Recap Accounting Process
Prepared by Mubashar majeed
Introduction to Financial Statements
• Companies prepare interim financial
statements
• and annual financial statements.
Introduction to Financial Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Three primary
financial
statements.
We will use a corporation
to describe these
statements.
Introduction to Financial Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Describes
where the
enterprise
stands at a
specific date.
Depicts the
revenue and
expenses for a
designated
period of time.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Concept of the Business Entity
Vagabond Travel
Agency
A business
entity is
separate from
the personal
affairs of its
owner.
Assets and Liabilities
• Assets are economic resources that are
owned by the business and are
expected to provide positive future
cash flows.
• Liabilities are debts that represent
negative future cash flows for the
enterprise.
• Owners’ equity represents the owner’s
claim to the assets of the business.
The Accounting Equation
Travel
Assets =Vagabond
Liabilities
+ Agency
Owners’ Equity
Balance Sheet
December 31, 2002
$300,000
= $80,000 +Liabilities
$220,000
Assets
& Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Debit and Credit Rules
Debits and credits affect accounts as
follows:
A = L + OE
ASSETS
LIABILITIES
EQUITIES
Debit
Credit
for
for
Increase Decrease
Debit
Credit
for
for
Decrease Increase
Debit
Credit
for
for
Decrease Increase
Double Entry AccountingThe Equality of
Debits and Credits
A = L + OE
=
Debit
balances
Credit
balances
In the double-entry accounting system,
every transaction is recorded by equal
dollar amounts of debits and credits.
¶ May 1: Jill Jones and her family invested $8,000
in JJ’s Lawn Care Service and received 800 shares
of stock.
Will Cash increase
or decrease?
Will Capital Stock
increase or
decrease?
¶ May 1: Jill Jones and her family invested $8,000
in JJ’s Lawn Care Service and received 800 shares
of stock.
Cash increases
$8,000 with a debit.
Capital Stock
increases $8,000
with a credit.
Cash
5/1 8,000
Capital Stock
5/1 8,000
· May 2: JJ’s purchased a riding lawn mower
for $2,500 cash.
Will Cash increase
or decrease?
Will Tools &
Equipment increase
or decrease?
· May 2: JJ’s purchased a riding lawn mower
for $2,500 cash.
Cash decreases
$2,500 with a credit.
Cash
5/1 8,000
5/2 2,500
Tools & Equipment
increases $2,500
with a debit.
Tools & Equipment
5/2 2,500
¸ May 8: JJ’s purchased a $15,000 truck. JJ’s
paid $2,000 down in cash and issued a note
payable for the remaining $13,000.
Will Truck increase
or decrease?
Will Cash and
Notes Payable
increase or
decrease?
¸ May 8: JJ’s purchased a $15,000 truck. JJ’s
paid $2,000 down in cash and issued a note
payable for the remaining $13,000.
Truck increases
$15,000 with a debit.
Truck
5/8 15,000
Cash decreases
$2,000 with a credit.
Notes Payable
increases $13,000
with a credit.
Cash
5/1 8,000
5/2 2,500
5/8 2,000
Notes Payable
5/8 13,000
The Journal
In an actual accounting system, transactions
are initially recorded in the journal.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2003
May 1 Cash
Capital Stock
Owners invest cash in the business.
8,000
8,000
Posting Journal Entries to the Ledger
Accounts
Posting
involves
copying
information
from the
journal to the
ledger
accounts.
The Ledger
Cash
Accounts
Payable
Capital
Stock
Accounts are
individual records
showing increases
and decreases.
The entire group of
accounts is kept
together in an
accounting record
called a ledger.
The Use of Accounts
Increases are
recorded on one
side of the Taccount, and
decreases are
recorded on the
other side.
Title of Account
Left
or
Debit
Side
Right
or
Credit
Side
Debit and Credit Entries
Receipts are
on the debit
side.
5/1
5/25
5/29
5/31
Bal.
Cash
8,000
5/2 2,500 Payments are
credit
75
5/8 2,000 on the
side.
750 5/28
150
5/31
50
4,125
The balance is the
difference between the
debit and credit entries in
the account.
Posting Journal Entries to the Ledger Accounts
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2003
May 1 Cash
8,000
Capital Stock
8,000
Owners invest cash
in the business.
