PART TWO

FINANCIAL ACCOUNTING:
An Introduction
R e q u i r e d R e a d i n g : Wa r r e n e t a l . ( 2 0 0 9 ) A c c o u n t i n g , 2 3 e ( F r o m c h a p t e r 2 - c h a p t e r 4 )
 Introduction
The Role of Accounting in Business
 Accounting can be defined as an information system that provides reports to
users about the economic activities and condition of a business.
 In Financial Accounting, the day-to-day processing of an organisation’s
financial transactions and the summarising of those transactions to satisfy the
information needs of external users.
 Subject to many rules and regulations (a regulatory framework) imposed by
company legislation, stock exchange regulations and financial reporting
standards.

2
Conceptual Framework for Financial Reporting

 Conceptual Framework sets out AGREED CONCEPTS that underlie

financial reporting.
 The concepts include the following:
• Objective,
• Qualitative characteristics,
• Element definitions
 Objective of financial reporting
 Provide financial information about the reporting entity that is useful to
existing and potential investors, lenders and other creditors in making
decisions about providing resources to the entity
 Note: other aspects of the Conceptual Framework flow logically from the
objective

4
Qualitative characteristics
 If financial information is to be useful, it must be RELEVANT and
FAITHFULLY REPRESENT what it purports to represent (i.e.
fundamental qualities).
o Relevance: capable of making a difference in users’ decisions
o Faithful representation: faithfully represents the phenomena it claims to
represent
– completeness (depiction including numbers and words)
– neutrality (unbiased)
– free from error (ideally)
Note: faithful representation replaces reliability

5
 Financial information without both relevance and faithful representation is not
useful, and it cannot be made useful by being more comparable, verifiable, timely
or understandable.
 The usefulness of financial information is enhanced if it is comparable, verifiable,
timely and understandable
• Comparability: like things look alike; different things look different
• Verifiability: knowledgeable and independent observers could reach consensus,
but not necessarily complete agreement, that a depiction is a faithful representation
• Timeliness: having information available to decision-makers in time to be capable
of influencing their decisions
• Understandability: Classify, characterise, and present information clearly and
concisely
6
Elements
 Asset: Resource controlled as a result of past events and from which future
economic benefits are expected to flow
 Liability: Present obligation arising from past events, the settlement of
which is expected to result in outflow of resources embodying economic
benefits
 Equity: Assets minus liabilities
 Income: increases in economic benefits during period from inflows or
enhancements, outflows or depletions of assets or decreases of liabilities
from in increase in equity, other than contributions from equity
 Expense: decreases in economic benefits during period from outflows or
depletions liabilities or incurrences of liabilities from in decreases in
equity, other than distributions to equity. 7
 Generally Accepted Accounting Principles

Financial Statements
Balance
Balance Sheet
Sheet
Various users Income
Income Statement
Statement
Statement
Statement of
of Owner’s
Owner’s Equity
need financial Statement of Cash
Equity
Flows
Statement of Cash Flows
information Note
Note Disclosure
Disclosure

The accounting profession

has attempted to develop a Generally
Generally Accepted
Accepted
set of standards that are Accounting
Accounting Principles
Principles
(GAAP)-IFRS
(GAAP)-IFRS
generally accepted and
universally practiced.
Assumptions

Monetary Unit Assumption requires that companies include in the

accounting records only transaction data that can be expressed in terms of
money.

Economic Entity Assumption requires that activities of the entity

be kept separate and distinct from the activities of its owner and all other
economic entities.
Forms of Business Ownership

Proprietorship Partnership Corporation

 Generally owned  Owned by two or  Ownership

by one person. more persons. divided into
 Often small  Often retail and shares of stock
service-type service-type  Separate legal
businesses businesses entity organized
 Owner receives  Generally under state
any profits, unlimited corporation law
suffers any personal liability  Limited liability
losses, and is  Partnership
personally liable
agreement
for all debts.
 The Basic Accounting Equation

Assets
Assets = + Owner’s
Liabilities Equity

Provides the underlying framework for recording and summarizing

economic events.

Assets are claimed by either creditors or owners.

Claims of creditors must be paid before ownership claims.

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Supplies, Equipment, etc.

Assets
Assets +
Owner’s
= Liabilities Equity
Liabilities
 Claims against assets (debts and obligations).
 Creditors - party to whom money is owed.
 Accounts payable, Notes payable, etc.

Assets
Assets +
Owner’s
= Liabilities Equity
Owner’s Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Investment by owners and revenues (+)
 Drawings and expenses (-).

