Review of the Accounting Process Chapter 2 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. 2-2 OVERVIEW Chapter 1 explained that the primary means of conveying financial information to investors, creditors, and other external users is through financial statements and related notes. The purpose of this chapter is to review the fundamental accounting process used to produce the financial statements. This review establishes a framework for the study of the concepts covered in intermediate accounting. Actual accounting systems differ significantly from company to company. This chapter focuses on the many features that tend to be common to any accounting system. 2-3 The Accounting Equation A = L + OE + Owner Investments - Owner Withdrawals + Revenues + Gains - Expenses - Losses 2-4 Accounting Equation for a Corporation A = L + SE + Paid-in Capital + Retained Earnings + Revenues - Expenses - Dividends + Gains - Losses Accounting Equation, Debits and Credits, Increases and Decreases Permanent Accounts—assets, liabilities, paid-in capital, retained earnings Temporary Accounts-revenues, gains, expenses, losses 2-5 10 Steps Source Documents During the Accounting Period Transaction Analysis Record in Journal 2-6 Post to Ledger At the End of the Accounting Period Financial Statements Adjusted Trial Balance Record & Post Adjusting Entries At the End of the Year Close Temporary Accounts Post-Closing Trial Balance Unadjusted Trial Balance The Accounting Processing Cycle 2-7 The Steps of the Accounting Processing Cycle Example : Heidi Jara opened Jara’s Cleaning Service on July 1, 2015. During July, the following transactions were completed. July 1- Stockholders invested $20,000 cash in the business in exchange for common stock. 1- Purchased used truck for $9,000, paying $4,000 cash and the balance on account. 3- Purchased cleaning supplies for $2,100 on account. 5- Paid $1,800 cash on a 1-year insurance policy effective July 1. 12- Billed customers $4,500 for cleaning services. 18 - Paid $1,500 cash on amount owed on truck and $1,400 on amount owed on cleaning supplies. 2-8 2-9 20 - Paid $2,500 cash for employee salaries. 21- Collected $3,400 cash from customers billed on July 12. 25- Billed customers $6,000 for cleaning services. 31- Paid $350 for the monthly gasoline bill for the truck. 31- Paid a $5,600 cash dividend. The chart of accounts for Jara’s Cleaning Service contains the following accounts: No. 101 Cash, No. 112 Accounts Receivable, No. 126 Supplies, No. 130 Prepaid Insurance, No. 157 Equipment, No. 158 Accumulated Depreciation— Equipment, No. 201 Accounts Payable, 2-10 No. 212 Salaries and Wages Payable, No. 311 Common Stock, No. 320 Retained Earnings, No. 332 Dividends, No. 350 Income Summary, No. 400 Service Revenue, No. 631 Supplies Expense, No. 633 Gasoline Expense, No. 711 Depreciation Expense, No. 722 Insurance Expense, and No. 726 Salaries and Wages Expense. Instructions (a) Journalize and post the July transactions. (b) Prepare a trial balance at July 31 (c) Enter the following adjustments 2-11 (1) Unbilled and uncollected revenue for services performed at July 31 were $2,700. (2) Depreciation on equipment for the month was $500. (3) One-twelfth of the insurance expired. (4) An inventory count shows $600 of cleaning supplies on hand at July 31. (5) Accrued but unpaid employee salaries were $1,000. d) Prepare a adjusted Trial Balance on July 31. e) Prepare an income statement and a retained earnings statement for July and a classified balance sheet at July 31. (f)Journalize and post closing entries and complete the closing process. (g) Prepare a post-closing trial balance at July 31. 2-12 Adjusting Entries At the end of the period, adjusting entries are required to satisfy the realization principle and the matching principle. Prepayments Accruals Estimates 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. Accountants must often make estimates in order to comply with the accrual accounting model. 2-13 Prepaid Expenses Expense Asset Unadjusted Balance Credit Adjustment Today, I will pay for my first 6 months’ rent. Debit Adjustment Prepaid Expenses Items paid for in advance of receiving their benefits 2-14 Depreciation Depreciation is the process of allocating the cost of plant and equipment over their expected useful lives. Straight-Line Depreciation Asset Cost - Salvage Value = Useful Life 2-15 Depreciation After posting, the accounts look like this: Furniture and Fixtures Beg. bal. 12,000 Bal. 12,000 Depreciation Expense Beg. bal. 200 Bal. 200 Accumulated Depreciation Beg. bal. 200 200 Bal. 2-16 Unearned Revenues Liability Debit Adjustment Unadjusted Balance Buy your season tickets for all home basketball games NOW! “Go Big Red” Revenue Credit Adjustment Unearned Revenue Cash received in advance of performing services 2-17 Accrued Liabilities Expense Debit Adjustment I won’t pay you until the job is done! Liability Credit Adjustment Accrued Liabilities Liabilities recorded when an expense has been incurred prior to cash payment. 