Transcript piimt.us

Accounting
Zoubida SAMLAL - MBA , CFA Member,
PHD candidate for HBS program
1
PLAN
Module
chapter
Part I
Introduction to accounting
Types of Accounting and Regulators
Part II
Accounting and financial systems
Recording transactions
Part III
Closing Process
Introduction to Accounting and
Regulators
3
Fundamental concepts
What is accounting?
• the language of business
• a process of identifying, recording, summarizing, and reporting
economic information to decision makers in the form of financial
statements
• a mean to communicate financial information.
• a way to convey information about a business to users.
4
Definitions of Accounting
• “The process of identifying, measuring, and communicating
economic information to permit informed judgements and
decisions by users of the information.”
—American Accounting Association (AAA)
•
“A service activity whose function is to provide quantitative
information, primarily financial in nature, about economic
entities that is intended to be useful in making economic
decisions.”
—American Institute of Certified Public Accountants
(AICPA)
5
Primary Functions of Accounting
1. Recording data about business transactions
2. Summarizing results of business activity into useful report-
However, managers in today's environment demand more
detailed reports like sales by district or sales by product type.
3. Providing assurances that the business is operating as
intended and that the assets of the organization are protected
6
Accounting as an Aid to Decision Making
• Accounting helps in decision making by showing where
and when money has been spent, by evaluating
performance, and by showing the implications of choosing
one plan instead of another.
• Fundamental relationships in the decision-making process:
Event
Accountant’s
analysis and
recording
Financial
statements
Users
Fundamental concepts
Who uses accounting information?
• Owners
• Managers
• Investors (including potential)
– Analysts on their behalf
• Creditors (including potential)
• Government (tax assessment)
• Regulators
• Customers
8
Fundamental concepts
• Accounting has two main divisions:
1- Financial accounting
Primarily prepared for users external to the company: Revenues,
earnings, assets, etc.
2- Management accounting
Primarily for internal purposes : Costing, budgeting, net present
value, etc.
9
Fundamental concepts
There are several ways that cash gets into a company:
• Investment by owners
• Investment by creditors (loans)
• Payments from customers
• Repayment of amounts loaned to other entities
• Return on investments (interest and dividend)
• Proceeds from selling assets
10
Fundamental concepts
Cash going in can be organized into three categories:
Operations
• Payments from customers
• Refunds from suppliers
Financing
• Investment by owners
• Investment by creditors (loans)
Investing
• Return on investments (interest and dividend)
• Proceeds from selling assets
• Repayment of amounts loaned to other entities
11
Fundamental concepts
Similarly, money going out of an entity can be categorized:
Operations
• Payments to suppliers
• Refunds to customers
Financing
• Payment of dividends or capital to owners
• Repayment of creditors
Investing
• Purchase of assets
• Amounts invested in other entities (debt or equity)
12
Fundamental concepts
Financial accounting categorizes all transactions and events based
on their substance because the users of the information are using
it with the assumption that these categorizations are being made
accurately.
If money invested by owners was reported as revenue, this would
be counter to the fundamental definition of revenue (i.e. that it
results from the operations of the company).
The separation of income and capital is a fundamental concept of
financial accounting.
13
Standards and Regulatory bodies
14
Securities and Exchange Commission
Established by federal government
Accounting and reporting for public companies
Securities Act
of 1933
Securities Act
of 1934
Encouraged private standard-setting body
SEC requires public companies to adhere to GAAP aka IFRS
Oversight
Enforcement Authority
Financial Accounting Standards Board
Wheat Committee’s recommendations resulted in the creation of a the
Financial Accounting Standards Board (FASB) in 1973.
Financial
Accounting
Foundation
Selects members of the FASB
Funds their activities
Exercises general oversight.
Financial
Accounting
Standards Board
Mission to establish and improve
standards of financial accounting
and reporting.
Financial Accounting
Standards Advisory
Council
Consult on major policy issues.