Assets
Assets +
Owner’s
= Liabilities Equity
Increases in Owner’s Equity
 Investments by owner are the assets the owner puts into
the business.
 Revenues result from business activities entered into for
the purpose of earning income.
 Common sources of revenue are: sales, fees,
services, commissions, interest, dividends, royalties,
and rent.
Decreases in Owner’s Equity

 Drawings An owner may withdraw cash or other assets for personal

use.
 Expenses are the cost of assets consumed or services used in the process
of earning revenue.

 Common expenses are: salaries expense, rent expense, utilities

expense, tax expense, etc.
 Using the Accounting Equation

Transactions are a business’s economic events recorded by

accountants.
 May be external or internal.
 Not all activities represent transactions.
 Each transaction has a dual effect on the accounting equation.
Illustration: Are the following events recorded in the accounting records?
Discuss
Purchase options with
Event computer customer Pay rent

Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?

Record/
Don’t Record
Financial Statements
Companies prepare four financial statements :

Income Owner’s Equity Statement of

Balance Sheet
Statement Statement Cash Flows
Income Statement

 Reports the revenues and expenses for a specific period

of time.
 Lists revenues first, followed by expenses.
 Shows net income (or net loss).
Owner’s Equity Statement

 Reports the changes in owner’s equity for a specific

period of time.
 The time period is the same as that covered by the
income statement.
Balance Sheet
 Reports the assets, liabilities, and owner’s equity at a
specific date.
 Lists assets at the top, followed by liabilities and owner’s
equity.
 Total assets must equal total liabilities and owner’s equity.
 Is a snapshot of the company’s financial condition at a
specific moment in time (usually the month-end or year-
end).
Statement of Cash Flows
 Information for a specific period of time.
 Answers the following:

1. Where did cash come from?

2. What was cash used for?

3. What was the change in the

cash balance?
The Account

 Record of increases and decreases

Account in a specific asset, liability, equity,
revenue, or expense item.
 Debit = “Left”
 Credit = “Right”

Account Name
An account can be Debit / Dr. Credit / Cr.
illustrated in a T-
account form.
Debits and Credits

Double-entry system
► Each transaction must affect two or more accounts to
keep the basic accounting equation in balance.
► Recording done by debiting at least one account and
crediting another.
► DEBITS must equal CREDITS.
 If Debit amounts are greater than Credit amounts, the
account will have a debit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000

Balance $15,000
 If Debit amounts are less than Credit amounts, the
account will have a credit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance $1,000
Debits and Credits
Assets  Assets - Debits should exceed
Debit / Dr. Credit / Cr.
credits.
 Liabilities – Credits should
Normal Balance
exceed debits.
Chapter
3-23

 Normal balance is on the

Liabilities increase side.
Debit / Dr. Credit / Cr.

Normal Balance

Chapter
3-24
 Debits and Credits

Owner’s Equity
Debit / Dr. Credit / Cr.
 Owner’s investments and revenues
increase owner’s equity (credit).

Normal Balance
 Owner’s drawings and expenses
Chapter
3-25
decrease owner’s equity (debit).

Owner’s Capital Owner’s Drawing Helpful Hint Because

Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. revenues increase owner’s
equity, a revenue account
has the same debit/credit
rules as the Owner’s
Normal Balance Normal Balance Capital account. Expenses
have the opposite effect.
Chapter Chapter
3-25 3-23
Debits and Credits

Revenue
Debit / Dr. Credit / Cr.

 The purpose of earning revenues

is to benefit the owner(s).
Normal Balance

 The effect of debits and credits on

Chapter

revenue accounts is the same as

3-26

their effect on Owner’s Capital.

Expense
Debit / Dr. Credit / Cr.  Expenses have the opposite
effect: expenses decrease owner’s
Normal Balance
equity.

Chapter
3-27
 Debits/Credits Rules

Balance Sheet Income Statement

Asset = Liability + Equity Revenue - Expense

Debit

Credit
 Summary of Debits/Credits Rules
Relationship among the assets, liabilities and owner’s equity of a business:

Basic
Assets = Liabilities + Owner’s Equity
Equation

Expanded
Basic
Equation

The equation must be in balance after every transaction. For every

Debit there must be a Credit.
Steps in the Recording Process

Analyze each transaction Enter transaction in a journal Transfer journal information to

ledger accounts

Business documents, such as a sales slip, a check, a bill, or

a cash register tape, provide evidence of the transaction.
The Journal
 Book of original entry.
 Transactions recorded in chronological order.
 Contributions to the recording process:
1. Discloses the complete effects of a transaction.

