Issues in Accounting

3-1

3Review of Accounting

Information System

3-2

1. Understand basic accounting terminology.

2. Explain double-entry rules.

3. Identify steps in the accounting cycle.

4. Record transactions in journals, post to ledger accounts,

and prepare a trial balance.

5. Explain the reasons for preparing adjusting entries.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

3-3

Identifying and recording

Journalizing

Posting

Trial balance

Adjusting entries

Adjusted trial balance

Preparing financial statements

Closing

Post-closing trial balance

Reversing entries

Accounting Information System

The Accounting Cycle

Financial Statements for Merchandisers

Basic terminology

Debits and credits

Accounting equation

Financial statements and ownership structure

Income statement

Statement of retained earnings

Balance sheet

Closing entries

The Accounting Information SystemThe Accounting Information SystemThe Accounting Information SystemThe Accounting Information System

3-4

Collects and processes transaction data.

Disseminates the information to interested parties.

Accounting Information SystemAccounting Information SystemAccounting Information SystemAccounting Information System

Accounting Information System (AIS)

3-5 LO 1 Understand basic accounting terminology.

Journal

Posting

Trial Balance

Adjusting Entries

Financial Statements

Closing Entries

Basic Terminology


Event

Transaction

Account

Real Account

Nominal Account

Ledger

3-6


LO 2 Explain double-entry rules.

An Account shows the effect of transactions on a

given asset, liability, equity, revenue, or expense

account.

Double-entry accounting system (two-sided effect).

Recording done by debiting at least one account and

crediting another.

DEBITS must equal CREDITS.

Debits and Credits

3-7

Account Name

Debit / Dr. Credit / Cr.

Debits and CreditsDebits and CreditsDebits and CreditsDebits and Credits

An arrangement that shows the effect of transactions on an account.

Debit = “Left”

Credit = “Right”

AccountAccount


An Account can An Account can be illustrated in a be illustrated in a T-Account form.T-Account form.

3-8

Account Name




$10,000 Transaction #2$3,000

$15,000$15,000

8,000

Balance

Transaction #1

Transaction #3

If Debit entries are greater than Credit entries, the account will have a debit balance.

3-9

Account Name



If Credit entries are greater than Debit entries, the account will have a credit balance.


$10,000 Transaction #2$3,000

$1,000$1,000

8,000 Transaction #3

Balance

Transaction #1

3-10

Chapter 3-23

AssetsAssets


Normal BalanceNormal Balance

Chapter 3-27



ExpenseExpense

Chapter 3-24

LiabilitiesLiabilities



Chapter 3-25



EquityEquity

Chapter 3-26



RevenueRevenue

Normal Balance Credit

Normal Balance Credit

Normal Balance

Debit

Normal Balance

Debit

Debits and Credits SummaryDebits and Credits SummaryDebits and Credits SummaryDebits and Credits Summary


3-11

Balance Sheet Balance Sheet Income StatementIncome Statement

= + =-Asset Liability Equity Revenue Expense

Debit

Credit

Debits and Credits SummaryDebits and Credits SummaryDebits and Credits SummaryDebits and Credits Summary


3-12

The Accounting EquationThe Accounting EquationThe Accounting EquationThe Accounting Equation


Relationship among the assets, liabilities and stockholders’

equity of a business:

The equation must be in balance after every transaction.

For every Debit there must be a Credit.

Illustration 3-3

3-13

Double-Entry System IllustrationDouble-Entry System IllustrationDouble-Entry System IllustrationDouble-Entry System Illustration

AssetsAssets LiabilitiesLiabilitiesStockholders’

Equity

Stockholders’ Equity

= +

1. Owners invest $40,000 in exchange for common stock.

+ 40,000 + 40,000


3-14

AssetsAssets LiabilitiesLiabilities= +

2. Disburse $600 cash for secretarial wages.

- 600 - 600 (expense)





3-15



3. Purchase office equipment priced at $5,200, giving a 10 percent promissory note in exchange.

+ 5,200 + 5,200




3-16



4. Received $4,000 cash for services rendered.

+ 4,000 + 4,000 (revenue)




3-17



5. Pay off a short-term liability of $7,000.

- 7,000 - 7,000




3-18


6. Declared a cash dividend of $5,000.

+ 5,000 - 5,000





3-19



7. Convert a long-term liability of $80,000 into common stock.

- 80,000 + 80,000




3-20



8. Pay cash of $16,000 for a delivery van.


- 16,000

+ 16,000

Note that the accounting equation equality is maintained after recording each transaction.

