Chapter 1 Accounting in action
What is Accounting
Accounting is the financial information system that consists of three basic activities-it identifies ,
records , and communicates the economic events of an organization to interested users.
Identification
Recording
Identify economic event s
Record,classify,and summarize
(transactions)
Communication
s
Prepare accounting reports
Analyze and interpret for users
Who uses accounting data ?
Internal users
Internal users of accounting information are managers who plan,organize,and run the
business.These include marketing managers,production supervisors,finance directors, and company
officers.
Managerial accounting provides internal reports to help users make decisions about their
companies.
Questions Asked by Internal Users
Finance
Is cash sufficient to
pay dividends to
SAP shareholders?
Marketing
Human Resources
Management
What price for product
will maximize the
company’s net income?
Can we afford to
give employees pay
raises this year?
Which product line is the most
profitable?Should any product
lines be eliminated?
External users
External users are individuals and organizations outside a company who want financial information
about the company.the two most common types are investors and creditors.Investors(owners) use
accounting information to make decisions to buy,hold,sell ownership shares of a
company.Creditors(such as suppliers and bankers)use accounting information to evaluate the risks
of granting credit or lending money. Financial accounting provides economic and financial
information for investors,creditors,and other external users.
Questions Asked by External Users
Investors
Is that Company
earning satisfactory
income?
Investors
How does A Company compare in size
and profitability with B company?
Creditors
Will A company be able to pay
its debts as they come due?
The Basic Accounting Equation
Assets
=
Liabilities
+
Equity
Assets-something that belongs to you or something you own.
Current Assets(used within a year)
-Cash
-Accounts receivables(A/R)means you will receive the money from the customer in the future,it is an
oral promise.A promise in spoken word only.
-Notes receivables(N/R) is a written promise from customer that you will receive the money in the
future.
-Prepaid expenses are expense that are paid in advance.It means the money is paid before the
expense actually happens.
-Office Supplies
Non-Current Assets(used for more than a year)
-Building -Furniture -Vehicles -Land -Equipment
Liabilities-
something that does not belong to you or something that you owe.
Current Liabilities(for less than a year)
-Accounts Payables(A/P)are the opposite of Accounts Receivable.It means you will pay the money to
the supplier in the future.It is also a promise made in spoken words only.
-Notes Payables(N/P)are the opposite of Note Receivable.It is written promise to pay the money to
the supplier in the future.
-Interest Payables
-Wages Payables -Tax Payables
-Unearned Revenue mean to collect the money first and do the service later in the future.
Non-Current Liabilities(for more than a year)
-Mortgage Payable
-Bank Loans
Stockholder’s Equity(the share holder’s portion of the assets of company)
the capital investment with which a company starts doing business.
-Share capital(ordinary)is the amounts paid in by share holders for the ordinary shares they
purchase.
Is
-Retained Earning:revenues increase equity,expense decrease equity and Dividends decrease equity.
Transaction Analysis :Transactions-business activities that involve the circulation of money
,e.g. buying,selling,etc.
Transaction
1
2
3
4
5
6
7
8
9
10
Bal.
Cash
+15000
-7000
Assets
Accounts
+ Receivable + Supplies
=
+ Equipment =
Liabilities +
Accounts
Share
Payable
+ Capital +
+ 15000
Equity
Retained Earnings
Rev.
-Exp.
-Div.
+7000
+1600
+1600
+1200
+1200
+250
+1500
-1700
-250
+600
-1300
8050
-250
+2000
+3500
-600
-900
-200
-250
-600
+
1400
+
1600
+
7000
=
1600
+
15000
18050
+
4700
-1950
18050
Transaction
1: Mr.A open a computer programming company as Softbyte Inc.On September 1,2014 ,he invests
1500$ cash in the business.
2:Softbyte Inc. purchases computer equipment for $7000 cash.
3:Softbyte Inc. purchases for $1600 from B Supply Company computer paper and agree that allow
Softbyte to pay this bill in October.
4:Softbyte Inc. receives $1200 cash from customer for services it have provided.
5:Softbyte receives a bill for $250 for advertising but postpones payment until a later date.
6:Softbyte Inc. provides $3500 of services for customers.the company receives cash for $1500 and it
bills the balance of $2000 on account.
7:Softbyte Inc. pays the following expenses in cash for September:rent $600 ,salaries $900,and
utilities $200.
8:Softbyte Inc. pay its $250 advertising bill in cash.(in Transaction5).
9:Softbyte receives $600 in cash from customer who had been billed(in Transaction6)
10:the corporation pays a dividend $1300 in cash to Mr.A.