Financial Accounting Standards Board
Missions is to establish and improve standards of financial accounting and
reporting. Differences between FASB and APB include:
Full-time, Remunerated Membership
Greater Autonomy
Increased Independence
Broader Representation
Standard-Setting Organizations
• Generally accepted accounting principles (GAAP) encompass the conventions,
rules, and procedures for determining acceptable accounting practices at a
particular time.
• Financial Accounting Standards Board (FASB) is primarily responsible for
evaluating, setting, or modifying GAAP in the U.S.
• Sarbanes-Oxley Act responded to cases of accounting fraud.
– Created the Public Accounting Oversight Board, which sets audit standards and
investigates and sanctions accounting firms that certify the books of publicly
traded firms.
– Senior executives must personally certify that the financial information reported by
the company is correct.
– Resulted in increase in demand for accountants.
Financial Reporting Challenges
IFRS in a Political Environment
Financial Reporting Challenges
The Expectations Gap
What the public thinks accountants should do vs. what accountants think
they can do.
Significant Financial Reporting Issues
 Non-financial measurements
 Forward-looking information
 Sort assets
 Timeliness
Financial Reporting Challenges
Ethics in the Environment of Financial Accounting
Companies that concentrate on “maximizing the bottom
line,” “facing the challenges of competition,” and
“stressing short-term results” place accountants in an
environment of conflict and pressure.
IFRS does not always provide an answer.
Doing the right thing is not always easy or obvious.
Financial Reporting Challenges
International Convergence
In 2002 the IASB and the FASB formalized their commitment
to the convergence of U.S. GAAP and international
standards. The Boards agreed to:
1. Make their existing financial reporting standards fully
converged as soon as practicable, and
2. Coordinate their future work programs to ensure that
once achieved, convergence is maintained.
12 Fundamental concepts
24
1) BUSINESS ENTITY CONCEPT
• Business is treated as separate & distinct from its members
• Separate set of books are prepared.
• Proprietor is treated as creditor of the business.
• For other business of proprietor different books are prepared.
25
2) MONEY MEASUREMENT CONCEPT
• Transactions of monetary nature are recorded.
• Transactions of qualitative nature, even though of great
importance to business are not considered.
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3) GOING CONCERN CONCEPT
• Business will continue for a long period.
• As per this concept, fixed assets are recorded at their original
cost & depreciation is charged on these assets.
• Because of this concept, outside parties enter into long term
contracts with the enterprise.
27
4) ACCOUNTING PERIOD CONCEPT
• Entire life of the firm is divided into time intervals for
ascertaining the profits/losses are known as accounting
periods.
• Accounting period is of two types- financial year(1st Apr
to 31st March) & calendar year(1st Jan to 31st Dec).
• For taxation purposes financial year is adopted as
prescribed by the Govt.
• Companies having their shares listed on stock exchange
publishes their quarterly results.
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5) HISTORICAL COST CONCEPT
• Assets are recorded at their original price.
• This cost serves the basis for further accounting treatment of
the asset.
• Acquisition cost relates to the past i.e. it is known as historical
cost.
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JUSTIFICATION FOR HISTORICAL COST
CONCEPT
• This cost is objectively verifiable.
• Justified by going concern concept.
• Current values are difficult to determine.
• Difficult to keep track of up down of the market price.
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DRAWBACKS OF HISTORICAL CONCEPT
• Assets for which nothing is paid will not be recorded like
reputation, brand value, etc.
• Information based on historical cost may not be useful to its
members.
31
6) DUAL ASPECT CONCEPT
• Every transaction recorded in books affects at least two
accounts.
• If one is debited then the other one is credited with same
amount.
• This system of recording is known as “DOUBLE ENTRY
SYSTEM”.
• ASSETS = LIABILITIES + CAPITAL
32
7) REVENUE RECOGNITION/REALISATION
CONCEPT
• Revenue means the addition to the capital as a result of
business operations.