2-18 Accrued Receivables Asset Debit Adjustment Yes, you can pay me in May for your April 15 tax return. Revenue Credit Adjustment Accrued Receivables Revenue earned in a period prior to the cash receipt. Adjusting Entries 2-19 2-20 Estimates Accountants often must make estimates of future events to comply with the accrual accounting model. Examples Depreciation Uncollectible accounts $ 2-21 The Income Statement Dress Right Clothing Corporation Income Statement For Month Ended July 31, 2013 Sales revenue $ Cost of goods sold Gross profit Other expenses: Salaries $ 10,500 Supplies 800 Rent 2,000 Depreciation 200 Total operating expenses Operating income Other income (expense): Rent revenue 250 Interest expense (333) Net income $ 38,500 22,000 16,500 13,500 3,000 (83) 2,917 The income statement summarizes the results of profit-generating activities of the company. The Statement of Comprehensive Income A few types of gains and losses, called other comprehensive income (OCI) or loss items, are excluded from the determination of net income and the income statement, but are included in the broader concept of comprehensive income. In the single statement approach, net income is a subtotal within the statement followed by these OCI items, culminating in a final total of comprehensive income. In the two statement approach, a company presents an income statement followed by a statement of comprehensive income. We will discuss comprehensive income in more depth in Chapter 4. 2-22 2-23 The Balance Sheet Dress Right Clothing Corporation Balance Sheet At July 31, 2013 Assets Current assets: Cash Accounts receivable Supplies Inventory Prepaid rent Total current assets Property and equipment: Furniture and fixtures Less: Accumulated depreciation Total assets $ $ 12,000 200 68,500 2,000 1,200 38,000 22,000 131,700 11,800 $ 143,500 The balance sheet presents the financial position of the company on a particular date. 2-24 The Balance Sheet Dress Right Clothing Corporation Balance Sheet At July 31, 2013 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Salaries payable Unearned rent revenue Interest payable Note payable Total current liabilities Long-term liabilities: Note payable Shareholders' equity: Capital stock Retained earnings Total shareholders' equity Total liabilities and shareholders' equity $ 35,000 5,500 750 333 10,000 51,583 30,000 $ 60,000 1,917 $ 61,917 143,500 Notice that assets of $143,500 equals total liabilities plus shareholders’ equity of $143,500. 2-25 The Statement of Cash Flows Dress Right Clothing Corporation Statement of Cash Flows For the Month of July 2013 Cash flows from Operating Activities: Cash inflows: From customers From rent Cash outflows: For rent For supplies To suppliers for merchandise To employees Net cash used by operating activities Cash flows from Investing Activities: Purchase of furniture and fixtures Cash flows from Financing Activities: Issue of capital stock Increase in notes payable Payment of cash dividend Net cash provided by financing activities Net increase in cash $ 36,500 1,000 (24,000) (2,000) (25,000) (5,000) $ (18,500) (12,000) $ 60,000 40,000 (1,000) $ 99,000 68,500 The statement of cash flows discloses the changes in cash during a period. 2-26 The Statement of Shareholders’ Equity Dress Right Clothing Corporation Statement of Shareholders' Equity For the Month of July 2013 Balance at July 1, 2013 Issue of capital stock Net income for July 2013 Less: Dividends Balance at July 31, 2013 Total Common Retained Shareholders' Stock Earnings Equity $ $ $ 60,000 60,000 2,917 2,917 (1,000) (1,000) $ 60,000 $ 1,917 $ 61,917 The statement of shareholders’ equity presents the changes in permanent shareholder accounts. 2-27 The Closing Process Income Summary Liabilities Permanent Accounts Shareholders’ Equity Temporary Accounts Assets Dividends Expenses Revenues The closing process applies only to temporary accounts. 2-28 Post-Closing Trial Balance DRESS RIGHT CLOTHING CORPORATION Post-Closing Trial Balance July 31, 2013 Account Title Debits Credits Cash 68,500 Accounts receivable 2,000 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 1,917 Totals 143,700 143,700 Lists permanent accounts and their balances. Total debits equal total credits. 2-29 End of Chapter 2