Chapter 2
Dr
Cr
The Accounting
Process
Chapter 2--Learning Objectives
1. Analyze transactions based
upon the accounting equation
Accounting Equation
Assets = Liabilities + Equity
or
Assets - Liabilities = Equity
Accounting Equation
Assets = Liabilities + Equity
Assets
Have value
Will generate future
cash flows
Accounting Equation
Assets = Liabilities + Equity
Assets
Factory building
Equipment
Accounts receivable
Accounting Equation
Assets = Liabilities + Equity
Liabilities
Obligations
Incurred to Acquire
Assets
Accounting Equation
Assets = Liabilities + Equity
Liabilities
Accounts Payable
Salaries Payable
Bonds Payable
Accounting Equation
Assets = Liabilities + Equity
Equity
Owner Claim to Assets
Assets - Liabilities
The Accounting Equation
Investments by Owners
Distributions to Owners
Assets = Liabilities + Equity
Revenues - Expenses
Gains - Losses
Transactions & Events
• Affect Balance Sheet only
• Affect Balance Sheet & Earnings
Transactions affecting the
balance sheet
•
•
•
•
•
Investments by owners
Distributions to owners
Use assets to acquire other assets
Use assets to extinguish debt
Acquire assets by incurring debt
Accounting Equation
Assets = Liabilities + Equity
Example
Purchased a Car for $22,000
Paid $5,000 down
Signed a note for the balance
Effect on Accounting Equation
Assets = Liabilities + Equity
Car
$22,000
Note $17,000
Cash ( 5,000)
Assets $17,000 = Liab $17,000
Transactions affecting Earnings
• Earnings = Change in net assets, excluding
investments by and distributions to owners
• Equity = Net assets
• Earnings increase equity
• Earnings = Revenues - Expenses + Gains Losses
• Earnings increase equity through revenues,
expenses, gains & losses
Chapter 2--Learning Objectives
2. Interpret the four traditional
financial statements
Financial Statements
1. Income statement
2. Statement of changes in
shareholders’ equity
3. Balance sheet
4. Statement of cash flows
Income Statement
Elements




Revenues
Expenses
Gains
Losses
}
For the
accounting
period
Statement of changes in
shareholders’ equity
 Investments by
owners
 Distributions to
owners
 Net income or
loss
}
For the
accounting
period
Balance Sheet
Elements
 Assets
 Liabilities
 Equity
}
At the end of the
accounting
period
Statement of cash flows
 Investing
activities
 Financing
activities
 Operating
activities
}
For the
accounting
period
Relationship of Financial
Statements
Income
Statement
Statement
of
Owner’s
Equity
Revenue
+ Gains
- Expenses
-Losses
Net Income
Balance
Sheet
Income
Statement
Revenue
+ Gains
- Expenses
-Losses
Statement
of
Owner’s
Equity
Balance
Sheet
R/E Beginning Balance
+ Net Income
- Dividends
Net Income
R/E Ending Balance
}
Income
Statement
Revenue
Statement
of
Owner’s
Equity
+ Gains
R/E BB
- Expenses
+ Net Income
-Losses
- Dividends
Net Income
R/E EB
Balance
Sheet
Income
Statement
Revenue
Statement
of
Owner’s
Equity
Balance
Sheet
Assets
+ Gains
R/E BB
Liabilities
- Expenses
+ Net Income
Equity
-Losses
- Dividends
Net Income
R/E EB
Income
Statement
Revenue
Statement
of
Owner’s
Equity
Balance
Sheet
Assets
+ Gains
R/E BB
Liabilities
- Expenses
+ Net Income
Equity
-Losses
- Dividends
Net Income
R/E EB
Income
Statement
Revenue
Statement
of
Owner’s
Equity
Balance
Sheet
Assets
+ Gains
R/E BB
Liabilities
- Expenses
+ Net Income
Equity
-Losses
- Dividends
Net Income
R/E EB
Income
Statement
Revenue
Statement
of
Owner’s
Equity
Balance
Sheet
Assets
+ Gains
R/E BB
Liabilities
- Expenses
+ Net Income
Equity
-Losses
- Dividends
Net Income
R/E EB
Income
Statement
Revenue
Statement
of
Owner’s
Equity
Balance
Sheet
Assets
+ Gains
R/E BB
Liabilities
- Expenses
+ Net Income
Equity
-Losses
- Dividends
Net Income
R/E EB
Income
Statement
Revenue
Statement
of
Owner’s
Equity
Balance
Sheet
Assets
+ Gains
R/E BB
Liabilities
- Expenses
+ Net Income
Equity
-Losses
- Dividends
Net Income
R/E EB
Chapter 2--Learning Objectives
3. Understand the accounting
model including the purpose