-1300
-1300
Financial Statements
Softbyte Inc.
Income statement
For the month ended September 30,2014
Revenue
Service revenue
Expenses
Salaries and wages expense
Rent expense
Advertising expense
Utilities expenses
Total expenses
Net income
$4700
$900
600
250
200
1950
$2750
Softbyte Inc.
Retained Earnings Statement
For the month ended September 30,2014
Retained earnings , September 1
Add:Net income
Less:Dividends
Retained earnings , September 30
$0
2750
2750
1300
$1450
Softbyte Inc.
Statement of Financial Position
September 30,2014
Assets
Equipment
Supplies
Accounts Receivable
Cash
Total assets
$7000
1600
1400
8050
$18050
Equity and Liabilities
Equity
Share capital-ordinary
Retained earnings
Liabilities
Accounts payable
Total equity and liabilities
$15000
1450
$16450
1600
$18050
Steps in Accounting:
1.Record the transaction
2.Classify into:-Assets –Liabilities –Revenue –Expense –Common Stock –Dividend ,etc.
3.Prepare Financial Statement:
-Income statement :to know profit or loss
-Retained Earnings Statement:to know the capital situation of the company
-Balance Sheet:A=L+SE
4.Interpret:to understand if the company is doing well or not and what can be done to improve the
present situation to help make future decision.
Chapter 2 The Recording Process
The Account
An accounting is an individual accounting record of increases and decreases in a specific asset,
liabilities, or equity item.In tis simplest from,an account consists of three parts : (1) a title, (2) a left
or debit side, and (3) a right or credit side as a T-account.
Title of Account
Left or debit side
Assets
Debit increase
Credit decrease
Right or credit side
Liabilities
Debit decrease
Credit increase
Share Capital-Ordinary
Debit decrease
Credit increase
Expenses
Debit increase
Credit decrease
Dividends
Debit increase
Credit decrease
Retained Earnings
Debit decrease
Credit increase
Revenues
Debit decrease
Credit increase
Steps in the Recording Process
Three basic steps in the recording process:
1.Analyze each transaction for its effects on the accounts.
2.Enter the transaction information in a journal.
3.transfer the journal in formation to appropriate accounts in the ledger.
The Journal -is referred to as the book of original entry. Entering transaction data in the journal is
known as journalizing. A complete entry consists of(1) the date of the transaction,(2) the accounts
and amounts to be debited and credited,and (3) a brief explanation of the transaction.
The Ledger –the entire group of accounts maintained by a company
The Trial balance –is a list of accounts and their balance at a given time.The steps for preparing are
(1)List the account titles and their balances,(2)Total the debit and credit columns,and(3)Prove the
equality of the two columns.
Example: A group of investors opened Laundromat Inc. on September 1 ,2014.During the first
month of operations, the following transactions occurred.
Sept. 1 Shareholders invested $200000 cash in the business.
2 Paid $10000 cash for store rent for the month September.
3 Purchased washers and dryers for $250000,paying $100000 in cash and signing a $150000,6
month ,12% note payable.
4 Paid $ 12000 for a one year accident insurance policy.
10 Received a bill for advertising $2000.
20 Declared and paid a cash dividend to shareholders $7000.
30 Determined that cash receipts for laundry fees for the month were $62000.
The chart of accounts are cash(101),Accounts receivable(112),Supplies(126),Prepaid
Insurance(130),Equipment(157),Accumulatede Depreciation-Equipment(158),Notes
Payable(200),Accounts Payable(201),Unearned service revenue(209),Salaries and wages
payable(212),Interest Payable(230),Share Capital-Ordinary(311),Retained
Earnings(320),Dividends(332),Income Summary(350),Service Revenue(400),Advertising
Expense(610),Supplies Expense(631),Depreciation Expense(711),Insurance Expense(722),Salaries
and wages Expense(726),Rent Expense(729),Utilities Expense(732),and Interest Expense(905).
General Journal
J1
Date
Account Titles and Explanation
2014
Sept.1 Cash
Share Capital-Ordinary
(Shareholders’ investment of cash in the
business)
2 Rent Expense
Cash
(Paid September rent)
3 Equipment
Cash
Note Payable
(Purchased laundry equipment for cash and
6 month ,12% note payable)
4 Prepaid Insurance
Cash
(Paid one year insurance policy)
10 Advertising Expense
Accounts Payable
(Received bill for advertising)
20 Dividends
Cash
(Declared and paid a cash dividend)
30 Cash
Service Revunue
(Received cash for services provided)
Ref.
