Chapter 2 On-Line Notes
Note: In this and all future chapters please use journal entries and not
the “horizontal method” described in the book for completing
assignments.
Expanding the Basic Accounting Equation:
Assets = Liabilities +
Dr. Cr.
+
-
Dr.
-
Cr.
+
Common
Stock
Dr. Cr.
+
Shareholders Equity
Retained
+ Earnings
Dr. Cr.
+
- Dividends + Revenues - Expenses
Dr. Cr.
Dr. Cr.
Dr. Cr.
+
+
+
-
Steps in the Accounting Cycle:
1.
Identify transactions or events to be recorded.
2.
Journalize transactions and events.
3.
Post from the journal to the ledger.
4.
Prepare unadjusted trial balance.
5.
Journalize and post adjusting entries.
6.
Prepare adjusted trial balance.
7.
Prepare financial statements.
8.
Journalize and post closing journal entries.
9.
Prepare post-closing trial balance.
Accounting for Inventories
a.
Perpetual inventory systems. The Inventory account is not
adjusted at year-end. Inventory records are maintained on
an on-going (perpetual) basis rather than on a periodic (e.g.,
once-per-year) basis (i.e., counting the inventory once per
year). The Cost of Goods Sold account is closed to the
Income Summary account.
b.
Periodic inventory systems. The Inventory account is
adjusted to reflect the year-end balance, and the related
purchases accounts are closed to the Cost of Goods Sold
account. Inventory records are not maintained on an ongoing basis.
Procedures and the Double-Entry Recording Process
The accounting process can be described as a set of procedures used in
identifying, recording, classifying, and interpreting information
related to the transactions and other events of a business enterprise.
To understand the accounting process, one must be aware of the basic
terminology employed in the process. The basic terminology includes:
events, transactions, real accounts, nominal accounts, ledger,
journal, posting, trial balance, adjusting entries, financial
statements, and closing entries. These terms refer to the various
activities that make up the accounting cycle and are discussed in
greater detail below.
Double-entry accounting refers to the process used in recording
transactions. The terms debit and credit are used in the accounting
process to indicate the effect a transaction has on account balances.
Also, the debit side of any account is the left side; the right side is the
credit side. Assets and expenses are increased by debits and decreased
by credits. Liabilities, owners' equity, and revenues are decreased by
debits and increased by credits.
The Accounting Cycle
In a double-entry system, for every debit there must be a credit and
vice-versa. This leads us, then, to the basic equation in accounting:
Assets = Liabilities + Stockholders' Equity.
The first step in the accounting cycle is analysis of transactions and
selected other events. The purpose of this analysis is to determine
which events represent transactions that should be recorded.
Events can be classified as external or internal. External events are
those between the enterprise and its environment, whereas internal
events relate to transactions totally within the enterprise.
Journalizing
Transactions are initially recorded in a journal, sometimes referred to
as the book of original entry. A general journal is merely a
chronological listing of transactions expressed in terms of debits and
credits to particular accounts. No distinction is made in a general
journal concerning the type of transaction involved. In addition to a
general journal, specialized journals are used to accumulate
transactions possessing common characteristics.
Posting
The next step in the accounting cycle involves transferring amounts
entered in the journal to the general ledger. The ledger is a book that
usually contains a separate page for each account. Transferring
amounts from a journal to the ledger is called posting. Transactions
recorded in a general journal must be posted individually, whereas
entries made in specialized journals are generally posted by columnar
total.
Trial Balance
The next step in the accounting cycle is the preparation of a trial
balance. A trial balance is a list of all open accounts in the general
ledger and their balances. An entity may prepare a trial balance at any
time in the accounting cycle. A trial balance prepared after posting has
been completed serves to check the mechanical accuracy of the posting
process and provides a listing of accounts to be used in preparing
financial statements.