General
Ledger
Date
2003
May 1
Cash
Debit
Credit
8,000
Balance
8,000
Posting Journal Entries to the Ledger Accounts
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2003
May 1 Cash
8,000
Capital Stock
8,000
Owners invest cash
in the business.
General
Ledger
Date
2003
May 1
Capital Stock
Debit
Credit
8,000
Balance
8,000
Ledger Accounts After Posting
Date
2003
May 1
2
General Ledger
Cash
Debit
Credit
8,000
2,500
Balance
8,000
5,500
This ledger format is referred to as a
running balance (as opposed to simple
T accounts).
What is Net Income?
Net income is not an asset it’s an increase in
owners’ equity from profits of the business.
A = L + OE
Increase
Decrease
Either (or both) of these
effects occur as net income
is earned . . .
Increase
. . . but this is
what “net income”
really means.
Retained Earnings
A = L + OE
Capital
Stock
Retained
Earnings
The balance in the Retained Earnings account represents the total
net income of the corporation over the entire lifetime of the business,
less all amounts which have been distributed to the stockholders as
dividends.
Revenue and Expenses
The price for goods
sold
and services rendered
during a given
accounting period.
The costs of goods and
services used up in the
process of earning
revenue.
Increases owner’s
equity.
Decreases owner’s
equity.
The Realization Principle: When To
Record Revenue
Realization Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.
The Matching Principle: When To
Record Expenses
Matching Principle
Expenses should be
recorded in the
period in which they
are used up.
Debits and Credits for Revenue and
Expense
Expenses
decrease
owner’s
equity.
EQUITIES
Debit
Credit
for
for
Decrease Increase
Revenues
increase
owner’s
equity.
EXPENSES
REVENUES
Debit
Credit
for
for
Increase Decrease
Debit
Credit
for
for
Decrease Increase
Let’s analyze the
revenue, and
expense
transactions for
JJ’s Lawn Care
Service for the
month of May.
We will also
analyze a dividend
transaction.
½ May 29: JJ’s provided lawn care services for
a client and received $750 in cash.
Will Cash increase
or decrease?
Will Sales Revenue
increase or
decrease?
½ May 29: JJ’s provided lawn care services for
a client and received $750 in cash.
Cash increases
$750 with a debit.
Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
Sales Revenue
increases $750 with
a credit.
Sales Revenue
5/29
750
¾ May 31: JJ’s purchased gasoline for the lawn
mower and the truck for $50 cash.
Will Cash increase
or decrease?
Will Gasoline
Expense increase or
decrease?
¾ May 31: JJ’s purchased gasoline for the lawn
mower and the truck for $50 cash.
Cash decreases $50
with a credit.
Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
5/31
50
Gasoline Expense
increases $50 with a
debit.
Gasoline Expense
5/31
50
¿ May 31: JJ’s Lawn Care paid Jill Jones and
her family a $200 dividend.
Will Cash increase
or decrease?
Will Dividends
increase or
decrease?
¿ May 31: JJ’s Lawn Care paid Jill Jones and
her family a $200 dividend.
Cash decreases
$200 with a credit.
Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
5/31
50
5/31
200
Dividends increase
$200 with a debit.
5/31
Dividends
200
Now, let’s look at
the Trial Balance
for JJ’s Lawn Care
Service for the
month of May.
JJ's Lawn Care Service
Unadjusted Trial Balance
May 31, 2003
Cash
$ 3,925
Accounts receivable
75
Tools & equipment
2,650
Truck
15,000
Notes payable
Accounts payable
Capital stock
Dividends
200
Sales revenue
Gasoline expense
50
Total
$ 21,900
$ 13,000
150
8,000
750
$ 21,900
All balances
are taken from
the ledger
accounts on
May 31 after
considering all
of JJ’s
transactions
for the month.
Proves equality
of debits and
credits.
The Accounting Cycle
Journalize
transactions.
Post entries to
the ledger
accounts.
Prepare trial
balance.
Prepare after closing Journalize and
post closing
trial balance.
entries.
Prepare
financial
statements.
Make end-ofyear
adjustments.
Prepare adjusted
trial balance.
Adjusting Entries
• THE ACCOUNTING CYCLE:
• Accruals and Deferrals
At the end of the
period, we need to
make adjusting entries
to get the accounts up
to date for the financial
statements.
Adjusting Entries
Adjusting
entries are
needed whenever
revenue or expenses
affect more than one
accounting
period.