of journals and ledgers
Journals
• Journals - Books of Original Entry
– Record transactions or events
• i.e, Journal entries
– In chronological order
– Complete record of effects of transaction on
accounts
– Accounts and amounts debited /credited
Sample Transaction
Paid $1,000 on Account to XYZ
Supplies
Journal Entry
Accounts Payable
Cash
1,000
1,000
Ledgers
• Ledgers - Contain Accounts
– General Ledger
• Contains accounts for financial statement
elements
Posting
• From Journal to General Ledger Account
Journal Entry
Accounts Payable
1,000
Cash
1,000
Accounts Payable
Debit
Credit
10,000
1,000
9,000
Types of Journal
• General Journals
• Special Journals
Special Journals
•
•
•
•
Cash Receipts Journal
Cash Disbursements Journal
Purchases Journal
Sales Journal
Cash Receipts Journal
• Record All receipts of Cash
– ie, deposits to the bank
• Examples:
– Cash sales
– Received Cash on account
– Sold company truck for cash
Cash Disbursements Journal
• Record All payments of Cash
– ie, checks written
• Examples:
– Paid supplier on account
– Purchased truck for cash
– Made mortgage payment
Sales Journal
• Record All Sales on Account
– When sale is made and no cash is received
Purchases Journal
• Record All Purchases of merchandise on
Account
– When purchases are made and no cash is paid
– Purchases of items other than merchandise are
recorded in the general journal
General Journal
• For All other Journal Entries
• Examples:
– Adjusting
– Closing
– Sales & purchase returns
Chapter 2--Learning Objectives
4. Perform the steps in the
accounting process
Accounting Cycle
Transactions
Events
Record
Inputs
Source
Docs
Accumulate
in Accounts
Outputs
Financial
Statements
During the Accounting Period
1 Identify transactions & events to record
2 Journalize transactions & events
3 Post from journals to ledgers
At the end of the accounting
period
4
5
6
7
8
9
Prepare Unadjusted Trial Balance
Journalize & Post adjusting entries
Prepare Adjusted Trial Balance
Prepare Financial Statements
Journalize & Post closing entries
Prepare Post Closing Trial Balance
At beginning of next accounting
period
10 Journalize & Post reversing entries
Adjusting Entries - Types
Deferrals
Accruals
Estimated Items
Inventory
Deferrals
Prepaid Expenses
Unearned revenues
Typical Deferred Expenses
Supplies
Prepaid Rent
Bookkeeping Approaches

Record transaction as expense

Record transaction as asset
Accounting Approach
Original debit to expense
– Adjusting Entry
Debit Prepaid
Credit Expense
Example:
12/1/x1: Paid 3 month rent in advance,
$3,000
Journal Entry
Rent Expense
Cash
3,000
3,000
Year End - 12/31
$1,000 has expired = Expense
$2,000 is unexpired = Asset
Have on Books
Want on Books
Rent Expense
1,000
Rent Expense
3,000
Prepaid Rent
2,000
Adjustment
Rent Expense
3,000
2,000
Prepaid Rent
2,000
1,000
Adjusting Entry
Prepaid Rent
Rent Expense
2,000
2,000
Accounting Approach
Original debit to Asset
– Adjusting Entry
Debit Expense
Credit Prepaid
Example:
12/1/x1: Paid 3 month rent in advance,
$3,000
Journal Entry
Prepaid Rent
Cash
3,000
3,000
Year End - 12/31
$1,000 has expired = Expense
$2,000 is unexpired = Asset
Have on Books
Want on Books
Rent Expense
1,000
Prepaid Rent
3,000
Prepaid Rent
2,000
Adjustment
Prepaid Rent
3,000
Rent Expense
1,000
1,000
2,000
Adjusting Entry
Rent Expense
Prepaid Rent
1,000
1,000
Unearned Revenues
Obligations to perform services for which
money has already been received
Typical Unearned Revenues
Rent Received in Advance
Subscriptions Received in Advance
Bookkeeping Approaches

Record transaction as revenue

Record transaction as liability
Accounting Approach
Original credit to Revenue
– Adjusting Entry
Debit Revenue
Credit Unearned Revenue
Example:
12/1/x1: Received 3 month rent in
advance, $3,000
Journal Entry
Cash
3,000
Rental Revenue
3,000
Year End - 12/31
$1,000 is earned
= Revenue
$2,000 is unearned = Liability
Have on Books
Want on Books
Rental Revenue
1,000
Rental Revenue
3,000