• Revenue is realized on three basis-:
1. Basis of cash
2. Basis of sale
3. Basis of production
33
8) MATCHING CONCEPT
• All the revenue of a particular period will be matched with the
cost of that period for determining the net profits of that
period.
• Accordingly, for matching costs with revenue, first revenue
should be recognized & then costs incurred for generating that
revenue should be recognized.
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Following points must be considered
while matching costs with revenue
• Outstanding expenses though not paid in cash are shown in the
P&L a/c.
• Prepaid expenses are not shown in the P&L a/c.
• Closing stock should be carried over to the next period as
opening stock.
• Income receivable should be added in the revenue & income
received in advance should be deducted from revenue.
35
9) ACCRUAL CONCEPT
• In this concept revenue is recorded when sales are made or
services are rendered it is immaterial whether cash is received
or not.
• Same with the expenses i.e. they are recorded in the
accounting period in which they assist in earning the revenues
whether the cash is paid for them or not.
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10) OBJECTIVITY CONCEPT
• Accounting transactions should be recorded in an objective
manner, free from the personal bias of either management or
the accountant who prepares the accounts.
• It is possible only when each transaction is supported by
verifiable documents & vouchers such as cash memos,
invoices.
37
11) TIMELINESS
• This principle states that the information should be provided to
the users at right time for the purpose of decision making.
• Delay in providing accounts serves no usefulness for the users
for decision making.
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12) COST BENEFIT PRINCIPLE
• This principle states that the cost incurred in applying the
principles should be less than the profits derived from them.
39
ACCOUNTING CONVENTIONS
ACCOUNTING CONVENTIONS
• An accounting convention may be defined as a custom or
generally accepted practice which is adopted either by general
agreement or common consent among accountants.
1) CONVENTION OF FULL DICLOSURE
• Information relating to the economic affairs of the enterprise
should be completely disclosed which are of material interest
to the users.
• Proforma & contents of balance sheet & P&L a/c are
prescribed by Companies Act.
• It does not mean that leaking out the secrets of the business.
2) CONVENTION OF CONSISTENCY
• Accounting method should remain consistent year by year.
• This facilitates comparison in both directions i.e. intra firm &
inter firm.
• This does not mean that a firm cannot change the accounting
methods according to the changed circumstances of the
business.
3) CONVENTION OF CONSERVATISM
• All anticipated losses should be recorded but all anticipated
gains should be ignored.
• It is a policy of playing safe.
• Provisions is made for all losses even though the amount
cannot be determined with certainty
4) CONVENTION OF MATERIALITY
• According to American Accounting Association, “An item
should be regarded as material if there is reason to believe that
knowledge of it would influence decision of informed
investor.”
• It is an exception to the convention of full disclosure.
• Items having an insignificant effect to the user need not to be
disclosed.
DIFFERENCE B/W CONCEPTS &
CONVENTIONS
BASIS
Established
Biasness
Uniformity
ACCOUNTING
CONCEPTS
By law
ACCOUNTING
CONVENTIONS
Guidelines based
upon customs or
usage
No space for
Biasness in adoption
personal biasness in
the adoption
Uniform adoption
No uniform adoption
Accounting and Financial
Statements
The Nature of Accounting
• The accounting system is a series of steps
performed to analyze, record, quantify,
accumulate, summarize, classify, report, and
interpret economic events and their effects on an
organization and to prepare the financial
statements.
Accounting as an Aid to
Decision Making
• Fundamental relationships in the decisionmaking process:
Event
Accountant’s
analysis &
recording
Financial
Statements
Users
Financial and Management
Accounting
• The major distinction between financial and
management accounting is the users of the
information.
– Financial accounting serves external users.
– Management accounting serves internal users,
such as top executives, management,
and administrators within
organizations.
Financial and Management Accounting
The primary questions about an organization’s
success that decision makers want to know are:
What is the financial picture of the organization
on a given day?
