FINANCIAL ACCOUNTING
a user perspective
Sixth Canadian Edition
CHAPTER 3
PROCESSING DATA THROUGH THE ACCOUNTING SYSTEM
John Wiley & Sons Canada, Ltd. ©2011
Prepared by L. de Grace C.A.
Basic Accounting Equation
2
Assets = Liabilities + Shareholders’ Equity
Double Entry Bookkeeping:
Replace with a “T” account
Assets
Liabilities + Shareholders’ Equity
Individual T Accounts
3
Name of Account
Debit
Credit
(Left side)
(Right side)
Assets
Cash (A)
Liabilities +
Shareholders’ Equity
Accounts Payable (L)
Common Shares (SE)
Double Entry Accounting
4
Increase
ASSETS
EXPENSES
LIABILITIES
SHAREHOLDERS’ EQUITY
REVENUES
Credit Right
Debit Left
LIABILITIES
SHAREHOLDERS’ EQUITY
REVENUES
Decrease
ASSETS
EXPENSES
Entries to T Accounts
5
Assets
Liabilities
Beginning
balance
Increases Decreases
Ending
balance
Beginning
balance
Decreases Increases
Ending
balance
Shareholders’ Equity
Beginning balance
Decreases Increases
Ending balance
Permanent Accounts
6



Statement of Financial Position accounts: assets,
liabilities, and shareholders’ equity accounts
Have balances that carry over from one period
to the next
Example: Retained Earnings
Temporary Accounts
7



Used temporarily to keep track of revenues,
expenses, and dividends during the period
Beginning balance is zero
End of period balance is transferred to Retained
Earnings
Entries to T Accounts
8
Retained Earnings (SE)
Beginning balance
Decrease in
Increase in
Shareholders’ Wealth
Shareholders’ Wealth
Ending balance
Revenues (SE)
Recorded
as credits
Expenses (SE)
Recorded
as debits
Dividends Declared (SE)
Recorded
as debits
Chart of Accounts
9
Financial transactions in the Accounting Cycle are
summarized in the Chart of Accounts.

Permanent Accounts

Statement of Financial Position Accounts

Assets






Cash
Accounts Receivable
Inventory
Prepaid Insurance
Land
Equipment

Liabilities




Accounts Payable
Interest Payable
Bank Loan
Shareholders’ Equity


Common Shares
Retained Earnings
Chart of Accounts
10

Temporary Accounts
 Statement
of Earnings Accounts:
 Sales
Revenues
 Cost of Goods Sold
 Insurance Expense
 Interest Expense
 Amortization Expense

Retained Earnings Statement Account:
o Dividends Declared
Accounting Cycle
11
Chart of Accounts
Opening balances
Transactions or
events
Closing entries
Preparation of
financial statements
Transaction analysis
Adjusted trial balance
Journal entries
Adjusting entries
Posting
Trial balance
Accounting Cycle
12

Opening Balances


Transactions or Events – Recognizing transactions


Evidenced by source documents
Transaction Analysis


Balances carried forward from the end of the last
accounting cycle
Decide which accounts are affected and by how much
Journal Entries

Journal: chronological listing of events
Journal Entry Format
13
1
Date
Account Name
Jan XX
Account to be debited
Account to be credited
- Brief explanation -
Debit Credit
$ XX
$ XX
Transaction Analysis
14

Transaction 1: On Feb 1, Demo Co. pays off $1,000 of the
principal of its bank loan.

Effects:


Liabilities (Bank loan) decreased by $1,000
Assets (Cash) decreased by $1,000
# Date
1
Account Name
Feb 1, 2011 Bank loan (L)
Cash (A)
- repayment of loan -
Debit Credit
1,000
1,000
Transaction Analysis
15

Transaction 2: On Feb 1, Demo Co. signs a one-year lease
agreement for office and storage space. The rent is $450 per month,
and Demo pays the first and last month’ rent (a total of $900)
immediately.

Effects:


Assets (Prepaid rent) increased by $900
Assets (Cash) decreased by $900
# Date
2
Account Name
Feb 1, 2011 Prepaid rent (A)
Cash (A)
- payment of rent in advance -
Debit Credit
900
900
Transaction Analysis
16

Transaction 3: On Feb 5, Demo Co. buys $30,000 of additional
inventory on account.