Rent Received in Advance
2,000
Adjustment
Rental Revenue
3,000
2,000
Rent Received in Advance
2,000
1,000
Adjusting Entry
Rental Revenue
2,000
Rent Rec’d in Adv
2,000
Accounting Approach
Original credit to Liability
– Adjusting Entry
Debit Liability
Credit Revenue
Example:
12/1/x1: Received 3 month rent in
advance, $3,000
Journal Entry
Cash
3,000
Rent Received
in Advance
3,000
Year End - 12/31
$1,000 in earned
= Revenue
$2,000 is unearned = Liability
Have on Books
Rent Rec’d in Advance
Want on Books
Rental Revenue
1,000
3,000
Rent Rec’d in Advance
2,000
Adjustment
Rent Rec’d in Advance
Rental Revenue
3,000
1,000
1,000
2,000
Adjusting Entry
Rent Rec in Adv
1,000
Rental Revenue
1,000
Accruals
Accrued Expenses
– Payables
Accrued Revenues
– Receivables
Typical Accrued Expenses
Salaries Payable
Interest payable
Taxes Payable
Most Common Accrued Revenue
Interest Receivable
Typical Estimated Items
Depreciation
Bad Debt Expense
Pension Expense
Inventory Adjustment
Close Beginning Inventory
Close Purchases
Insert Ending Inventory
Difference = Cost of Goods Sold
Cost of Goods Sold
Beginning Inventory
+ Purchases
Goods available for Sale
- Ending Inventory
Cost of Goods Sold
Example
Beginning Inventory
Purchases
Ending Inventory
10,000
95,000
7,000
Cost of Goods Sold
Beg Inv
+ Purchases
10,000
95,000
Available
105,000
- End Inv
7,000
CGS
98,000
Have on Books
Want on Books
Inventory
Inventory
10,000
Purchases
7,000
Cost of Goods Sold
98,000
95,000
Inventory
10,000
Purchases
95,000
CGS
Inventory
Purchases
95,000
CGS
10,000
Inventory
Purchases
95,000
CGS
10,000
Inventory
Purchases
95,000
CGS
10,000
Inventory
Purchases
CGS
10,000
95,000
Inventory
7,000
Purchases
CGS
10,000
95,000
7,000
Inventory
7,000
Purchases
CGS
10,000
95,000
98,000
7,000
Inventory
10,000
Account
Inventory
Purchases
CGS
95,000
Debit
Credit
10,000
Inventory
Account
Purchases
Inventory
Purchases
95,000
CGS
Debit
Credit
95,000
10,000
Inventory
Purchases
7,000
Account
Inventory
Cost of Goods Sold
Purchases
Inventory
CGS
98,000
Debit
Credit
7,000
98,000
95,000
10,000
Inventory
Purchases
CGS
10,000 10,000 95,000 95,000
7,000
98,000
7,000
98,000
Account
Inventory
Cost of Goods Sold
Purchases
Inventory
Debit
Credit
7,000
98,000
95,000
10,000
Closing the Books
The only thing left
Balance
Sheet
Assets
Liabilities
Permanent Accounts
Equity
Income
Statement
Revenue
Statement
of
Owner’s
Equity
+ Gains
R/E BB
- Expenses
+ Net Income
-Losses
- Dividends
Net Income
R/E EB
T
e
m
p
o
r
a
r
y
Income
Statement
Revenue
Statement
of
Owner’s
Equity
+ Gains
R/E BB
- Expenses
+ Net Income
-Losses
- Dividends
Net Income
R/E EB
Close
to
R/E
Closing
Close all income statement accounts to the
Income Summary
Close Income Summary to R/E
Close Dividends to R/E
Adjusted Trial Balance
Debits
Credits
Current Assets
40,000
Current Liabs
15,000
Investments
15,000
Long Term Liabs
65,000
Plant Assets
90,000
Common Stock
27,000
Dividends
2,000
Retained Earnings
CGS
45,000
Net Sales
Adm Expenses
11,000
Interest Revenue
Selling Expense
14,000
Interest Expense
4,000
Total
221,000
Total
6,000
100,000
8,000
221,000
Close Income Statement Accounts
Debit
Net Sales
Interest Revenue
CGS
Admin Expenses
Selling Expense
Interest Expense
Income Summary
Credit
100,000
8,000
45,000
11,000
14,000
4,000
34,000
Close Income Summary Account
Debit
Income Summary
Retained Earnings
Credit
34,000
34,000
Close Dividends
Debit
Retained Earnings
Dividends
Credit
2,000
2,000
Income Summary
Retained Earnings
6,000
34,000
38,000
34,000
0
Dividends
2,000
2,000
2,000
38,000
Reversing Entries
Reverse certain adjusting entries
Dated: Beginning of next accounting
period
Facilitate the bookkeeping process
What entries to reverse?
All Accruals
Those deferrals that increased balance sheet
accounts
– i.e., returns amounts to expense & revenue
accounts
Accrual Example
Salaries are $1,000/day. The year ended on
Tuesday. Salaries are paid each Monday for
the previous week.