Debit
101
311
200000
729
101
10000
157
101
200
250000
130
101
12000
610
201
2000
332
101
7000
101
400
62000
Credit
200000
10000
100000
150000
12000
2000
7000
62000
General Ledger
Cash
Ref.
Date Explanation
Debit
2014
Sep.1
J1
200000
2
J1
3
J1
4
J1
20
J1
30
J1
62000
Prepaid Insurance
Date Explanation Ref.
Debit
2014
Sep.4
J1
12000
Equipment
Date Explanation Ref.
Debit
2014
Sep.3
J1
250000
Credit
No.101
Balance
Credit
200000
190000
90000
78000
71000
133000
No.130
Balance
Credit
12000
No.157
Balance
10000
100000
12000
7000
250000
Date
2014
Sep.3
Date
2014
Sep.10
Date
2014
Sep.1
Date
2014
Sep.30
Notes Payable
Explanation Ref.
Debit
J1
Accounts Payable
Explanation Ref.
Debit
J1
Share Capital-Ordinary
Explanation Ref.
Debit
J1
Service Revenue
Explanation Ref.
Debit
J1
Credit
150000
No.200
Balance
Credit
150000
No.201
Balance
2000
2000
Credit
No.311
Balance
200000
Credit
200000
No.400
Balance
62000
62000
Date
Dividends
Explanation Ref.
Debit
Credit
No.332
Balance
2014
Sep.20
Date
Date
Advertising Expense
Explanation Ref.
Debit
Credit
2014
J1
7000
Rent Expense
Explanation Ref.
Debit
Credit
7000
No.729
Balance
Sep.10
J1
2000
2014
Sep.2
No.610
Balance
J1
10000
10000
Laundromat Inc.
Trial Balance
September 30,2014
Cash
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Share Capital-Ordinary
Dividends
Service Revenue
Advertising Expense
Rent Expense
Debit
$133000
12000
250000
Credit
150000
2000
200000
7000
62000
2000
10000
$414000
$414000
Chapter 3 Adjusting the Accounts
The Basics of Adjusting Entries
Ensure that the revenue recognition and expense recognition principles are followed.
An accounting year (Fiscal year)can start on other dates as well.
1)Adjusting entries are always prepared at the end of the present accounting period.
2) Adjusting entries are always prepared when a transaction affects 2 accounting periods ,that is the
present and future accounting periods.
3)Adjusting entries are prepared in order to know how much Revenue and Expenses belong to the
present period and how belong to the future accounting period.
2000
Types of Adjusting Entries
Classified as either deferrals or accruals.
Deferrals:
1.Prepaid expenses:Expenses paid in cash before they are used or consumed.
2.Unearned revenues:Cash received before service are performed.
Accruals:
1.Accrued revenues:Revenues for for services performed but not yet received in cash or recorded.
2.Accrued expenses:Expenses incurred but not yet paid in cash or recorded.
Adjusting Entries for Deferrals
Deferrals are costs or revenues that are recognized at a date later than point when cash was
originally exchanged.
Prepaid Expenses
Asset
Unadjusted
Balance
Expense
Credit
Adjusting
Entry(-)
Debit
Adjusting
Entry(+)
Unearned Revenues
Liabilities
Debit
Adjusting
Entry(-)
Revenue
Unadjusted
Balance
Credit
Adjusting
Entry(+)
Adjusting Entries for Accruals
This will increase both a statement of financial position and an income statement account.
Accrued Revenues means Revenues for service performed but not yet recorded at the statement
date are accrued revenues.
Accrued Expenses means Expense incurred but not yet paid or recorded at the statement date.
Accrued Revenues
Asset
Debit
Adjusting
Entry(+)
Revenue
Credit
Adjusting
Entry(+)
Accrued Expenses
Expense
Liabilities
Debit
Adjusting
Entry(+)
Credit
Adjusting
Entry(+)
Chapter 4 Completing the Accounting cycle
Using Worksheet
Worksheet is a multiple-column form used in the adjustment process and in preparing financial
statements.
Steps in preparing worksheet
1)Prepare a trial balance on the worksheet
2)Enter the adjustments in the Adjustments columns
3)Enter adjusted balances in the adjusted trial balance columns
4)Extend adjusted trial balance amounts to appropriate financial statement columns to appropriate
financial statement columns
5)Total the statement columns,compute the net income (or net loss),and complete the worksheet
Preparing Financial Statements from a worksheet
The income statement is prepared from the income statement columns.
The statement of financial position and retained earnings statement are prepared from the
statement of financial position columns.
Preparing Adjusting Entries from a Worksheet
The adjusting entries are prepared from the adjustments columns of the worksheet.
Closing the Books
At the end of the accounting period,the company makes the accounts ready for the next period.