How well did the organization do during a given
period?
CHART OF ACCOUNTS
The Chart of Accounts is organized using
three different methods.
1. First: Accounting Types
2. Second: Order of Liquidity - the ease
of converting to cash without loss of
value
3. Third: Account Numbers
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7 TYPES OF ACCOUNTS
1.
2.
3.
4.
Assets - Things you own
Liabilities - Things you owe
Equity - Owners Stake in Company
Revenue - Income through Sales of the Products of the
Business
5. Costs of Goods Sold - Costs to provide the service or to
manufacture or acquire the product the business sells
6. Expenses - Things that are paid for that are consumable and are
part of the cost of running a business
7. Other Revenue and Expenses - Revenue and Expenses that are
unusual cases and are not directly related to the business
product and are not usual costs of running a business.
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ORDER OF LIQUIDITY
• The Chart of Accounts’ second method of organization is
Order of Liquidity. Liquidity refers to the expectation that the
item can be converted to cash at least close to its current
value within one year.
• Accounts are listed in descending order of liquidity within
their accounting types, with cash at the top of the list for
Assets.
•
The liquidity classification is so important that Assets and
Liabilities are divided into the Subtypes of Current and Long
Term/Fixed to group items of similar liquidity together.
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ACCOUNT NUMBERS
• Assigning Account numbers starts by assigning a range of
numbers to each Accounting Type.
• The number of digits will be important in your software
system so when using ranges in the 1000’s there are 4 digits,
and the Account Numbers would range from 1000 to 9999.
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ACCOUNT NUMBERS
• Assets: 1000’s
– Current Assets 1000 – 1499; Fixed Assets 1500 -1999
• Liabilities: 2000’s
– Current Liabilities 2000 – 2499; Long Term Liabilities 2500 2999
• Equity: 3000’s
• Revenue: 4000’s
• Costs of Goods Sold: 5000’s
• Expenses: 7000’s
• Other Revenue: 8000’s
• Other Expenses: 9000’s
56
Use of Funds (Debit) Accounting
Types
• Each Accounting Type under the “Funds/Use
of Funds” Category increases in value or
balance with each debit (Use of Funds)
transaction entry and decreases in value or
balance with each credit (Source of Funds)
transaction entry. Use of Funds Accounts are
sometimes referred to as Debit Accounts.
57
Use of Funds (Debit) Accounting
Types
Positive balances for these accounts are balances where total
debits > total credits to the account and their balances should
show in the Debit Column.
1. Assets
2. Costs of Goods Sold
3. Expenses
4. Other Expenses
58
Source of Funds (Credit) Accounting
Types
• Each Accounting Type under the “Source of Funds” Category
increases in value or balance with each credit (Source of
Funds) transaction entry and decreases in value or balance
with each debit (Use of Funds) transaction entry. Source of
Funds Accounts are sometimes referred to as Credit
Accounts.
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Source of Funds (Credit) Accounting
Types
Positive balances for these accounts are balances where total
credits > total debits to the account and their balances should
show in the Credit Column.
1. Liabilities - Things you owe
2. Equity - Owners’ Stake in Company
3. Revenue - Income through Sales of the Products of the
Business
4. Other Revenues - Revenues that are unusual cases and are
not directly related to the business product and are not usual
revenues from running a business.
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FINANACIAL STATEMENTS
ANNUAL REPORT
• Financial Statements
– Income Statement
– Statement of Retained Earnings
– Balance Sheet
– Statement of Cash Flows
• Management Discussion and Analysis
• Notes to Financial Statements
• Auditor's Report
Financial Accounting Statements
• Income Statement - reports the results of
operations for a specific period of time
• Retained Earnings Statement - reports the
changes in retained earnings for a specific period
of time
• Balance Sheet - reports the assets, liabilities, and
stockholders’ equity at a specific date
• Statement of Cash Flows - reports the cash
receipts and payments for a specific period of
time
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Management Discussion
and Analysis
Covers three aspects of a company:
– liquidity - ability to pay near term
obligations
– capital resources - fund operations and
expansions
– results of operation
64
Notes to Financial Statements
• Provide additional information not
included in body of statements
• Describe accounting policies or explain
uncertainties and contingencies
65
Auditor's Report
• Auditor, a professional accountant who
conducts an independent examination of the
financial accounting data presented by a
company.
