14

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2. Posting7. October 9: Pioneer Advertising signs a contract with a local newspaper for advertising inserts (flyers) to be distributed starting the last Sunday in November. Pioneer will start work on the content of the flyers in November. Payment of $7,000 is due following delivery of the Sunday papers containing the flyers.LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-15

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2. Posting8. October 20: Pioneer Advertisings board of directors declares and pays a $5,000 cash dividend to shareholders.Cash5,000Dividends5,000Oct. 20DebitCreditCash100,0005,000DebitCreditDividends12,0009,0006,0005,000LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-16

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2. Posting9. October 26: Employees are paid every four weeks. The total payroll is $2,000 per day. The pay period ended on Friday, October 26, with salaries of $40,000 being paid.Cash40,000Salaries expense40,000Oct. 26DebitCreditCash100,00040,000DebitCreditSalaries Expense12,0009,0006,0005,00040,000LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-17

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2. Posting10. October 31: Pioneer Advertising receives $28,000 in cash and bills Copa Company $72,000 for advertising services of $100,000 provided in October. Accounts receivable72,000Cash28,000Oct. 31DebitCreditCash100,00072,000DebitCreditAccounts Receivable12,0009,0006,0005,00040,000Service revenue100,000100,000DebitCreditService Revenue28,00080,000Illustration 3-18

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3. Trial BalanceTrial Balance A list of each account and its balance; used to prove equality of debit and credit balances.LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.Illustration 3-19

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4. Adjusting EntriesLO 5 Explain the reasons for preparing adjusting entries.Makes it possible to:Report on the statement of financial position the appropriate assets, liabilities, and equity at the statement date. Report on the income statement the proper revenues and expenses for the period.Revenues are recorded in the period in which they are earned.Expenses are recognized in the period in which they are incurred.

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Types of Adjusting Entries1.Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.Deferrals3. Accrued Revenues. Revenues earned but not yet received in cash or recorded. 4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned.AccrualsLO 5 Explain the reasons for preparing adjusting entries.Illustration 3-20

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Adjusting Entries for DeferralsDeferrals are either prepaid expenses orunearned revenues.Illustration 3-21LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesPayment of cash that is recorded as an asset because service or benefit will be received in the future.insurancesuppliesadvertisingCash PaymentExpense RecordedBEFORErentpurchasing buildings and equipmentPrepayments often occur in regard to:LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesSupplies. Pioneer purchased advertising supplies costing$25,000 on October 5. Prepare the journal entry to record the purchase of the supplies.Cash25,000Advertising supplies25,000Oct. 5DebitCreditAdvertising Supplies25,00025,000DebitCreditCashLO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesSupplies. An inventory count at the close of business on October 31 reveals that $10,000 of the advertising supplies are still on hand.Advertising supplies15,000Advertising supplies expense15,000Oct. 31DebitCreditAdvertising Supplies25,00015,000DebitCreditAdvertising Supplies Expense15,00010,000LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesStatement Presentation:Advertising supplies identifies that portion of the assets cost that will provide future economic benefit.Illustration 3-35LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesStatement Presentation:Advertising expense identifies that portion of the assets cost thatexpired in October.

Illustration 3-34LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesInsurance. On Oct. 4th, Pioneer paid $6,000 for a one-year fire insurance policy, beginning October 1. Show the entry to record the purchase of the insurance. Cash6,000Prepaid insurance6,000Oct. 4DebitCreditPrepaid Insurance6,0006,000DebitCreditCashLO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesInsurance. An analysis of the policy reveals that $500 ($6,000 / 12) of insurance expires each month. Thus, Pioneer makes the following adjusting entry.Prepaid insurance500Insurance expense500Oct. 31DebitCreditPrepaid Insurance6,000500DebitCreditInsurance Expense5005,500LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesStatement Presentation:Prepaid Insurance identifies that portion of the assets cost that will provide future economic benefit.Illustration 3-35LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesStatement Presentation:Insurance expense identifies that portion of the assets cost thatexpired in October.

Illustration 3-34LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesDepreciation. Pioneer Advertising estimates depreciation on its office equipment to be $400 per month. Accordingly, Pioneer recognizes depreciation for October by the following adjusting entry.Accumulated depreciation400Depreciation expense400Oct. 31DebitCreditDepreciation Expense400400DebitCreditAccumulated DepreciationLO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesStatement Presentation:Accumulated Depreciationis a contra asset account.

Illustration 3-35LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Prepaid ExpensesStatement Presentation:Depreciation expense identifies that portion of the assets cost thatexpired in October.