Temporary accounts relate only to a given accounting period and be closed at the end of the period.
Permanent accounts relate to one or more future accounting periods and be not closed from period
to period.
Preparing Closing Entries
Directly from the adjusted balances in the ledger by following four entries accomplish the desired
result more efficiently:
1)Debit each revenue account for its balance, and credit income summary for total revenues.
2)Debit income summary for total expenses,and credit each expense account for its balance.
3)Debit income summary and credit retained earnings for the amount of net income.
4)Debit retained earnings for the balance in the dividends account,and credit dividends for the same
amount.
Posting Closing Entries
The post closing trial balance is to prove the equality of the permanent account balances carried
forward into the next accounting period.
Example
Watson Answering Service Inc.
Trial Balance
August 31,2014
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Share Capital-Ordinary
Dividends
Service Revenue
Salaries and wages Expense
Utilities Expense
Advertising Expense
Debit
$5400
2800
1300
2400
60000
Credit
$40000
2400
30000
1000
4900
3200
800
400
$77300
Other data:
a).Insurance expires at the rate of $200 per month.
b).$1000 of supplies are on hand at August 31.
c).Monthly depreciation on the equipment is $900.
d).Interest of $500 in the notes payable has accrued during August.
$77300
Watson Answering Service Inc.
Worksheet for the Month Ended August 31,2014
Trial Balance
Account Titles
Cash
AccountsReceivable
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
ShareCapitalOrdinary
Dividends
Service Revenue
Salaries and
Wages Expense
Utilities Expense
Advertising Expense
Totals
Insurance Expense
Supplies Expense
DepreciationExpense
Accumulated
Depreciation-Equipment
Interest Expense
Interest Payable
Totals
Net loss
Totals
Dr.
5400
2800
1300
2400
60000
Cr.
Adjustments
Dr.
Cr.
(b)300
(a)200
40000
2400
30000
1000
4900
3200
800
400
77300
Adjusted Trial
Balance
Dr.
Cr.
5400
2800
1000
2200
60000
40000
2400
30000
1000
4900
Income
Statement
Dr.
Cr.
Statement of
Financial Position
Dr.
Cr.
5400
2800
1000
2200
60000
40000
2400
30000
1000
4900
3200
800
400
3200
800
400
200
300
900
200
300
900
77300
(a)200
(b)300
(c)900
(c)900
(d)500
1900
900
500
(d)500
1900
78700
900
500
500
78700
6300
6300
4900
1400
6300
72400
1400
73800
500
73800
73800
Watson Answering Service Inc.
Statement of Financial Position
August 31,2014
Assets
Property,plant, and equipment
Equipment
Less:Accumulated depreciation-equipment
Current assets
Prepaid insurance
Supplies
Accounts receivable
Cash
Total assets
$60000
900
$59100
2200
1000
2800
5400
11400
$70500
Equity and Liabilities
Equity
Share capital-ordinary
Retained earnings
Non-Current Liabilities
Notes payable
Current liabilities
Notes payable
Accounts payable
Interest payable
Total equity and liabilities
Aug.31 Service Revenue
Income Summary
(To Close revenue account)
31 Income Summary
Salaries and Wages Expense
Depreciation Expense
Utilities Expense
Interest Expense
Advertising Expense
Supplies Expense
Insurance Expense
(To Close net loss to retained earnings)
31 Retained Earnings
Income Summary
(To Close net loss to retained earnings)
31 Retained Earnings
Dividends
(To Close dividends to retained earnings)
$30000
2400
$27600
35000
5000
2400
500
7900
$70500
4900
4900
6300
3200
900
800
500
400
300
200
1400
1400
1000
1000
Chapter 5
Accounting for purchase and sale of merchandise
Merchandise business is engaged in the buying and selling of articles or goods. The articles they buy and sell
are called merchandise. Anything we buy to use in the business is asset. Computation of discount (purchase
discount or sales discount)
(Purchase or sell - return) x
FOB Shipping point means buyer must pay transportation or freight on merchandise purchased (freight in)
FOB destination means seller is responsible for freight charges on sale of merchandise (delivery expense or
freight out)
TRANSACTIONS
Purchase Merchandise
Return the merchandise
Transportation charges
On merchandise purchased
Pay for merchandise within discount
period
Sell merchandise to customer
Customer return the merchandise sold
PERPETUAL SYSTEM
Merchandise Inventory
Cash / Acc payable
JOURNAL ENTRIES
PERIODIC SYSTEM
XX
Purchase
XX
Cash / Acc Payable
Cash / Acc payable
XX
Merchandise Inventory
XX
Merchandise Inventory
Cash / Acc payable
XX
XX
Acc Payable
XX
Cash
Merchandise Inventory
1.Cash / Acc receivable XX
