Chapter 3
Review of a
Company’s
Accounting System
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.
2
Accounting Equation
Assets
=
Liabilities
+
Stockholder’s
Equity
3
Accounting Equation
Assets
Assets are the corporation’s economic
resources and have future value.
4
Accounting Equation
= Liabilities
Liabilities are obligations or
debts. A liability is a present
obligation for a future
sacrifice as a result of a past
transaction.
5
Accounting Equation
+ Stockholders’ Equity
Stockholder’s
equity is the
residual interest in
assets or net worth,
which is assets
minus liabilities.
Net Worth
6
Revenues
Revenues are
charges to
customers for goods
or services
provided.
7
Expenses
Expenses are assets that
have expired, been
consumed, or become
cost of goods sold and
have no future value.
8
Accounts
Title
Account title.
9
Accounts
Title
Debit
“Debit” refers
to the left side.
10
Credit refers to
the right side.
Accounts
Debit
Title
Credit
11
Accounts
In the double-entry system, for each
transaction that a company records, the total
dollar amount of the debits must equal the
total dollar amount of the credits.
12
Accounts
Assets
Asset Accounts
(debit) (credit)
Increase Decrease
Permanent (Real) Accounts
=
Liabilities + Stockholders’ Equity
Liability Accounts
(debit) (credit)
Decrease Increase
Capital Stock Accounts
(debit)
(credit)
Decrease Increase
Retained Earnings .
(debit)
(credit)
Decrease Increase
The debits must equal the credits
13
Accounts
Temporary (Nominal) Accounts
Revenue Accounts
(debit)
(credit)
Decrease Increase
Retained Earnings.
(debit)
(credit)
Decrease Increase
Expense Accounts
(debit)
(credit)
Increase Decrease
Dividend Accounts
(debit)
(credit)
Increase Decrease
14
Financial Statements
1. The Income Statement--This statement
summarizes the results of a company’s
income-producing activities for an accounting
period.
2. The Balance Sheet--The balance sheet
summarizes the amounts of a company’s
assets, liabilities, and stockholders’ equity on
a particular date.
3. The Statement of Cash Flows--It
summarizes a company’s cash receipts and
cash payments during the accounting period.
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The Accounting Cycle
1. Record daily transactions in a journal.
2. Post the journal entries to the accounts in
the ledger.
3. Prepare and post adjusting entries.
4. Prepare the financial statements.
5. Prepare and post closing entries for
revenue, expense, and dividend accounts.
16
Comprehensive
Illustration for Dapple
Corporation
Step 1: Journalizing:
Recording in the
General Journal
17
GENERAL JOURNAL
Date
2007
Account Titles and Explanations
Jan. 1 Cash
Capital Stock
Issued 2,000 shares of no-par
stock at $10 per share
Debit
Credit
20,000
On January 1, 2007, various stockholders
invest in Dapple by purchasing 2,000
shares of no-par stock at $10 per share.
20,000
18
GENERAL JOURNAL
Date
Account Titles and Explanations
Debit
Credit
2007
Jan. 1 Cash On January 16, Dapple purchases
20,000
Capital
twoStock
acres of land as a building
Issued 2,000
no-par
site,shares
payingof$1,500
an acre.
stock at $10 per share
16 Land
Cash
Purchased 2 acres of land at
$1,500 per acre.
20,000
3,000
3,000
19
Comprehensive
Illustration for Dapple
Corporation
Step 2: Posting to
the Ledger
20
GENERAL JOURNAL
Date
2007
Account Titles and Explanations
Jan. 1 Cash
Capital Stock
Issued 2,000 shares of no-par
stock at $10 per share
Debit
Credit
20,000
16 Land
3,000
Cash
Cash
Purchased 2 acres of land at
01/01 20,000
Capital Stock
$1,500 per acre.
01/01 20,000
20,000
3,000
21
GENERAL JOURNAL
Date
Account Titles and Explanations
Debit
Credit
Cash
Jan. 1 Cash
01/01 20,000 01/1620,000
3,000
Capital Stock
20,000
Issued 2,000 shares of no-par
stock at $10 per share
2007
16 Land
Cash
Purchased 2 acres of land at
$1,500 perLand
acre.