• Auditor gives an unqualified opinion if the
financial statements present the financial
position, results of operations, and cash flows
in accordance with GAAP.
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Statement of Cash Flows
67
Statement of Cash Flows
The Cash Flow Statement (Statement of Cash Flows) provides
an overview of the way Funds move through an Entity, how
they impact Overall Value and eventually reconcile with Cash
Balances and determine Net Cash Flow in any given year.
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3 Types of Business Activity
• Financing
• Investing
• Operating
69
Investing Activities
Obtaining the
Resources or Assets
needed to operate the business
Examples of assets...
•
•
•
•
Cash
Accounts Receivable
Prepaid Rent
Buildings, Equipment, Furniture
70
Investing Activities - Examples
• Purchase or Sale of computers, delivery
trucks, furniture, buildings
• Purchase or Sale of investments
71
Cash flow statement
1. Operating Activities
Net Income
+ Depreciation Expense (+ Increase and -Decrease in
Accumulated Depreciation)
+ Increases in Current Liabilities
+ Decreases in Current Assets
- Increases in Current Assets
- Decreases in Current Liabilities
Cash flow statement
2. Investing Activities
+ Decreases in Long Term/Fixed Assets (Independent
of Accumulated Depreciation)
- Increases in Long Term/Fixed Assets (Independent of
Accumulated Depreciation)
Cash flow statement
3. Financing Activities
+ Increases in Long Term Liabilities/Debt
- Decreases in Long Term Liabilities/Debt
+ Increases in Owners’ Capital
- Decreases in Owners’ Capital
- Increases in Dividends
Beginning Cash Balance - Net Increase/Decrease =
Ending Cash Balance
Statement of Cash Flows
Cash Flows From Operating Activities
Net Income
Depreciation
Increase in Payables
Net Cash Provided by Operating Activities
Cash Flows From Investing Activities
Increase in Fixed Assets
Net Cash Used by Investing Activities
$45,104
$496
$1,700
————
$47,300
————
$2,950
————
-$2,950
————
Cash Flows From Financing Activities
Net Cash Provided by Financing Activities
Increase in Cash and Cash Equivalents (Net Cash Flow)
Cash and Cash Equivalents at Beginning of Year
Cash and Cash Equivalents at End of Year
$0
————
$0
————
$44,350
$0
————
$44,350
Income Statement
Income Statement
• The Income Statement Accounting Types are
Revenue, Cost of Goods Sold and Expenses. The
Accounts that are not on the Income Statement
are on the Balance Sheet.
• As its name suggests, the purpose of the Income
Statement is to report Income. Income =
Revenue - Expenses. It is almost that simple, but
there is more to the Income Statement than a
simple calculation.
Income Statement
Revenue
-Cost of Goods Sold
—————=Gross Margin
-Expenses
—————=Operating Income
+Other Revenue
-Other Expenses
—————=Net Income
CSU CORPORATION
Income Statement
For the Year Ended December 31, 2008
1st- head up the statement
•name of company
•name of statement
•period of time covered
CSU CORPORATION
Income Statement
For the Year Ended December 31, 2008
Revenues
Service revenue
2nd - List the revenues
$17,000
CSU CORPORATION
Income Statement
For the Year Ended December 31, 2008
Revenues
Service revenue
Expenses
Rent expense
Insurance expense
Supplies expense
Total expenses
$17,000
$9,000
1,000
200
10,200
3rd - List and total the expenses
CSU CORPORATION
Income Statement
For the Year Ended December 31, 2008
Revenues
Service revenue
Expenses
Rent expense
Insurance expense
Supplies expense
Total expenses
Net Income
$17,000
$9,000
1,000
200
10,200
$ 6,800
4th - Subtract expenses from
revenues to obtain net income.