Effects:


Assets (Inventory) increased by $30,000
Liabilities (Accounts payable) increased by $30,000
# Date
3
Account Name
Feb 5, 2011 Inventory (A)
Accounts payable (L)
- purchase of inventory on account
Debit Credit
30,000
30,000
Transaction Analysis
17

Transaction 4: On Feb 8, Demo Co. sells goods to customers for
$40,000. Cash sales were $4,000, while the remaining $36,000
are on account.

Effects:



Assets (Cash) increased by $4,000
Assets (Accounts receivable) increased by $36,000
Shareholders’ equity (Sales revenues) increased by $40,000
# Date
Account Name
4 Feb 8, 2011 Cash (A)
Accounts receivable (A)
Sales revenues(SE)
- sale of goods for cash and on account-
Debit Credit
3,000
36,000
40,000
Transaction Analysis
18

Transaction 5: The company determines that the cost of goods sold
on Feb 8 is $27,000.

Effects:


Assets (Inventory) decreased by $27,000
Shareholders’ equity (Cost of goods sold) increased by $27,000
# Date
Account Name
5 Feb 8, 2011 Cost of goods sold (SE)
Inventory (A)
- Removal of goods sold from inventory-
Debit Credit
27,000
27,000
Transaction Analysis
19

Transaction 6: On Feb 10, Demo Company buys office supplies for
$500 cash.

Effects:


Assets (Office supplies) increased by $500
Assets ( Cash) decreased by $500
# Date
Account Name
6 Feb 10 2011 Office supplies (A)
Cash (A)
- Purchase of supplies for cash-
Debit Credit
500
500
Transaction Analysis
20

Transaction 7: On Feb 12, Demo Company buys additional
equipment for $3,000 cash.

Effects:


Assets (Equipment) increased by $3,000
Assets ( Cash) decreased by $3,000
# Date
Account Name
7 Feb 12 2011 Equipment (A)
Cash (A)
- Purchase of equipment for cash-
Debit Credit
3,000
3,000
Transaction Analysis
21

Transaction 8: On Feb 15, shareholders invest an additional
$5,000 cash in the business.

Effects:


Assets (Cash) increased by $5,000
Shareholders’ Equity (Share Capital) increased by $5,000
# Date
Account Name
8 Feb 15 2011 Cash (A)
Share capital (SE)
- Issuance of shares for cash-
Debit Credit
5,000
5,000
Transaction Analysis
22

Transaction 9: On Feb 18, Demo collects all but $5,000 of the
amounts due from its customers.

Analysis:
Beginning accounts receivable
$2,000
Sales on account during period
36,000
Total A/R to be collected
38,000
Ending balance in A/R
(5,000)
Cash collected during the period $ 33,000
Transaction Analysis
23

Transaction 9 (continued)

Effects:


Assets (Cash) increased by $33,000
Assets (Accounts receivable) decreased by $33,000
# Date
Account Name
9 Feb 18 2011 Cash (A)
Accounts receivable (A)
- Collection of customers’ accounts -
Debit Credit
33,000
33,000
Transaction Analysis
24

Transaction 10: On Feb 20, Demo Co. makes payments of $34,000
on its accounts payable.

Effects:


Assets (Cash) decreased by $34,000
Liabilities (Accounts payable) decreased by $34,000
# Date
Account Name
10 Feb 20 2011 Accounts payable (L)
Cash (A)
- Payment of amounts due to suppliers -
Debit Credit
34,000
34,000
Transaction Analysis
25

Transaction 11: On Feb 25, Demo Co. pays $2,500 for salaries. In
addition, employees are still owed $300 for time worked during
February.

Effects:



Assets (Cash) decreased by $2,500
Liabilities (Salaries payable) increased by $500
Shareholders’ equity (Salaries expense) decreased by $2,800
# Date
Account Name
11 Feb 25 2011 Salaries expense (SE)
Cash (A)
Salaries payable
- To record salaries for February -
Debit Credit
2,800
2,500
300
Transaction Analysis
26

Transaction 12: On Feb 28, dividends of $400 are declared.