01/16 3,000
3,000
3,000
22
After posting, the general
ledger accounts contain
the same information as
in the general journal,
just in a different format.
23
Ledger T Account
Cash
01/01
20,000
04/02
8,000
04/20
160
The 12/01
balance of each 450
12/02 account1,960
permanent
isDetermine
calculatedthe
(see
account
balance.
Example
3-3).
Balance
2,792
01/16
03/30
03/30
04/08
04/15
07/15
10/01
12/28
12/29
3,000
10,840
360
7,300
250
3,300
1,800
428
500
24
After the journal entries
are posted for the
accounting period, a trial
balance is often prepared.
25
Credits
Debits
The trial balance is used to
verify that the total of the
debit balances is equal to
the total of the credit
balances.
26
Comprehensive
Illustration for Dapple
Corporation
Step 3: Preparation
of Adjusting Entries
27
Adjusting Entries
1. The purpose of adjusting entries is to
record revenues and expenses in the
correct period
2. Dated the last day of the accounting period
3. Usually one nominal and one real account
4. No equity accounts or cash (except bank
reconciliation)
28
On March 30, Dapple Corporation purchased
a one-year comprehensive insurance policy.
29
GENERAL JOURNAL
Date
Account Titles and Explanations
Debit
Credit
2007
On
purchased
Jan.
1 March
Cash 30, Dapple Corporation20,000
a one-year
comprehensive
insurance policy.
Capital
Stock
20,000
Issued 2,000 shares of no-par
stock at $10 per share
Mar.
30
Prepaid Insurance
Cash
Purchased a 1-year comprehensive insurance policy.
360
360
30
GENERAL JOURNAL
Date
Account Titles and Explanations
Adjusting Entries
Dec. 31 Insurance Expense
Prepaid Insurance
To record expiration of 9 months
of insurance coverage purchased.
Debit
Credit
270
By December 31, nine months of the
policy had expired.
270
31
Adjusting Entries
Prepaid Insurance
03/30
360
Balance
12/31
Adj.
270
90
Insurance Expense
12/31 Adj.
270
By December 31, nine months of the
policy had expired.
32
On December 1, Dapple Corporation
received $450 for 3 months’ rent in advance.
33
GENERAL JOURNAL
Titles and
Debit
Credit
OnAccount
December
1, Explanations
Dapple Corporation
2007
received
advance.
Jan.
1 Cash $450 for 3 months’ rent in20,000
Date
Capital Stock
Issued 2,000 shares of no-par
stock at $10 per share
Dec. 1 Cash
Unearned Rent
Received 3-months’ rent in advance at $150 per month. Company owes use of portion of
building to Fritz Company for
the 3-month period.
20,000
450
450
34
GENERAL JOURNAL
Date
Account Titles and Explanations
Adjusting Entries
Debit
Dec. 31 Insurance
Expense31, one month’s rent
270
By December
Prepaid
($450 ÷Insurance
3 = $150) has been earned.
To record expiration of 9 months
of insurance coverage purchased.
31 Unearned Rent
150
Rent Revenue
To record earning of 1 month of
rent revenue from receipt collected in advance on December 1.
Credit
270
150
35
Adjusting Entries
Unearned Rent
12/31 Adj. 150
12/01
450
Balance
300
Rent Revenue
12/31 Adj.
150
This entry is posted to the ledger.
36
On December 31, Dapple
Corporation has accrued salaries of
$900.
Entries must be journalized
before they are posted. Examine
the accrued salaries journal
entries in Example 3-4.
37
Adjusting Entries
Salaries Expense
10/01
1,800
12/31 Adj. 900
Salaries Payable
12/31 Adj.
900
Next, the adjusting entry is posted.
38
On September 1, Dapple Corporation
accepted a $1,320, 15% note as
payment when it sold an acre of land.
39
Date
GENERAL JOURNAL
On September
1, Dapple Corporation
Account Titles and Explanations
Debit
Credit
accepted a $1,320, 15% note as
Adjusting Entries
payment when it sold an acre of land.
Sept. 1 Notes Receivable
1,320
Loss on Sale of Land
180
Land
Sold 1 acre of land at less than it
cost, incurring a loss. Buyer
issued a note due in 6 months and
bearing 15% annual interest.