Year end adjustment (for 2 days)
Salary Expense
2,000
Salaries Payable
2,000
Accounting Approaches
Make reversing entry
Don’t make reversing entry
Payment of the Salaries:
Assume no reversing entry is made
When the salaries are paid the following
Monday
Salaries Payable
2,000
Salary Expense
3,000
Cash
5,000
At year end
Salary Expense
2,000
Salaries Payable
2,000
Adjusting Entry
Salary Expense
2,000
2,000
Salaries Payable
2,000
Closing Entry
Beginning of next accounting period
Salary Expense
Salaries Payable
2,000
Salary Expense
3,000
Salaries Payable
2,000
2,000
Pay Salaries
Account balances after payment
Salary Expense
3,000
Salaries Payable
Assume instead:
The following reversing entry was made
Salaries Payable
2,000
Salary Expense
2,000
Payment of the Salaries
• When the salaries are paid the following
Monday
Salary Expense
Cash
5,000
5,000
At year end
Salary Expense
2,000
Salaries Payable
2,000
Adjusting Entry
Salary Expense
2,000
2,000
Salaries Payable
2,000
Closing Entry
Beginning of next accounting period
Salary Expense
2,000
Salaries Payable
2,000
2,000
Reversing Entry
Pay Salaries
Salary Expense
5,000
Salaries Payable
2,000
3,000
End result is the same
Deferrals
Adjusting
Entry Increases
Asset or
Liability
Reverse
Adjusting Entry
Decreases
Asset or
Liability
Don’t
Reverse
Deferrals:
Example - Deferred Expenses
Original =
Debit to Expense
Original =
Debit to Asset
Adjusting Entry
Adjusting Entry
Debit Prepaid
Debit Expense
Credit Expense
– Reverse
Credit Prepaid
– Don’t Reverse
Example:
12/1/x1: Paid 3 month rent in advance,
$3,000
Original entry to expense
Journal Entry
Rent Expense
Cash
3,000
3,000
Adjustment
Rent Expense
3,000
2,000
Prepaid Rent
2,000
1,000
Adjusting Entry
Prepaid Rent
Rent Expense
2,000
2,000
Year End Balances
Rent Expense
1,000
1,000
Prepaid Rent
2,000
Closing Entry
Beginning of Next Year
Rent Expense
2,000
Prepaid Rent
2,000
Reversing Entry
2,000
Example:
12/1/x1: Paid 3 month rent in advance,
$3,000
Original entry to asset
Journal Entry
Prepaid
Cash
3,000
3,000
Adjustment
Prepaid
3,000
Rent Expense
1,000
1,000
2,000
Adjusting Entry
Rent Expense
Prepaid Rent
1,000
1,000
Year End Balances
Rent Expense
1,000
1,000
Prepaid Rent
2,000
Closing Entry
Beginning of Next Year
Rent Expense
Prepaid Rent
2,000
Don’t Reverse
Exercise
• Given: Adjusting Entries
• Determine whether each AJE relates to
– Accrual (A)
– Deferral (D)
• If a deferral, Did the entry Increase a
Balance Sheet Account?
• Reverse AJE?
SALARY EXPENSE
SALARIES PAYABLE
Accrual (A)
or
Deferral (D)
Reverse?
Yes
or
No
SUPPLIES EXPENSE
SUPPLIES
Accrual (A)
or
Deferral (D)
Increase Balance
Sheet Account?
Yes
or
No
Yes
or
No
Reverse?
SUPPLIES
SUPPLIES EXPENSE
Accrual (A)
or
Deferral (D)
Increase Balance
Sheet Account?
Yes
or
No
Yes
or
No
Reverse?
INTEREST EXPENSE
INTEREST PAYABLE
Accrual (A)
or
Deferral (D)
Reverse?
Yes
or
No
RENT RECEIVED IN ADVANCE
RENTAL REVENUE
Accrual (A)
or
Deferral (D)
Increase Balance
Sheet Account?
Yes
or
No
Yes
or
No
Reverse?
RENTAL REVENUE
RENT RECEIVED IN ADVANCE
Accrual (A)
or
Deferral (D)
Increase Balance
Sheet Account?
Yes
or
No
Yes
or
No
Reverse?
Other Adjusting Entries
Estimated Items
Cost of Goods Sold
Should they be reversed?
NEVER
DEPRECIATION EXPENSE
ACCUMULATED DEPRECIATION
Reverse?
Yes
or
Estimated Item
Never Reverse
No
INVENTORY
COST OF GOODS SOLD
PURCHASES
Reverse?
Yes
or
Cost of Goods Sold
Never Reverse
No