2. Provides a chronological record of transactions.

3. Helps to prevent or locate errors because the debit and

credit amounts can be easily compared.
Journalizing - Entering transaction data in the journal.
Illustration: On September 1, Ray Neal invested $15,000 cash in
the business; softbyte, and Softbyte purchased computer
equipment for $7,000 cash.

General Journal

Date Account Title Ref. Debit Credit

Sept. 1 Cash 15,000
Owner’s Capital 15,000

Equipment 7,000
Cash 7,000
Simple and Compound Entries
Illustration: On July 1, Butler Company purchases a delivery truck
costing $14,000. It pays $8,000 cash now and agrees to pay the
remaining $6,000 on account.

General Journal

Date Account Title Ref. Debit Credit

July 1 Equipment 14,000
Cash 8,000
Accounts payable 6,000
The Ledger
 General Ledger contains the entire group of accounts
maintained by a company.
Standard Form of Account
 Posting
process of
transferring
amounts from
the journal to
the ledger
accounts.
Chart of Accounts
Accounts and account numbers arranged in sequence in which
they are presented in the financial statements.
 The Recording Process Illustrated

Follow these steps:

1. Determine what
type of account is
involved.
2. Determine what
items increased or
decreased and by
how much.
3. Translate the
increases and
decreases into
debits and credits.
Summary of Journalizing and Posting
Trial Balance
Limitations of a Trial Balance

The trial balance may balance even when

1. a transaction is not journalized,
2. a correct journal entry is not posted,
3. a journal entry is posted twice,
4. incorrect accounts are used in journalizing or posting, or
5. offsetting errors are made in recording the amount of a
transaction.
Timing Issues
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.

Generally a
 month, Alternative Terminology
The time period assumption
 quarter, or is also called the
 year. periodicity assumption.
 Fiscal and Calendar Years

 Monthly and quarterly time periods are called interim periods.

 Public companies must prepare both quarterly and annual financial
statements.
 Fiscal Year = Accounting time period that is one year in length.
 Calendar Year = January 1 to December 31.
Accrual- versus Cash-Basis Accounting

Accrual-Basis Accounting
 Transactions recorded in the periods in which the
events occur.
 Companies recognize revenues when they perform
services (rather than when cash is received).
 Expenses are recognized when incurred (rather than
when paid).
Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
 Revenues recognized when cash is received.
 Expenses recognized when cash is paid.
 Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).
Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE

Match expenses with revenues in
the period when the expense makes
its contribution to revenue.
“Let the expenses follow the
revenues.”
GAAP relationships in revenue
and expense recognition
The Basics of Adjusting Entries
Adjusting Entries
 Ensure that the revenue recognition and expense
recognition principles are followed.
 Necessary because the trial balance may not contain
up-to-date and complete data.
 Required every time a company prepares financial
statements.
 Will include one income statement account and one
balance sheet account.
 Types of Adjusting Entries
Categories of adjusting entries

Deferrals Accruals

1. Prepaid Expenses. Expenses 1. Accrued Revenues.

paid in cash before they are Revenues for services
used or consumed. performed but not yet received
in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.
 Types of Adjusting Entries

Trial Balance – Each

account is analyzed to
determine whether it is
complete and up-to-
date.
Adjusting Entries for Deferrals

Deferrals are expenses or revenues that are

recognized at a date later than the point when cash
was originally exchanged. There are two types:

 Prepaid expenses and

 Unearned revenues.
 PREPAID EXPENSES
Payment of cash, that is recorded as an asset because service or
benefit will be received in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

 insurance  rent
 supplies  equipment
 advertising  buildings
PREPAID EXPENSES

 Expire either with the passage of time or through use.

 Adjusting entry:
► Increase (debit) to an expense account and
► Decrease (credit) to an asset account.
Illustration: Pioneer Advertising Agency purchased supplies
costing $2,500 on October 5. Pioneer recorded the payment
by increasing (debiting) the asset Supplies. This account
shows a balance of $2,500 in the October 31 trial balance.
An inventory count at the close of business on October 31
reveals that $1,000 of supplies are still on hand.

Oct. 31 Supplies expense 1,500

Supplies 1,500
Illustration: On October 4, Pioneer
Advertising Agency paid $600 for a one-year
fire insurance policy. Coverage began on
October 1. Pioneer recorded the payment by
increasing (debiting) Prepaid Insurance. This
account shows a balance of $600 in the
October 31 trial balance. Insurance of $50
($600 ÷ 12) expires each month.