Sale
2. Cost of Goods Sold
XX
Merchandise Inventory
(cost)
2.Jornal entries
1.Sales Return and
Allowance
Cash / Acc payable
(selling price)
XX
XX
XX
XX
Cash / Acc Payable
Purchase Return
And allowances
Freight – in or
Transportation – in
Cash / Acc payable
Acc payable
Cash
Purchase Discount
1. Journal entry only
Cash / Acc Receivable
Sale
(Selling price)
XX
XX
XX
XX
XX
XX
XX
XX
XX
XX
XX
1.Journal entry only
XX
XX
Transportation charge
on merchandise sold
2.Merchandise Inventory XX
Cost of Goods Sold
XX
(cost)
Delivery expense
XX
Cash / Account Payable
XX
Collect account
Receivable within
discount period
Cash
Sales Discount
Acc Receivable
XX
XX
XX
1.Slaes return and
Allowance
XX
Cash / Acc receivable
XX
(Freight out)
Delivery Expense
XX
Cash /Account Payable
XX
Cash
XX
Sales Discount
XX
Acc Receivable
XX
Chapter 6
Inventory is the stock of goods which a business keeps for sales. Ending inventory is the unsold stock
of merchandise on the last day of an accounting period (usually December 31). The ending inventory
of one year (December 31) is the beginning inventory (January 1) of the next year. Usually ending
inventory comes from different purchase. So it is rather difficult to decide the cost of it. The business
should include cost of ending inventory in the Income statement and balance sheet. If ending
inventory is overstated. Then net income will be overstated under value ending inventory cost will
understate net income.
There are two main systems to compute cost of ending inventory.
1. Periodic system
2. Perceptual system
Periodic system
(a) First In first out (FIFO)
(b) Weighted average method
(c) Lower of cost or market price (LCM) method
We must decide the cost of ending inventory. First we must find out the ending inventory in units.
The following format we can to get the ending inventory in units.
Date
Details
Beginning Inventory
1st purchase
2nd purchase
Less purchase return
3rd purchase
4th purchase
Total Unit
Unit Sold
Ending Inventory (units)
Computation of units sold
Units sold
XX
Units sold
XX
Less sales return (units)
Total units sold
(XX)
XX
Units
XX
XX
XX
XX
XX
XX
XX
(XX)
XX
Unit Cost
XX
XX
XX
XX
XX
XX
Total Cost
XX
XX
XX
(XX)
XX
XX
XXX
(a) First in first out
Under this method merchandise purchased first will be sold first. So ending inventory comes
from the last purchase (newest purchase)
Cost of ending inventory
Cost of goods sold = Total cost – cost od ending inventory
(b) Weighted average method
Cost of ending inventory =
x ending inventory (units)
(c) Lower of cost or market price (LCM) method
Under this method compute cost price of ending inventory and total market price. Compute both
and take the lower one as the cost of ending inventory.
Chapter 7
Bank Reconciliation
Now a day almost all business units open bank account and deposit all the cash in the bank and
make payments by check. But usually the bank account of cash balance may be differed from its own
cash record in the business. Bank reconciliation statement is prepared by business to make the cash
balance as per business records equal to its bank balance
The common items causing the difference in cash balance as per business record and bank
statement are;
1.Deposit in transit = Cash received by the business and given to bank for deposit, but the bank not
yet recorded the deposit
2.Outstanding checks = These are check issued by the business but not yet paid by bank
3.Credit memo items =These are usually revenue items on which cash was collected by bank for the
business and recorded in the deposit column of bank statement but these item are not yet recorded
in the business records.
4.Debit memo items = These are expenses paid by bank on behalf of the business but not recorded
in the business cash payment journal.
5.NSF cheque = This is a check received by the business from a customer, which is the given to the
bank to collect cash from the bank of the customer. But the customers’ bank refuses to pay money
on the check saying that there is not sufficient fund in the customer account
6.Stop order check = this is a check issued by the business, then later told the bank not to pat cash
on that check but the bank paid cash by mistake
Format of bank reconciliation statement
Name of Business
Bank Reconciliation
As on …………..
1)balance as per book
Add deposit in transit
XXX
XXX
XXX
XXX
XXX
Less Outstanding Check No.
XXX
XXX
(XXX)
Adjusted Balance
XXX
2)Balance as per book
XXX
Add credit memo items.
XXX
XXX
XXX
XXX
Less debit memo items
XXX
XXX
(XXX)
XXX