Every
adjusting
entry involves a
change in either a
revenue or expense
and an asset
or liability.
Types of adjustment
• Two types of adjustment
• 1- Deferrals
• Result from prepayments made or received
• E.g. Payment of six month rent paid or received
• 2- Accrual
• These are items are unrecorded , unpaid or not
yet received
• E.g. Salaries payable, Services revenue receivable
Adjustment
Adjustment
Deferral
Prepaid Expense
Expense
……….Prepaid
Accrual
Depreciation
Expense
Unearned
Revenue
Dep. Exp.
Unearned
Revenue
Accumulated
Dep.
Accrued
Expenses
Accrued
Revenue
Revenue
Expenses
Payable
A/R
Revenue
Rules for Adjusting Entries
• Affect 1 Income statement account
• Affect 1 balance sheet account
• Cash account is never be involved
Converting Assets to Expenses
$2,400 Insurance Policy
Coverage for 12 Months
$200 Monthly Insurance Expense
Jan. 1
Dec. 31
On January 1, Webb Co. purchased a oneyear insurance policy for $2,400.
Converting Assets to Expenses
Initially, costs that benefit more than one
accounting period are recorded as assets.
GENERAL JOURNAL
Date
Jan.
Account Titles and Explanation
1 Unexpired Insurance
Cash
Purchase a one-year insurance policy.
Debit
Credit
2,400
2,400
Converting Assets to Expenses
The costs are expensed as they are used to
generate revenue.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Monthly Adjusting Entry for Insurance
Jan. 31 Insurance Expense
Unexpired Insurance
Insurance expense for January.
200
200
Converting Assets to Expenses
Balance Sheet
Income Statement
Cost of assets
that benefit
future periods.
Cost of assets
used this period to
generate revenue.
Unexpired Insurance
1/1 2,400 1/31
200
Bal. 2,200
Insurance Expense
1/31
200
The Concept of Depreciation
Depreciable assets are physical objects
that retain their size and shape but lose
their economic usefulness over time.
Depreciation is the systematic allocation of
the cost of a depreciable asset to expense.
Depreciation Is Only an Estimate
On May 2, 2003, JJ’s Lawn Care Service
purchased a lawn mower with a useful
life of 50 months for $2,500 cash.
Using the straight-line method, calculate
the monthly depreciation expense.
Depreciation
Cost of the asset
expense (per =
Estimated useful life
period)
$50 = $2,500
50
Depreciation Is Only an Estimate
JJ’s Lawn Care Service would make the
following adjusting entry.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Depreciation Expense: Tools & Eq.
Accumulated Depreciation: Tools & Eq.
To record one month's depreciation.
Contra-asset
Debit
Credit
50
50
Depreciation Is Only an Estimate
JJ’s $15,000 truck is depreciated over 60
months as follows:
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Depreciation Expense: Truck
Debit
Credit
250
Accumulated Depreciation: Truck
To record one month's depreciation.
$15,00060 months = $250 per month
250
JJ's Lawn Care Service
Partial Balance Sheet
Accumulated depreciation
May 31, 2001 would
appear on the balance
Assets sheet as
Cash
$ 3,925
follows:
Accounts receivable
75
Tools & equipment $ 2,650
Less: Accum. depr.
50
2,600
Truck
$ 15,000
O
Less: Accum. depr.
250 14,750
T
Converting Liabilities to Revenue
End of Current Period
Prior Periods
Transaction
Collected from
customers in
advance
(creates a
liability).
Current Period
Future Periods
Adjusting Entry
 Recognize portion
earned as revenue,
and
 Reduce balance of
liability account.
Converting Liabilities to Revenue
Examples Include:
Airline Ticket Sales
Sports Teams’ Sales of
Season Tickets
Converting Liabilities to Revenue
$6,000 Rental Contract
Coverage for 12 Months
$500 Monthly Rental Revenue
Jan. 1
Dec. 31
On January 1, Webb Co. received $6,000 in
advance for a one-year rental contract.
Converting Liabilities to Revenue
Initially, revenues that benefit more than one
accounting period are recorded as liabilities.
GENERAL JOURNAL
Date
Jan.
Account Titles and Explanation
1 Cash
Unearned Rental Revenue
Collected $6,000 in advance for rent.