Illustration 3-34LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Unearned RevenuesReceipt of cash that is recorded as a liability because the revenue has not been earned.rentairline ticketsschool tuitionCash ReceiptRevenue RecordedBEFOREmagazine subscriptionscustomer depositsUnearned revenues often occur in regard to:LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Unearned RevenuesUnearned Revenue. Pioneer Advertising received $12,000 on October 2 from KC for advertising services expected to be completed by December 31. Show the journal entry to record the receipt on Oct. 2nd. Unearned service revenue12,000Cash12,000Oct. 2DebitCreditCash12,00012,000DebitCreditUnearned Service RevenueLO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Unearned RevenuesDebitCreditService Revenue100,00012,000DebitCreditUnearned Service Revenue4,0008,000Unearned Revenues. Analysis reveals that Pioneer earned $4,000 of the advertising services in October. Thus, Pioneer makes the following adjusting entry.Service revenue4,000Unearned service revenue4,000Oct. 314,000LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Unearned RevenuesStatement Presentation:Unearned service revenue identifies that portion of the liability that has not been earned.

Illustration 3-35LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Unearned RevenuesStatement Presentation:Service revenue represents that portion of the liability that was earned in October.

Illustration 3-34LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for AccrualsAccruals are either accrued revenues oraccrued expenses.Illustration 3-27LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Accrued RevenuesRevenues earned but not yet received in cash or recorded.rentinterestservices performedBEFOREAccrued revenues often occur in regard to:Cash ReceiptRevenue RecordedAdjusting entry results in:LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Accrued RevenuesAccrued Revenues. In October Pioneer earned $2,000 for advertising services that it did not bill to clients before October 31. Thus, Pioneer makes the following adjusting entry.Service revenue2,000Accounts receivable2,000Oct. 31DebitCreditAccounts Receivable72,000DebitCreditService Revenue100,0004,0002,000106,0002,00074,000

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Adjusting Entries for Accrued RevenuesLO 5 Illustration 3-34Statement PresentationIllustration 3-35

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Adjusting Entries for Accrued ExpensesExpenses incurred but not yet paid in cash or recorded.rentinterestBEFOREAccrued expenses often occur in regard to:Cash PaymentExpense Recordedsalariestaxes

Adjusting entry results in:LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Accrued ExpensesAccrued Interest. Pioneer signed a three-month, 12%, note payable in the amount of $50,000 on October 1. The note requires interest at an annual rate of 12 percent. Three factors determine the amount of the interest accumulation: 123Illustration 3-29LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Accrued ExpensesInterest payable500Interest expense500Oct. 31DebitCreditInterest Expense500500DebitCreditInterest PayableAccrued Interest. Pioneer signed a three-month, 12%, note payable in the amount of $50,000 on October 1. Prepare the adjusting entry on Oct. 31 to record the accrual of interest.LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Accrued ExpensesLO 5 Illustration 3-34Statement PresentationIllustration 3-35

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Adjusting Entries for Accrued ExpensesAccrued Salaries. At October 31, the salaries for these days represent an accrued expense and a related liability to Pioneer. The employees receive total salaries of $10,000 for a five-day work week, or $2,000 per day.LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Accrued ExpensesSalaries payable6,000Salaries expense6,000Oct. 31DebitCreditSalaries Expense40,0006,000DebitCreditSalaries PayableAccrued Salaries. Employees receive total salaries of $10,000 for a five-day work week, or $2,000 per day. Prepare the adjusting entry on Oct. 31 to record accrual for salaries.6,00046,000LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Accrued ExpensesLO 5 Illustration 3-34Statement PresentationIllustration 3-35

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Adjusting Entries for Accrued ExpensesSalaries expense34,000Salaries payable6,000Nov. 23DebitCreditSalaries Expense34,0006,000DebitCreditSalaries PayableAccrued Salaries. On November 23, Pioneer will again pay total salaries of $40,000. Prepare the entry to record the payment of salaries on November 23.Cash40,0006,000LO 5 Explain the reasons for preparing adjusting entries.

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Adjusting Entries for Accrued ExpensesBad Debts. Assume Pioneer reasonably estimates a bad debt expense for the month of $1,600. It makes the adjusting entry for bad debts as follows.Illustration 3-32LO 5 Explain the reasons for preparing adjusting entries.

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5. Adjusted Trial BalanceShows the balance of all accounts, after adjusting entries, at the end of the accounting period. LO 5 Illustration 3-33

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6. Preparing Financial StatementsLO 6 Prepare financial statement from the adjusted trial balance.Financial Statements are prepared directly from the Adjusted Trial Balance. Statement of Financial PositionIncome StatementRetained Earnings Statement

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6. Preparing Financial StatementsLO 6Illustration 3-34

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6. Preparing Financial StatementsLO 6Illustration 3-35

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7. Closing EntriesLO 7 Prepare closing entries.To reduce the balance of the income statement (revenue and expense) accounts to zero. To transfer net income or net loss to equity.Statement of financial position (asset, liability, and equity) accounts are not closed.Dividends are closed directly to the Retained Earnings account.

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7. Closing EntriesLO 7Illustration 3-36

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7. Closing EntriesIllustration 3-37LO 7

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8. Post-Closing Trial BalanceLO 7 Prepare closing entries.Illustration 3-38

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9. Reversing EntriesLO 7 Prepare closing entries.After preparing the financial statements and closing the books, a company may reverse some of the adjusting entries before recording the regular transactions of the next period.