Retained Earnings
CSU CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2008
1st- head up the statement
•name of company
•name of statement
•period of time covered
CSU CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2008
Retained earnings, January 1
$
2nd - Start with beginning
retained earnings
0
CSU CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2008
Retained earnings, January 1
Add: Net Income
$
0
6,800
6,800
3rd - Add net income from the
current year - subtotal
CSU CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 1998
Retained earnings, January 1
Add: Net Income
$
Less: Dividends
Retained earnings, December 31 $ 6,800
0
6,800
6,800
0
4th - Subtract current year’s
dividends and total
Balance Sheet
The Balance Sheet
The balance sheet equation:
Assets = Liabilities + Owners’ Equity
or
Owners’ Equity = Assets - Liabilities
CSU CORPORATION
Balance Sheet
December 31, 2008
1st- head up the statement
•name of company
•name of statement
•date
CSU CORPORATION
Balance Sheet
December 31, 2008
Assets
Cash
Accounts receivable
Supplies
Equipment
Total assets
$ 2,000
4,000
1,800
16,000
$23,800
2nd - list the assets and total
CSU CORPORATION
Balance Sheet
December 31, 2008
Assets
Cash
Accounts receivable
Supplies
Equipment
Total assets
Liabilities and Stockholders’ Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
$ 2,000
4,000
1,800
16,000
$23,800
$ 2,000
5,000
7,000
3rd - list the liabilities and subtotal
CSU CORPORATION
Balance Sheet
December 31, 2008
4th - list stockholders’ equity
subtotal. Add to liabilities,
Total
CSU CORPORATION
Balance Sheet
December 31, 2008
Assets
Cash
Accounts receivable
Supplies
Equipment
Total assets
Liabilities and Stockholders’ Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
Stockholders’ equity
Common stock
Retained earnings
Total Stockholders’ equity
Total liabilities and stockholders’ equity
$ 2,000
4,000
1,800
16,000
$23,800
$ 2,000
5,000
7,000
10,000
6,800
16,800
$23,800
CSU CORPORATION
Balance Sheet
December 31, 2008
Assets
Cash
Accounts receivable
Supplies
Equipment
Total assets
Liabilities and Stockholders’ Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
$ 2,000
4,000
1,800
16,000
$23,800
$ 2,000
5,000
7,000
3rd - list the liabilities and subtotal
CSU CORPORATION
Balance Sheet
December 31, 1998
4th - list stockholders’ equity
subtotal. Add to liabilities,
Total
In what order are financial
statements prepared?
WHY?
CSU CORPORATION
Income Statement
For the Year Ended December 31, 2008
Revenues
Service revenue
Expenses
Rent expense
Insurance expense
Supplies expense
Total expenses
Net Income
$17,000
$9,000
1,000
200
10,200
$ 6,800
Net Income is needed for the
Statement of Retained Earnings.
CSU CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2008
Retained earnings, January 1
Add: Net Income
$
Less: Dividends
Retained earnings, December 31 $ 6,800
0
6,800
6,800
0
Ending Retained Earnings is needed
for the balance sheet.
CSU CORPORATION
Balance Sheet
December 31, 2008
Assets
Cash
Accounts receivable
Supplies
Equipment
Total assets
Liabilities and Stockholders’ Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
Stockholders’ equity
Common stock
Retained earnings
Total Stockholders’ equity
Total liabilities and stockholders’ equity
$ 2,000
4,000
1,800
16,000
$23,800
$ 2,000
5,000
7,000
10,000
6,800
16,800
$23,800
Analyzing and Recording
Transactions
Analyzing and Recording Process
Exchanges of economic consideration between
two parties.
External Transactions
occur between the
organization and an outside
party.