Note that the accounting equation equality is maintained after recording each transaction.



3-21

Ownership structure dictates the types of accounts that are part of the equity section.

Proprietorship or Partnership

Proprietorship or Partnership CorporationCorporation

Capital Account Drawing Account

Common Stock Additional Paid-in

Capital Dividends Declared Retained Earnings

Financial Statements and Ownership StructureFinancial Statements and Ownership StructureFinancial Statements and Ownership StructureFinancial Statements and Ownership Structure


3-22

Financial Statements and Ownership StructureFinancial Statements and Ownership StructureFinancial Statements and Ownership StructureFinancial Statements and Ownership Structure


Stockholders’ EquityStockholders’ Equity

Balance Sheet

Statement of Retained Earnings

Net income or Net loss (Revenues less expenses)(Revenues less expenses)

Income StatementIncome Statement

Net income or Net loss (Revenues less expenses)(Revenues less expenses)

Income StatementIncome StatementDividendsDividends

Retained Earnings Retained Earnings (Net income retained in business)(Net income retained in business)

Retained Earnings Retained Earnings (Net income retained in business)(Net income retained in business)

Common Stock Common Stock (Investment by stockholders)(Investment by stockholders)

Common Stock Common Stock (Investment by stockholders)(Investment by stockholders)

Illustration 3-4

3-23

The Accounting CycleThe Accounting CycleThe Accounting CycleThe Accounting Cycle

LO 3 Identify steps in the accounting cycle.

TransactionsTransactions

1. Journalization1. Journalization

6. Financial Statements6. Financial Statements

7. Closing entries7. Closing entries

8. Post-closing trail balance8. Post-closing trail balance

9. Reversing entries9. Reversing entries

3. Trial balance3. Trial balance

2. Posting2. Posting

5. Adjusted trial balance5. Adjusted trial balance

4. Adjustments4. AdjustmentsWork SheetWork Sheet

Illustration 3-6

3-24

Identify and Recording TransactionsIdentify and Recording TransactionsIdentify and Recording TransactionsIdentify and Recording Transactions

What to Record?

FASB states, “transactions and other events and

circumstances that affect a business enterprise.”

LO 3 Identify steps in the accounting cycle.

Types of Events:

External – between a business and its environment.

Internal – event occurring entirely within a business.

3-25

General Journal – a chronological record of transactions. Journal Entries are recorded in the journal.

1. Journalizing1. Journalizing1. Journalizing1. Journalizing

LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.

September 1: Stockholders invested $15,000 cash in the corporation in exchange for shares of stock.

Illustration 3-7

3-26

Posting – the process of transferring amounts from the journal to the ledger accounts.

2. Posting2. Posting2. Posting2. Posting


Illustration 3-7

Illustration 3-8

3-27

Posting – Transferring amounts from journal to ledger.


LO 4

Illustration 3-8

3-28

Expanded Example



The purpose of transaction analysis is

(1) to identify the type of account involved, and

(2) to determine whether a debit or a credit is required.

Keep in mind that every journal entry affects one or more of the following items: assets, liabilities, stockholders’ equity, revenues, or expense.

3-29

1. October 1: Stockholders invest $100,000 cash in an advertising venture to be known as Pioneer Advertising Agency Inc.

Common stock 100,000

Cash 100,000Oct. 1

Debit Credit

Cash

100,000100,000 100,000100,000

Debit Credit

Common Stock



3-30

2. October 1: Pioneer Advertising purchases office equipment costing $50,000 by signing a 3-month, 12%, $50,000 note payable.

Notes payable 50,000

Equipment 50,000Oct. 1

Debit Credit

Equipment

50,00050,000 50,00050,000

Debit Credit

Notes Payable



3-31

3. October 2: Pioneer Advertising receives a $12,000 cash advance from KC, a client, for advertising services that are expected to be completed by December 31.