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Accounting Cycle SummarizedLO 7 Prepare closing entries.Enter the transactions of the period in appropriate journals.Post from the journals to the ledger (or ledgers).Take an unadjusted trial balance (trial balance).Prepare adjusting journal entries and post to the ledger(s).Take a trial balance after adjusting (adjusted trial balance).Prepare the financial statements from the second trial balance.Prepare closing journal entries and post to the ledger(s).Take a trial balance after closing (post-closing trial balance).Prepare reversing entries (optional) and post to the ledger(s).

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Financial Statements for a Merchandising CompanyLO 7Illustration 3-39

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Financial Statements of a Merchandising CompanyIllustration 3-40LO 7 Prepare closing entries.

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Financial Statements of a Merchandising CompanyLO 7Illustration 3-41

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Internal controls are a system of checks and balances designed to prevent and detect fraud and errors. Both of these actions are required under SOX.Companies find that internal control review is a costly process. One study estimates the cost for U.S. companies at over $35 billion, with audit fees doubling in the first year of compliance. The enhanced internal control standards apply only to large public companies listed on U.S. exchanges. There is continuing debate over whether foreign issuers should have to comply.

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Most companies use accrual-basis accountingrecognize revenue when it is earned and expenses in the period incurred, without regard to the time of receipt or payment of cash.Under the strict cash basis, companiesrecord revenue only when they receive cash, and record expenses only when they disperse cash.Cash basis financial statements are not in conformity with IFRS.LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

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Illustration: Quality Contractor signs an agreement to construct a garage for $22,000. In January, Quality begins construction, incurs costs of $18,000 on credit, and by the end of January delivers a finished garage to the buyer. In February, Quality collects $22,000 cash from the customer. In March, Quality pays the $18,000 due the creditors. Illustration 3A-1LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

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Illustration: Quality Contractor signs an agreement to construct a garage for $22,000. In January, Quality begins construction, incurs costs of $18,000 on credit, and by the end of January delivers a finished garage to the buyer. In February, Quality collects $22,000 cash from the customer. In March, Quality pays the $18,000 due the creditors.Illustration 3A-2LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

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Conversion From Cash Basis To Accrual BasisIllustration: Dr. Diane Windsor, like many small business owners, keeps her accounting records on a cash basis. In the year 2010, Dr. Windsor received $300,000 from her patients and paid $170,000 for operating expenses, resulting in an excess of cash receipts over disbursements of $130,000 ($300,000 - $170,000). At January 1 and December 31, 2010, she has accounts receivable, unearned service revenue, accrued liabilities, and prepaid expenses as shown in Illustration 3A-5.Illustration 3A-5LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

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Conversion From Cash Basis To Accrual BasisIllustration: Calculate service revenue on an accrual basis.Illustration 3A-5Illustration 3A-8LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

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Conversion From Cash Basis To Accrual BasisIllustration: Calculate operating expenses on an accrual basis.Illustration 3A-5Illustration 3A-11LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

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Conversion From Cash Basis To Accrual BasisIllustration 3A-12LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

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Theoretical Weaknesses of the Cash BasisTodays economy is considerably more lubricated by credit than by cash. The accrual basis, not the cash basis, recognizes all aspects of the credit phenomenon. Investors, creditors, and other decision makers seek timely information about an enterprises future cash flows.

LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

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LO 9 Identifying adjusting entries that may be reversed.Illustration of Reversing EntriesAccrualsIllustration 3B-1

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LO 9 Identifying adjusting entries that may be reversed.Illustration of Reversing EntriesDeferralsIllustration 3B-2

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LO 9 Identifying adjusting entries that may be reversed.Summary of Reversing EntriesAll accruals should be reversed.All deferrals for which a company debited or credited the original cash transaction to an expense or revenue account should be reversed.Adjusting entries for depreciation and bad debts are not reversed.Recognize that reversing entries do not have to be used. Therefore, some accountants avoid them entirely.

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LO 10 Prepare a 10-column worksheet.A company prepares a worksheet either on columnar paper or within an electronic spreadsheet. A company uses the worksheet to adjust account balances and to prepare financial statements.

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LO 10 Prepare a 10-column worksheet.A company prepares a worksheet either on columnar paper or within an electronic spreadsheet. Worksheet Columns

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LO 10 Prepare a 10-column worksheet.Adjusted Trial BalanceIllustration 3C-1

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The Worksheet: Provides information needed for preparation of the financial statements.Sorts data into appropriate columns, which facilitates the preparation of the statements.LO 10 Prepare a 10-column worksheet.Preparing Financial Statements from a Worksheet

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Illustration 3-39LO 10

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Illustration 3-40LO 10 Prepare a 10-column worksheet.

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Illustration 3-41LO 10

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CopyrightCopyright 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.