Oct. 31 Insurance expense 50

Prepaid insurance 50
Depreciation
 Buildings, equipment, and motor vehicles (assets that
provide service for many years) are recorded as assets,
rather than an expense, in the year acquired.

 Depreciation is the process of allocating the cost of an

asset to expense over its useful life.

 Depreciation does not attempt to report the actual change

in the value of the asset.
Illustration: For Pioneer Advertising, assume
that depreciation on the equipment is $480 a
year, or $40 per month.
Oct. 31
Depreciation expense 40
Accumulated depreciation 40

Accumulated Depreciation is called a

contra asset account.
Statement Presentation
 Accumulated Depreciation is a contra asset account
(credit).
 Appears just after the account it offsets (Equipment) on
the balance sheet.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
 UNEARNED REVENUES

Receipt of cash that is recorded as a liability because the service has

not been performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

 Rent  Magazine subscriptions
 Airline tickets  Customer deposits
UNEARNED REVENUES

 Adjusting entry is made to record the revenue for services

performed during the period and to show the liability that
remains at the end of the period.
 Results in a decrease (debit) to a liability account and an
increase (credit) to a revenue account.
Illustration: Pioneer Advertising Agency received $1,200 on
October 2 from R. Knox for advertising services expected to be
completed by December 31. Unearned Service Revenue shows a
balance of $1,200 in the October 31 trial balance. Analysis reveals
that the company performed $400 of services in October.

Oct. 31 Unearned service revenue 400

Service revenue 400
Adjusting Entries for Accruals

Accruals are made to record

 Revenues for services performed
OR
 Expenses incurred
in the current accounting period that have not been
recognized through daily entries.
 ACCRUED REVENUES

Revenues for services performed but not yet received in cash or

recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

 Rent  Services performed
 Interest
 ACCRUED REVENUES

 Adjusting entry shows the receivable that exists and records the
revenues for services performed.
 Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
Illustration: In October Pioneer Advertising
Agency earned $200 for advertising services
that had not been recorded.
Oct. 31
Accounts receivable 200
Service revenue 200
 ACCRUED EXPENSES

Expenses incurred but not yet paid in cash or recorded.

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

 Rent  Taxes
 Interest  Salaries
ACCRUED EXPENSES

 Adjusting entry records the obligation and recognizes the

expense.
 Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Illustration: Pioneer Advertising Agency signed a three-month
note payable in the amount of $5,000 on October 1. The note
requires Pioneer to pay interest at an annual rate of 12%.

Oct. 31 Interest expense 50

Interest payable 50
Illustration: Pioneer Advertising Agency last paid salaries on
October 26; the next payment of salaries will not occur until
November 9. The employees receive total salaries of $2,000 for a
five-day work week, or $400 per day. Thus, accrued salaries at
October 31 are $1,200 ($400 x 3 days).
Summary of Basic Relationships
The Adjusted Trial Balance
Adjusted Trial Balance
 Prepared after all adjusting entries are journalized and
posted.

 Purpose is to prove the equality of debit balances and

credit balances in the ledger.

 Is the primary basis for the preparation of financial

statements.
The Financial Statements

Financial
FinancialStatements
Statementsare
areprepared
prepareddirectly
directlyfrom
fromthe
the
Adjusted
AdjustedTrial
TrialBalance.
Balance.

Owner’s
Income Balance
Equity
Statement Sheet
Statement
Preparation of the income statement and owner’s
equity statement from the adjusted trial balance
Preparation of the balance sheet from
the adjusted trial balance
Using a Worksheet

Steps in Preparing a Worksheet

 Multiple-column form used in preparing financial
statements.
 Not a permanent accounting record.
 Five step process.
 Use of worksheet is optional.
Steps in Preparing a Worksheet
 1. Prepare a Trial Balance on the Worksheet
Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Prepaid Insurance 600
Office Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200
Owner's Capital 10,000
Owner's Drawing 500
Service Revenue 10,000

Salaries Expense 4,000

Rent Expense 900
Totals 28,700 28,700

Trial balance amounts come

directly from ledger accounts.
Include all accounts
with balances.
General journal
showing adjusting
entries