Unearned service revenue 12,000

Cash 12,000Oct. 2

Debit Credit

Cash

100,000100,000 12,00012,000

Debit Credit

Unearned Service Revenue


12,00012,000


3-32

4. October 3: Pioneer Advertising pays $9,000 office rent, in cash, for October.

Cash 9,000

Rent expense 9,000Oct. 3

Debit Credit

Cash

100,000100,000 9,0009,000

Debit Credit

Rent Expense


12,00012,0009,0009,000


3-33

5. October 4: Pioneer Advertising pays $6,000 for a one-year insurance policy that will expire next year on September 30.

Cash 6,000

Prepaid insurance 6,000Oct. 4

Debit Credit

Cash

100,000100,000 6,0006,000

Debit Credit

Prepaid Insurance


12,00012,0009,0009,000

6,0006,000


3-34

6. October 5: Pioneer Advertising purchases, for $25,000 on account, an estimated 3-month supply of advertising materials from Aero Supply.

Accounts payable 25,000

Supplies 25,000Oct. 5

Debit Credit

Supplies

25,00025,000 25,00025,000

Debit Credit

Accounts Payable



3-35

7. October 9: Pioneer Advertising signs a contract with a local newspaper for advertising inserts (flyers) to be distributed starting the last Sunday in November. Pioneer will start work on the content of the flyers in November. Payment of $7,000 is due following delivery of the Sunday papers containing the flyers.



3-36

8. October 20: Pioneer Advertising’s board of directors declares and pays a $5,000 cash dividend to stockholders.

Cash 5,000

Dividends 5,000Oct. 20

Debit Credit

Cash

100,000100,000 5,0005,000

Debit Credit

Dividends


12,00012,0009,0009,000

6,0006,000

5,0005,000


3-37

9. October 26: Employees are paid every four weeks. The total payroll is $2,000 per day. The pay period ended on Friday, October 26, with salaries of $40,000 being paid.

Cash 40,000

Salaries expense 40,000Oct. 26

Debit Credit

Cash

100,000100,000 40,00040,000

Debit Credit

Salaries Expense


12,00012,0009,0009,000

6,0006,000

5,0005,000

40,00040,000


3-38

10. October 31: Pioneer Advertising receives $28,000 in cash and bills Copa Company $72,000 for advertising services of $100,000 provided in October.

Accounts receivable 72,000Cash 28,000Oct. 31

Debit Credit

Cash

100,000100,000 72,00072,000

Debit Credit

Accounts Receivable


12,00012,0009,0009,000

6,0006,000

5,0005,000

40,00040,000

Service revenue 100,000

100,000100,000

Debit Credit

Service Revenue

28,00028,000

80,00080,000

3-39

Trial BalanceTrial Balance – A list of each account and its balance; used to prove equality of debit and credit balances.

3. Trial Balance3. Trial Balance3. Trial Balance3. Trial Balance

LO 4

Illustration 3-19

3-40

4. Adjusting Entries4. Adjusting Entries4. Adjusting Entries4. Adjusting Entries

LO 5 Explain the reasons for preparing adjusting entries.

Makes it possible to:

Report on the statement of financial position the appropriate assets, liabilities, and equity at the statement date.

Report on the income statement the proper revenues and expenses for the period.

► Revenues are recorded in the period in which they are earned.

► Expenses are recognized in the period in which they are incurred.

3-41

Types of Adjusting EntriesTypes of Adjusting EntriesTypes of Adjusting EntriesTypes of Adjusting Entries

1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.

Prepayments

3. Accrued Revenues. Revenues earned but not yet received in cash or recorded.

4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.

2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned.

Accruals


Illustration 3-20

3-42

Deferrals are either prepaid

expenses or

unearned revenues.

Adjusting Entries for DeferralsAdjusting Entries for DeferralsAdjusting Entries for DeferralsAdjusting Entries for Deferrals

Illustration 3-21


3-43

Payment of cash that is recorded as an asset because service or benefit will be received in the future.

Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”

insurance

supplies

advertising

Cash PaymentCash Payment Expense RecordedExpense RecordedBEFORE


rent

buildings and equipment

Prepayments often occur in regard to:

3-44

Supplies.Supplies. Pioneer purchased advertising supplies costing$25,000 on October 5. Prepare the journal entry to record the purchase of the supplies.