Debit
Credit
6,000
6,000
Converting Liabilities to Revenue
Over time, the revenue is recognized as it is
earned.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Monthly Adjusting Entry for Rent Revenue
Jan. 31 Unearned Rental Revenue
Rental Revenue
Rental revenue for January.
500
500
Converting Liabilities to Revenue
Balance Sheet
Income Statement
Liability for
future periods.
Revenue earned
this period.
Unearned Rental Revenue
1/31
500
1/1 6,000
Bal. 5,500
Rental Revenue
1/31
500
Accruing Unpaid Expenses
End of Current Period
Prior Periods
Current Period
Adjusting Entry
 Recognize expense
incurred, and
 Record liability for
future payment.
Future Periods
Transaction
Liability will be
paid.
Accruing Unpaid Expenses
Hey, when do
we get paid?
Examples Include:
Interest
Wages and Salaries
Property Taxes
Accruing Unpaid Expenses
$3,000 Wages
Expense
Monday,
May 29
Wednesday,
May 31
Friday,
June 2
On May 31, Webb Co. owes wages of $3,000.
Pay day is Friday, June 2.
Accruing Unpaid Expenses
Initially, an expense and a liability are
recorded.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Wages Expense
Wages Payable
To accrue wages owed to employees.
Debit
Credit
3,000
3,000
Accruing Unpaid Expenses
Balance Sheet
Income Statement
Liability to be
paid in a future
period.
Cost incurred this
period to generate
revenue.
Wages Payable
5/31 3,000
Wages Expense
5/31 3,000
Accruing Unpaid Expenses
$5,000 Weekly Wages
$3,000 Wages
Expense
Monday,
May 29
$2,000 Wages
Expense
Wednesday,
May 31
Friday,
June 2
Let’s look at the entry for June 2.
Accruing Unpaid Expenses
The liability is extinguished when the debt is
paid.
GENERAL JOURNAL
Date
Account Titles and Explanation
June 2 Wages Expense (for June)
Wages Payable (accrued in May)
Cash
Weekly payroll for May 29-June 2.
Debit
Credit
2,000
3,000
5,000
Accruing Uncollected Revenue
End of Current Period
Prior Periods
Current Period
Adjusting Entry
Recognize revenue
earned but not yet
recorded, and
Record receivable.
Future Periods
Transaction
Receivable will be
collected.
Accruing Uncollected Revenue
Examples Include:
Interest Earned
Work Completed But Not
Yet Billed to Customer
Accruing Uncollected Revenue
$170 Interest
Revenue
Saturday,
Jan. 15
Monday,
Jan. 31
Tuesday,
Feb. 15
On Jan. 31, the bank owes Webb Co.
interest of $170. Interest is paid on the 15th
day of each month.
Accruing Uncollected Revenue
Initially, the revenue is recognized and a
receivable is created.
GENERAL JOURNAL
Date
Account Titles and Explanation
Jan. 31 Interest Receivable
Interest Revenue
To recognize interest revenue.
Debit
Credit
170
170
Accruing Uncollected Revenue
Balance Sheet
Receivable to
be collected in a
future period.
Interest Receivable
1/31
170
Income Statement
Revenue earned
this period.
Interest Revenue
1/31
170
Accruing Uncollected Revenue
$320 Monthly Interest
$170 Interest
Revenue
Saturday,
Jan. 15
$150 Interest
Revenue
Monday,
Jan. 31
Tuesday,
Feb. 15
Let’s look at the entry for February 15.
Accruing Uncollected Revenue
The receivable is collected in a future period.
GENERAL JOURNAL
Date
Account Titles and Explanation
Feb. 15 Cash
Debit
Credit
320
Interest Revenue (for February)
150
Interest Receivable (accrued Jan. 31)
170
To record interest received.
Accruing Income Taxes Expense: The Final
Adjusting Entry
As a corporation earns taxable income, it
incurs income taxes expense, and also a
liability to governmental tax authorities.
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Income Taxes Expense
Income Taxes Payable
Estimated income taxes applicable to
taxable income earned in December.
Debit
Credit
780
780
Effects of the Adjusting Entries
Journalize
transactions.
Post entries to
the ledger
accounts.
Prepare trial
balance.
Recall from the accounting cycle
discussed in Chapter 3, that after
the adjusting entries are made, an
adjusted trial balance is prepared.