Adjusting
Journal
Entries
 2. Enter the Adjustments in the Adjustments Columns
Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500 1,500
Prepaid Insurance 600 50
(a)
Office Equipment 5,000
(b)
Notes Payable 5,000
Adjustments Key:
Accounts Payable 2,500
Unearned Revenue 1,200 400 (a) Supplies Used.
Owner's Capital 10,000
(d) (b) Insurance Expired.
Owner's Drawing 500
Service Revenue 10,000 400 (c) Depreciation Expensed.
(d) 200 (d) Service Revenue Earned.
Salaries Expense 4,000 1,200 (e)
Rent Expense 900 (g) (e) Service Revenue Accrued.
Totals 28,700 28,700 (f) Interest Accrued.
Supplies Expense 1,500
Insurance Expense (a) 50
(g) Salaries Accrued.
(b)
Accumulated Depreciation 40
(c)
Depreciation Expense 40
(c)
Accounts Receivable (e) 200
Interest Expense (f) 50 Enter adjustment amounts, total
Interest Payable (f) 50 adjustments columns,
Salaries Payable (g) 1,200
Totals 3,440 3,440
and check for equality.

Add additional accounts as needed.

 3. Complete the Adjusted Trial Balance Columns
Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200
Supplies 2,500 (a) 1,500 1,000
Prepaid Insurance 600 (b) 50 550
Office Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 (d) 400 800
Owner's Capital 10,000 10,000
Owner's Drawing 500 500
Service Revenue 10,000 (d) 400 10,600
(e) 200
Salaries Expense 4,000 (g) 1,200 5,200
Rent Expense 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500
Insurance Expense (b) 50 50
Accumulated Depreciation (c) 40 40
Depreciation Expense (c) 40 40
Accounts Receivable (e) 200 200
Interest Expense (f) 50 50
Interest Payable (f) 50 50
Salaries Payable (g) 1,200 1,200
Totals 3,440 3,440 30,190 30,190

Total the adjusted trial balance

columns and check for equality.
 4. Extend Amounts to Financial Statement Columns
Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200
Supplies 2,500 (a) 1,500 1,000
Prepaid Insurance 600 (b) 50 550
Office Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 (d) 400 800
Owner's Capital 10,000 10,000
Owner's Drawing 500 500
Service Revenue 10,000 (d) 400 10,600 10,600
(e) 200
Salaries Expense 4,000 (g) 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
Insurance Expense (b) 50 50 50
Accumulated Depreciation (c) 40 40
Depreciation Expense (c) 40 40 40
Accounts Receivable (e) 200 200
Interest Expense (f) 50 50 50
Interest Payable (f) 50 50
Salaries Payable (g) 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600

Extend all revenue and expense account

balances to the income statement columns.
 5. Total Columns, Compute Net Income (Loss)
Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200 15,200
Supplies 2,500 (a) 1,500 1,000 1,000
Prepaid Insurance 600 (b) 50 550 550
Office Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 (d) 400 800 800
Owner's Capital 10,000 10,000 10,000
Owner's Drawing 500 500 500
Service Revenue 10,000 (d) 400 10,600 10,600
(e) 200
Salaries Expense 4,000 (g) 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
Insurance Expense (b) 50 50 50
Accumulated Depreciation (c) 40 40 40
Depreciation Expense (c) 40 40 40
Accounts Receivable (e) 200 200 200
Interest Expense (f) 50 50 50
Interest Payable (f) 50 50 50
Salaries Payable (g) 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Compute Net Income or Net Loss.
Preparing Statements from a Worksheet
 Income statement is prepared from the income
statement columns.
 Balance sheet and owner’s equity statement are
prepared from the balance sheet columns.
 Companies journalize and post adjusting entries.
Preparing Statements from a Worksheet
Preparing Adjusting Entries from a Worksheet

 Adjusting entries are prepared from the adjustments

columns of the worksheet.
 Journalizing and posting of adjusting entries follows the
preparation of financial statements when a worksheet is
used.
Closing the Books

At the end of the accounting period, the company makes

the accounts ready for the next period.
 Preparing Closing Entries

Closing entries formally recognize, in the general ledger, the transfer of

 net income (or net loss) and owner’s drawing to owner’s capital.