1,500
40
Adjusting Entries
Interest Receivable
12/31 Adj.
66
Interest Revenue
12/31 Adj.
66
Refer to Example 3-4 for the journalized
adjusting entry. By December 31, the
company has earned 4 months of interest
totaling $66 ($1,320 x 0.15 x 4/12).
41
Examine the remaining
adjusting entries in Example
3-4. Then, refer to Example 33 to see their impact on the
ledger.
42
GENERAL
JOURNAL
Some companies
may record
the receipt of
Date revenue
Account
and Explanations
Debit ofCredit
in Titles
advance
as revenues instead
2007
unearned revenues. 20,000
Jan. 1 Cash
At Dec.
31Stock
some of the revenue has still not
Capital
20,000
Issued
2,000 and
shares
no-par entry must be
been
earned
anofadjusting
stock at $10 per share
made.
Dec. 1 Cash
Rent Revenue
450
Dec. 31 Rent Revenue
Unearned Rent
Adjusting entry using alternative
method of recording deferred
revenue
300
450
300
43
GENERAL JOURNAL
Date
Account Titles and Explanations
Debit
Credit
Prepaid expenses may be recorded as
Jan.expenses
1 Cash and the unused portion adjusted
20,000
at
Capital Stockyear end.
20,000
2007
Mar.
30
Issued 2,000 shares of no-par
stock at $10 per share
Insurance Expense
Cash
Purchased a 1-year comprehensive insurance policy.
Dec. 31 Prepaid Insurance
Insurance Expense
360
360
90
90
44
Sales Returns
Sales Returns and Allowances
Accounts Receivable
500
500
OR debit Sales directly.
Sales
Accounts Receivable
500
500
45
Periodic Cost of Goods Sold
Inventory, January 1, 2007
$0
Purchases
$12,600
Less: Purchases returns
(300)
Purchases discounts
(100)
Net purchases
12,200
Cost of goods available for sale
$12,200
Less: Inventory, December 31, 2007 (2,140)
Cost of goods sold
$ 10,060
46
Comprehensive
Illustration for Dapple
Corporation
Step 4: Preparation
of Financial
Statements
47
The completed financial
statements for Dapple
Corporation are found in
Example 3-6 through 3-8.
48
Comprehensive
Illustration for Dapple
Corporation
Step 5: Preparation
of Closing Entries
49
Closing entries (1)
…(2) update the
reduce the balance in
retained earnings and
each temporary account
inventory accounts.
to zero, and...
50
Typical Order of Closing Entries
1. Close temporary accounts with credit
balances to Income Summary and record
the ending inventory.
2. Close temporary accounts with debit balances
to Income Summary and close the
beginning inventory.
3. Close Income Summary to Retained
Earnings.
4. Close Dividends Distributed to Retained
Earnings.
51
Refer again to Example 3-9
to see how the closing
entries “closed” the
temporary accounts.
54
Guidelines for Reversing Entries
Reversing entries may be made for selected
adjusting entries.
1. Dated the first day of the next
accounting period.
2. Any adjusting entry that increases a
real account may be reversed, except
estimated items such as Accumulated
Depreciation and Allowance for
Doubtful Accounts.
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Guidelines for Reversing Entries
3. Other exceptions are Taxes Payable and
any adjusting entries that do not
reverse in the current period.
REVERSING ENTRY
56
Subsidiary Ledgers
Why use a subsidiary ledger?
1.
2.
3.
4.
To reduce the size of the general ledger.
To minimize errors.
To divide the accounting task.
To keep up-to-date records of its dealings
with charge customers and suppliers.
57
Subsidiary Ledgers
General Ledger
Subsidiary
Ledger
Frank Company
Balance 3,000
Accounts Receivable
Balance 7,000
Knox Company
Balance 4,000
58
Special Journals
Sales Journal. Used to record all (and only)
sales of merchandise on account.
Purchases Journal. Used to record all (and
only) purchases of merchandise on account.
Cash Receipts Journal. Used to record all
cash receipts.
Cash Payments Journal. Used to record all
cash payments.
General Journal. Used to record adjusting,
closing, and reversing entries and other
transactions not recorded in the special
journals.
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Chapter 3
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