Effects:


Shareholders’ equity (Dividends declared) decreased by $400
Liabilities (Dividends payable) increased by $400
# Date
Account Name
12 Feb 28 2011 Dividends declared(SE)
Dividends payable (L)
- Payment of amounts due to suppliers -
Debit Credit
400
400
Accounting Cycle
27

Ledger
 Each
account is listed separately
 Each page represents a specific T account
 Posting
to the Ledger
 Posting:
transferring the information from the journal
entry to the ledger accounts
Demo Co.
Worksheet
John Wiley & Sons Canada, Ltd. ©2011
Accounting Cycle
28

Trial Balance
 Lists
debit and credit balances in all accounts
 Ensures that:
Total debit balances = Total credit balances
DEMO Co.
Trial Balance
February 28, 2011
29
Account Names
Cash
Accounts receivable
Inventory
Prepaid insurance
Prepaid rent
Office supplies on hand
Land
Equipment
Accumulated depreciation on equipment
Accounts payable
Interest payable
Income tax payable
Salaries payable
Dividends payable
Bank loan
Share capital
Retained earnings
Sales revenue
Cost of goods sold
Salaries expense
Rent expense
Utilities expense
Depreciation expense
Insurance expense
Interest expense
Income tax expense
Dividends declared
Totals
Debits
2,190
5,000
Credits
17,000
300
900
500
15,000
7,500
150
5,500
50
235
300
400
9,000
22,500
455
40,000
27,000
2,800
400
78,590
78,590
Accounting Cycle
30

ACCRUAL BASIS: Recognize revenues earned in a period
and expenses incurred to generate those revenues. Recognition
is based on the event itself and not on the timing of the cash
flows.

Adjusting Entries
 To
correct an error
 To recognize a transaction or event not recorded during
the period
Adjusting Entries
31

Most common types of adjusting entries:
 Depreciation
of capital assets;
 Expiration of prepaid expenses;
 Accrual of interest
 Consumption of supplies
Adjusting Entries
32

Transaction 13: Interest on the company’s bank loan must be
accrued (recognized) for the month of February.
February interest = $9,000 x 6% x 1/12 = $45

Effects:


Shareholders’ equity (Interest expense) decreased by $45
Liabilities (Interest payable) increased by $45
# Date
Account Name
13 Feb 28 2011 Interest expense (SE)
Interest payable (L)
- Recognition of Feb interest on loan -
Debit Credit
45
45
Adjusting Entries
33


Transaction 14: Rent must be recorded for the month of
February.
Monthly rent = $450
Effects:


Shareholders’ equity (Rent expense) decreased by $450
Assets (Prepaid rent) decreased by $450
# Date
Account Name
14 Feb 28 2011 Rent expense (SE)
Prepaid rent (A)
- Recognition of Feb rent -
Debit Credit
450
450
Adjusting Entries
34


Transaction 15: Demo Co. determines that the cost of office
supplies still on hand at the end of February is $300.
Analysis: Cost of supplies, beginning of period
$ –
Supplies purchased during the period
500
Total supplies available
500
Supplies on hand, end of period
300
Cost of supplies consumed during period
$ 200
Adjusting Entries
35

Transaction 15: (continued)

Effects:


Shareholders’ equity (Supplies expense) decreased by $200
Assets (Supplies on hand) decreased by $200
# Date
Account Name
15 Feb 28 2011 Office supplies expense (SE)
Supplies on hand (A)
- Recognition of supplies expense for Feb
-
Debit Credit
200
200
Adjusting Entries
36

Transaction 16: Demo Co. received a $135 bill for utilities
consumed in February, but does not plan to pay it until March.

Effects:


Shareholders’ equity (Utilities expense) decreased by $135
Liabilities (Utilities payable) increased by $135
# Date
Account Name
16 Feb 28 2011 Utilities expense (SE)
Utilities payable (L)
- Recognition of utilities for Feb -
Debit Credit
135
135
Adjusting Entries
37


Transaction 17: Demo Company’s accountant determined that the
depreciation on the equipment for February should be $250.
Effects:


Shareholders’ equity (Depreciation expense) decreased by $250
Assets (Accumulated depreciation) decreased by $250
# Date
Account Name
17 Feb 28 2011 Depreciation expense (SE)
Accumulated depreciation (XA)
- Recognition of depreciation for Feb -
Debit Credit
250
250
Adjusting Entries
38


Transaction 18: The cost of insurance coverage for February
must be recognized.
Recall from Ch 2 – Paid for a six-month policy
$360/6mths = $60 per month

Effects:


Shareholders’ equity (Insurance expense) decreased by $60
Assets (Prepaid insurance) decreased by $60
# Date
Account Name
18 Feb 28 2011 Insurance expense (SE)
Prepaid insurance (A)
- Recognition of insurance expired in Feb -
Debit Credit
60
60
Income Tax Expense
39