Cash 25,000

Supplies 25,000Oct. 5

Debit Credit

Supplies

25,00025,000 25,00025,000

Debit Credit

Cash



3-45

Supplies. An inventory count at the close of business on October 31 reveals that $10,000 of the advertising supplies are still on hand.

Supplies 15,000

Supplies expense 15,000Oct. 31

Debit Credit

Supplies

25,00025,000 15,00015,000

Debit Credit

Supplies Expense

15,00015,000


10,00010,000


3-46

Statement

Presentation:

Supplies identifies that

portion of the asset’s

cost that will provide

future economic benefit.

Adjusting Entries Adjusting Entries for “Prepaid for “Prepaid Expenses”Expenses”


Illustration 3-35

Illustration 3-35

3-47

Statement

Presentation:

Supplies expense

identifies that portion of

the asset’s cost that

expired in October.

Illustration 3-35



3-48

Insurance. On Oct. 4th, Pioneer paid $6,000 for a one-year fire insurance policy, beginning October 1. Show the entry to record the purchase of the insurance.

Cash 6,000

Prepaid insurance 6,000Oct. 4

Debit Credit

Prepaid Insurance

6,0006,000 6,0006,000

Debit Credit

Cash



3-49

Insurance. An analysis of the policy reveals that $500 ($6,000 / 12) of insurance expires each month. Thus, Pioneer makes the following adjusting entry.

Prepaid insurance 500

Insurance expense 500Oct. 31

Debit Credit

Prepaid Insurance

6,0006,000 500500

Debit Credit

Insurance Expense


500500

5,5005,500


3-50

Statement

Presentation:

Prepaid insurance


the asset’s cost that will

provide future economic

benefit.



Illustration 3-35

Illustration 3-35

3-51

Statement

Presentation:

Insurance expense



expired in October.

Illustration 3-35



3-52

Depreciation. Pioneer Advertising estimates depreciation on its office equipment to be $400 per month. Accordingly, Pioneer recognizes depreciation for October by the following adjusting entry.

Accumulated depreciation 400

Depreciation expense 400Oct. 31

Debit Credit

Depreciation Expense

400400 400400

Debit Credit

Accumulated Depreciation



3-53

Statement

Presentation:

Accumulated Depreciation—is a contra asset account.



Illustration 3-35

Illustration 3-35

3-54

Statement

Presentation:

Depreciation expense



expired in October.

Illustration 3-35



3-55

Receipt of cash that is recorded as a liability because the revenue has not been earned.

Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”

rent

airline tickets

school tuition

Cash ReceiptCash Receipt Revenue RecordedRevenue RecordedBEFORE

magazine subscriptions

customer deposits

Unearned revenues often occur in regard to:


3-56

Unearned Revenue. Pioneer Advertising received $12,000 on October 2 from KC for advertising services expected to be completed by December 31. Show the journal entry to record the receipt on Oct. 2nd.

Unearned advertising revenue 12,000

Cash 12,000Oct. 2

Debit Credit

Cash

12,00012,000 12,00012,000

Debit Credit

Unearned Rent Revenue



3-57

Debit Credit

Service Revenue

100,000100,000 12,00012,000

Debit Credit

Unearned Service Revenue

4,0004,000

8,0008,000


Unearned Revenues. Analysis reveals that Pioneer earned $4,000 of the advertising services in October. Thus, Pioneer makes the following adjusting entry.

Service revenue 4,000

Unearned service revenue 4,000Oct. 31

4,0004,000


3-58

Statement

Presentation:

Unearned service revenue identifies that portion of the liability that has not been earned.

Adjusting Entries Adjusting Entries for “Unearned for “Unearned

Revenues”Revenues”

Adjusting Entries Adjusting Entries for “Unearned for “Unearned

Revenues”Revenues”Illustration 3-35

Illustration 3-35

3-59

Statement

Presentation:

Service Revenue

includes the portion of

unearned service

revenue earned in

October.

Illustration 3-35



3-60

End of Session 4End of Session 4End of Session 4End of Session 4

To be Continued ………………..

Issues in Accounting

Documents

doubleentry rules

credit balance

debit balance

creditsif credit entries

debit entries

normal balancechapter

account namedebit

normal balancerevenue3