Closing entries are only made at the end of the annual accounting period.
 Closing the Books

Note:
Owner’s Drawing is closed
directly to Capital and not to
Income Summary because
Owner’s Capital is a
Owner’s Drawing is not an permanent account; all
other accounts are
expense. temporary accounts.
Closing entries journalized
Posting
Closing
Entries
Preparing a Post-Closing Trial Balance
Purpose is to prove the equality of the permanent account
balances after journalizing and posting of closing entries.
Summary of the Accounting Cycle

1.
1. Analyze
Analyze business
business transactions
transactions

9.
9. Prepare
Prepare aa post-closing
post-closing 2.
2. Journalize
Journalize the
the
trial
trial balance
balance transactions
transactions

8.
8. Journalize
Journalize and
and post
post 3.
3. Post
Post to
to ledger
ledger accounts
accounts
closing
closing entries
entries

7.
7. Prepare
Prepare financial
financial 4.
4. Prepare
Prepare aa trial
trial balance
balance
statements
statements

6.
6. Prepare
Prepare an
an adjusted
adjusted trial
trial 5.
5. Journalize
Journalize and
and post
post
balance
balance adjusting
adjusting entries
entries
 Summary of the Accounting Cycle
Correcting Entries

 Unnecessary if the records are error-free.

 Made whenever an error is discovered.
 Must be posted before closing entries.
Instead of preparing a correcting entry, it is possible to
reverse the incorrect entry and then prepare the correct entry.
 Illustration (Case 1): On May 10, Mercato Co. journalized and posted
a $50 cash collection on account from a customer as a debit to Cash
$50 and a credit to Service Revenue $50. The company discovered the
error on May 20, when the customer paid the remaining balance in full.
Incorrect Cash 50
entry Service Revenue
50
Correct Cash 50
entry Accounts Receivable
50
Correcting Service Revenue 50
entry Accounts Receivable
50
 Illustration (Case 2): On May 18, Mercato purchased on account
equipment costing $450. The transaction was journalized and posted
as a debit to Equipment $45 and a credit to Accounts Payable $45. The
error was discovered on June 3,
Incorrect Equipment 45
entry Accounts Payable
45
Correct Equipment 450
entry Accounts Payable
450
Correcting Equipment 405
entry Accounts Payable
405
 The Classified Balance Sheet
 Presents a snapshot at a point in time.
 To improve understanding, companies group similar
assets and similar liabilities together.
Standard Classifications

Assets Liabilities and Owner’s Equity

Current assets Current liabilities
Long-term investments Long-term liabilities
Property, plant, and equipment Owner’s (Stockholders’) equity
Intangible assets
Current Assets

 Assets that a company expects to convert to cash or

use up within one year or the operating cycle, whichever
is longer.
 Operating cycle is the average time it takes from the
purchase of inventory to the collection of cash from
customers.
Current Assets

Usually listed in the order they expect to convert them into cash.
Long-Term Investments
 Investments in stocks and bonds of other companies.
 Investments in long-term assets such as land or buildings
that a company is not currently using in its operating
activities.
Property, Plant, and Equipment
 Long useful lives.
 Currently used in operations.
 Depreciation - allocating the cost of assets to a number
of years.
 Accumulated depreciation - total amount of
depreciation expensed thus far in the asset’s life.
Property, Plant, and Equipment
Intangible Assets
 Assets that do not have physical substance.
Current Liabilities
 Obligations company is to pay within the coming year or
its operating cycle, whichever is longer.
 Usually list notes payable first, followed by accounts
payable. Other items follow in order of magnitude.
 Liquidity - ability to pay obligations expected to be due
within the next year.
Current Liabilities
Long-Term Liabilities
 Obligations a company expects to pay after one year.
Owner’s Equity
 Proprietorship - one capital account.
 Partnership - capital account for each partner.
 Corporation - Capital Stock and Retained Earnings.
Illustration( jan 1, 2021)
1. Each transaction during NetSolutions’ first month of operations is described
in the following paragraphs.
1.Nov. 1, 2009 Chris Clark deposits $25,000 in a bank account in the name of Net Solutions.
2.Nov. 5, 2009 Net Solutions paid $20,000 for the purchase of land as a future building site.
3.Nov. 10, 2009 Net Solutions purchased supplies for $1,350 and agreed to pay the supplier in the
near future.
4.Nov. 18, 2009 Net Solutions received cash of $7,500 for providing services to customers.
5.Nov. 30, 2009 Net Solutions paid the following expenses during the month: wages, $2,125; rent,
$800; utilities, $450; and miscellaneous, $275.
6.Nov. 30, 2009 Net Solutions paid creditors on account, $950.
7.Nov. 30, 2009 Chris Clark determined that the cost of supplies on hand at the end of the month was
$550.
8.Nov. 30, 2009 Chris Clark withdrew $2,000 from Net Solutions for personal use.

138
THE END