Chapter 3 On-line Notes
Adjusting Entries
Preparation of adjusting journal entries is the next step in the
accounting cycle. Adjusting entries are entries made at the end of
accounting periods to bring all accounts up to date on an accrual
accounting basis so that correct financial statements can be prepared.
Adjusting entries are necessary to achieve a proper matching of
revenues and expenses in the determination of net income for the
current period and to achieve an accurate statement of the assets and
equities existing at the end of the period. One common characteristic
of adjusting entries is that they affect at least one real account
(asset, liability, or equity account) and one nominal account (revenue or
expense account). Adjusting entries can be classified as: prepaid
expenses, unearned revenues, accrued revenues, and accrued
expenses.
Prepaid expenses and unearned revenues refer to situations where cash
has been paid or received but the corresponding expense or revenue will
not be recognized until a future period. Accrued revenues and accrued
expenses are revenues and expenses recognized in the current period
for which the corresponding payment or receipt of cash is to occur in a
future period. Estimated items are expenses such as bad debts and
depreciation whose amounts are a function of unknown future events or
developments.
Adjusted Trial Balance
After adjusting entries are recorded and posted, an adjusted trial
balance is prepared. This trial balance serves as a basis for the
preparation of the financial statements discussed in the next two
chapters.
Closing-Basic Process
After financial statements have been prepared, nominal (revenues and
expenses) accounts should be reduced to zero in preparation for
recording the transactions of the next period. This closing process
requires recording and posting of closing entries. All nominal accounts
are reduced to zero by closing them through the Income Summary
account. The net balance in the Income Summary account is equal to net
income or net loss for the period. The net income or net loss for the
period is transferred to owners' equity by closing the Income Summary
account to Retained Earnings.
Post-Closing Trial Balance
A third trial balance may be prepared after the closing entries are
recorded and posted. This post-closing trial balance shows that equal
debits and credits have been posted properly to the Income Summary
account.
Closing Inventory and Related Accounts
When inventory records are maintained on other than a perpetual basis,
an adjustment is usually needed to reflect the difference between the
beginning and ending inventory. This year-end inventory adjustment
eliminates all nominal accounts related to the purchase of inventory by
transferring them to Cost of Goods Sold. The adjustment also
eliminates the beginning inventory amount and establishes the amount of
ending inventory to be included on the balance sheet. A typical
inventory adjusting entry would include debits and credits to the
following accounts:
Dr.
Cr.
Inventory (ending)
XX,XXX
Purchase Discounts
X,XXX
Purchase Returns and Allowances
X,XXX
Cost of Goods Sold
XXX,XXX
Inventory (beginning)
Purchases
Transportation-In
XX,XXX
XXX,XXX
X,XXX
In summary, the steps in the accounting cycle performed every fiscal
period are as follows:
a. Enter the transactions of the period in appropriate journals.
b. Post from the journals to the ledger (or ledgers).
c. Take an unadjusted trial balance.
d. Prepare adjusting journal entries and post them to the ledger(s).
e. Take a trial balance after adjusting (adjusted balance).
f. Prepare the financial statements from the second trial balance.
g. Prepare closing journal entries and post them to the ledger(s).
h. Take a trial balance after closing (post-closing trial balance).
i. Prepare reversing entries and post them to the ledger(s). (Optional
step-see appendix)
Chapter 4 On-line Notes
Work Sheet
A multicolumn (8, 10, 12, etc.) work sheet serves as an aid to the
accountant in adjusting the account balances and preparing the financial
statements. The work sheet provides an orderly format for the
accumulation of information necessary for preparation of financial
statements. Use of a work sheet does not replace any financial statements,
nor does it alter any of the steps in the accounting cycle.
An Example of Recording Transactions and Preparing Adjusting Journal
Entries:
Kwik Window Cleaning Service, Inc., began operations on April 1 of the
current year. Transactions for April are as follows:
Apr.
1
2
2
3
5
12
18
29
30
30
30
Issued 380 shares of $50 par value capital stock to initial
investors for $19,000 cash.