Make end-ofyear
adjustments.
Prepare adjusted
trial balance.
THE ACCOUNTING CYCLE:
Reporting Financial Results
JJ's Lawn Care Service
Adjusted Trial Balance
May 31, 2003
Cash
$ 3,925
Accounts receivable
75
Tools & equipment
2,650
Accumulated depr.:
tools & eq.
$
50
Truck
15,000
Accumulated depr.:
truck
250
Notes payable
13,000
Accounts payable
150
Capital stock
8,000
Dividends
200
Sales revenue
750
Gasoline expense
50
Depr. exp.: tools &
eq.
50
Depr. exp.: truck
250
Total
$ 22,200 $ 22,200
This is the
Adjusted Trial
Balance for JJ’s.
Now, let’s
prepare the
financial
statements for
JJ’s Lawn Care
Service for May.
JJ's Lawn Care Service
Income Statement
For the month ending May 31, 2003
Sales revenue
Operating expenses:
Gasoline expense
$ 50
Depr. exp.: tools & eq.
50
Depr. exp.: truck
250
Net income
Net income also appears on the
Statement of Owner’s Equity.
$ 750
350
$ 400
Statement of Retained Earnings
This statement summarizes the increases
and decreases in Retained Earnings during
the period.
•Business
Earnings
•Dividends
•Business
Losses
JJ's Lawn Care Service
Statement of Retained Earnings
For the Month Ended May 31, 2003
Retained earnings, May 1, 2003
Add: Net income for May
Subtotal
Less: Dividends
Retained earnings, May 31, 2003
$
400
$ 400
200
$ 200
Now, let’s prepare the Balance Sheet.
JJ's Lawn Care Service
Balance Sheet
May 31, 2003
Assets
Cash
Accounts receivable
Tools & equipment
$ 2,650
Less: Accum. depr.: tools & eq.
50
Truck
$ 15,000
Less: Accum. depr.: truck
250
Total assets
Liabilities & Stockholders' Equity
Liabilities:
Notes payable
Accounts payable
Total liabilities
Stockholders' equity:
Capital stock
$ 8,000
Retained earnings
200
Total stockholders' equity
Total liabilities & stockholders' equity
$
3,925
75
2,600
14,750
$ 21,350
$ 13,000
150
$ 13,150
8,200
$ 21,350
Closing the Temporary Equity Accounts

Close Revenue accounts to
Income Summary.

Close Expense accounts to
Income Summary.

Close Income Summary account
to Retained Earnings.

Close Dividends to Retained
Earnings.
The closing process gets the
temporary accounts ready for
the next accounting period.
Closing Entries for Revenue Accounts
Since Sales Revenue has a credit balance, the
closing entry requires a debit to the Sales Revenue
account.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Sales Reveune
Income Summary
To close the revenue account.
Debit
Credit
750
750
Closing Entries for Revenue Accounts
Income Summary
750
Sales Revenue
750
750
-
750
Closing Entries for Expense Accounts
Since expense accounts have a debit balance, the
closing entry requires a credit to the expense
accounts.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Income Summary
Debit
Credit
350
Gasoline Expense
50
Depreciation Exp.: Tools & Equipment
50
Depreciation Exp.: Truck
To close the expense accounts.
250
Closing Entries for Expense Accounts
Gasoline Exp.
50
50
Depr. Exp.: Tools &
Equipment
50
50
-
Depr. Exp.: Truck
250
250
-
Income Summary
350
750
400
Net Income
Closing the Income Summary Account
Since Income Summary has a $400 credit balance,
the closing entry requires a debit to Income
Summary.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Income Summary
Retained Earnings
To close Income Summary.
Debit Credit
400
400
Closing the Income Summary Account
Retained
Earnings
400
400
Income Summary
350
750
400
The balance in Income
Summary is now zero.
JJ's Lawn Care Service
After-Closing Trial Balance
May 31, 2003
Cash
Accounts receivable
Tools & equipment
Accumulated depr.:
tools & equipment
Truck
Accumulated depr.:
truck
Notes payable
Accounts payable
Capital stock
Retained earnings
Total
$ 3,925
75
2,650
$
After all
closing
entries are
made, JJ’s
After-Closing
Trial Balance
looks like
50
this.
15,000
250
13,000
150
8,000
200
$ 21,650 $ 21,650
End of Topic