Transaction 19: Income tax expense must be recognized for

each accounting period.
Recall from Ch 2 – Income tax rate is 25%
Income before tax $8,880 x 25% = $2,220

Effects:


Shareholders’ equity (Income tax expense) decreased by $2,220
Liabilities (Income taxes payable) increased by $2,220
# Date
Account Name
19 Feb 28 2011 Income tax expense (SE)
Income taxes payable (L)
- Recognition of income tax expense for Feb
Debit Credit
2,220
2,220
Accounting Cycle
40

Adjusted trial balance
 After

adjusting entries
Financial statement preparation
 Statement
of Earnings, Statement of Financial Position,
and Cash Flow Statement

Closing entries
 Balances
in temporary accounts are transferred to
Retained Earnings
Demo Co.
Worksheet
DEMO Co.
Adjusted Trial Balance
February 28, 2011
41
Account Names
Cash
Accounts receivable
Inventory
Prepaid insurance
Prepaid rent
Office supplies on hand
Land
Equipment
Accumulated depreciation on equipment
Accounts payable
Interest payable
Income tax payable
Salaries payable
Dividends payable
Bank loan
Share capital
Retained earnings
Sales revenue
Cost of goods sold
Salaries expense
Rent expense
Utilities expense
Depreciation expense
Insurance expense
Interest expense
Income tax expense
Dividends declared
Totals
Debits
2,190
5,000
Credits
17,000
240
450
300
15,000
7,500
400
5,500
95
2,455
300
400
9,000
22,500
455
40,000
27,000
2,800
450
315
250
60
45
2,220
400
81,420
81,420
Demo Company Limited
Statement of Earnings
For the Month Ended
February 28, 2011
January 31, 2011
Revenues:
Sales
$
40,000
$
13,000
Expenses:
Cost of goods sold
Salaries
Rent
Utilities
Office supplies
Depreciation
Insurance
Interest
Income tax
Net income
42
( 27,000)
( 2,800)
( 450)
( 315)
( 200)
( 250)
( 60)
( 45)
( 2,220)
$
6,660
( 9,000)
( 2,000)
( 500)
( 300)
–
( 150)
( 60)
( 50)
( 235)
$
705
Demo Company Limited
Statement of Financial Position
As of
February 28, 2011
January 31, 2011
Current assets:
Cash
$
Accounts receivable
2,190
$
2,090
5,000
2,000
17,000
14,000
Prepaid insurance
240
300
Prepaid rent
450
–
Office supplies
300
–
25,180
18,390
15,000
15,000
Inventory
Non-current assets:
Land
Equipment, original cost
Less: Accumulated dep'n
7,500
4,500
( 400)
7,100
( 150)
4,350
22,100
Total assets
43
$
47,280
19,350
$
37,740
Demo Company Limited
Statement of Financial Position
As of
February 28, 2011
January 31, 2011
5,500
95
2,455
300
400
315
9,065
19,500
50
235
–
–
–
9,785
9,000
18,065
10,000
19,785
22,500
6,715
29,215
47,280
17,500
455
17,955
37,740
Current liabilities:
Accounts payable
Interest payable
Income tax payable
Salaries payable
Dividends payable
Utilities payable
Non-current liabilities:
Bank loan
Total liabilities
44
Shareholders’ equity:
Share capital
Retained earnings
Total shareholders’ equity
Total liabilities & S/H equity
$
$
Closing Entries
45
Remember! Only temporary accounts are closed.

Step 1: Close the Revenue accounts and transfer to Retained
Earnings debiting the Revenues (to bring their balances to zero)
and crediting Retained Earnings.
Revenues
Closing Entry
for $R
Retained Earnings
Balance = $R
Closing Entry
for $R
Balance = 0
Balance = $R
Closing Entries
46

Step 2:
Close the Expense accounts and transfer their
balances to Retained Earnings by crediting the Expenses (to
bring their balances to zero) and debiting Retained
Earnings.
Expenses
Balance = $R
Balance = $E
Closing Entry
for $E
Balance = 0
Retained Earnings
Closing Entry
for $E
Balance = $NI
Retained Earnings
47
Retained earnings at the end of January
Net income for February
Dividends declared in February
Retained earnings at the end of February
$
455
6,660
(400)
$ 6,715
Copyright
48
Copyright © 2011 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or
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or damages, caused by the use of these programs or from the use of the information
contained herein.
John Wiley & Sons Canada, Ltd. ©2011