Purchased two used trucks for a total of $8,000, paying $3,000
in cash with the balance due in 60 days.
Purchased ladders, scaffolding, and other equipment for $1,400
cash.
Paid two-year premium on liability insurance, $600.
Purchased supplies on account, $850.
Billed customers for service, $2,900.
Collected $1,700 on account from customers.
Paid bill for truck fuel used in April, $190.
Paid April newspaper advertising, $50.
Paid wages of employees, $1,600.
Billed customers for services, $1,850.
Required:
a.
Record the above transactions in general journal form.
b.
Prepare adjusting journal entries to adjust the books for insurance
expense, supplies expense, depreciation expense on trucks,
depreciation expense on equipment, and income tax expense based on
the following information:
i.
ii.
Supplies on hand on April 30 amounted to $180.
Depreciation for April was $150 on trucks and $45 on
equipment.
iii.
Income taxes for the month are estimated at $350.
Solution:
Part a:
Apr.
1
Cash
19,000
Capital Stock
19,000
Issued 380 shares of $50 par value stock for cash.
(380 shares x $50 per share.)
2
Trucks
8,000
Cash
3,000
Accounts Payable
5,000
Purchased two trucks, $3,000 down, remainder due in 60 days.
2
Equipment
1,400
Cash
Purchased scaffolding and other equipment.
3
Prepaid Insurance
600
Cash
Paid two-year premium on liability insurance policy.
600
Supplies on Hand
Accounts Payable
Purchased supplies on account.
850
5
850
12
Accounts Receivable
Service Fees
Billed customers for service.
2,900
18
Cash
1,700
Accounts Receivable
Collections on account from customers
1,400
2,900
1,700
29
30
Fuel Expense
Cash
Paid truck fuel bill for April.
Advertising Expense
Cash
Paid for April newspaper advertising.
190
190
50
50
30
Wages Expense
Cash
Paid employees’ wages.
1,600
30
Accounts Receivable
Service Fees
Billed customers for service.
1,850
1,600
1,850
Part b:
Apr.
30
Insurance Expense
Prepaid Insurance
To record insurance expense for April.
25
25
30
Supplies Expense
Supplies on Hand
To record supplies expense for April.
670
30
Depreciation Expense—Trucks
150
Accumulated Depr.—Trucks
To record April depreciation on trucks.
150
30
Depreciation Expense—Equipment
45
Accumulated Depr.—Equipment
To record April depreciation on equipment.
45
30
Income Tax Expense
350
Income Tax Payable
To record estimated income taxes for April.
350
670
Kwik Window Cleaning Service
Worksheet
Description
Unadjusted Trial Balance
Dr.
Cash
Accounts Receivable
Supplies on Hand
Prepaid Insurance
Cr.
850
670
600
25
Equipment
1,400
Accounts Payable
Capital Stock
Service Fees
Wages Expense
Dr.
3,050
8,000
Advertising Expense
Adjusted Trial Balance
Cr.
13,860
Trucks
Fuel Expense
Adjustments
Dr.
Income Statement
Cr.
Dr.
Cr.
Balance Sheet
Dr.
Cr.
13,860
13,860
3,050
3,050
180
180
575
575
8,000
8,000
1,400
1,400
5,850
5,850
5,850
19,000
19,000
19,000
4,750
4,750
190
190
4,750
190
50
50
50
1,600
1,600
1,600
Supplies Expense
670
670
670
Depreciation Exp.--Trucks
150
150
150
Depr. Exp.— Equip.
45
45
45
Insurance Expense
25
25
25
350
350
350
Income Tax Expense
Acc. Depr.-Trucks
45
45
45
Acc. Depr.-Equip.
150
150
150
Income Tax Payable
Subtotals
350
350
29,600
29600
1240
1240
30,145
30145
29,600
29600
1240
1240
30,145
30145
Net Income
Totals
350
3080
4,750
27,065
25395
4,750
27065
27065
1,670
4,750
1,670