Internal Transactions
occur within the
organization.
Analyzing and Recording Process
Accounting process:
-Identifies business transactions and events,
-Analyzes and records their effects, and
-Summarizes and presents information in reports
and financial statements.
Steps in accounts process that focus on
analyzing and recording transactions and events are:
(1)Record relevant transactions and events in a journal,
(2) Post journal information to ledger accounts, and
(3) Prepare a trial balance.
Accounting records are informally referred as the accounting
books, or simply the books.
Analyzing and Recording Process
Analyze each transaction and event
from source documents
Prepare and analyze the
trial balance
Record relevant transactions and
events in a journal
Post journal
information to
ledger (T)
accounts
Source Documents
Checks
Employee
Earnings
Records
Bills from
Suppliers
Purchase
Orders
Bank
Statements
Sales
Tickets
The Account and its Analysis
An account is a
record of
increases and
decreases in a
specific asset,
liability, equity,
revenue, or
expense item.
The general
ledger is a record
containing all
accounts used by
the company.
The Account and its Analysis
Assets
Assets
Asset
Accounts
Accounts
Accounts
=
Liability
Liability
Liability
Accounts
Accounts
Accounts
+
Equity
Equity
Equity
Accounts
Accounts
Accounts
Asset Accounts
Cash
Land
Buildings
Asset
Accounts
Accounts
Receivable
Notes
Receivable
Prepaid
Accounts
Equipment
Supplies
Liability Accounts
Accounts
Payable
Notes
Payable
Liability
Accounts
Accrued
Liabilities
Unearned
Revenue
Dividends
Payable
Equity Accounts
Retained
Earnings
Common
Stock
Dividends
Declared
Equity
Accounts
Revenues
Expenses
The Account and its Analysis
Assets
=
Liabilities
+
–
Common
Stock
Dividends
+
+
Revenues
Equity
–
Expenses
Ledger and Chart of Accounts
The ledger is a collection of all accounts for an
information system.
A company’s size and diversity of operations affect
the number of accounts needed.
The chart of accounts is a list of all accounts and
includes an identifying number for each account.
101
106
126
128
167
201
236
307
318
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accounts payable
Unearned revenue
Common stock
Retained Earnings
319
403
406
622
637
640
652
690
Dividends
Consulting Revenues
Rental revenue
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Debits and Credits
A T-account represents a ledger account and is
a tool used to understand the effects of one or
more transactions.
T- Account
(Left side)
(Right side)
Debit
Credit
Double-Entry Accounting
NORMAL Balance
ASSETS = LIABILITIES + EQUITY
DR
=
CR
CR
Assets are on the left side of the equation; therefore,
the left, or debit side is the normal balance side for
assets.
Liabilities and equities are on the right side;
therefore, the right, or credit side is the normal
balance side for liabilities and equity.
Double-Entry Accounting
ASSETS = LIABILITIES + EQUITY
||
ASSETS = LIABILITIES + Common Stock – DIV + REV - EXP
Total amount that is debited to accounts must
equal the total amount credited to accounts
for each transaction.
Sum of debit account balances in the ledger
must equal the sum of credit account
balances.
Double-Entry Accounting
NORMAL Balance
Assets
ASSETS
Debit
+
=
Liabilities
-
Debit
-
Equity
EQUITIES
LIABILITIES
Credit
+
Credit
+
Debit
-
Credit
+
Whether a debit or a credit is an increase or decrease depends
on the NORMAL Balance of the account.
Double-Entry Accounting
NORMAL Balance
Equity
_
Common
Stock
Stock
Dividends
Debit Credit
-
Dividends
+
Revenues
Revenues
Debit Credit
+
+
-
Expenses
Expenses
Debit Credit
-
_
+
Debit Credit
+
-
Double-Entry Accounting
NORMAL Balance
An account balance is the difference between the increases and
decreases in an account.
Notice the T-Account
Cash
Investment by owner for stock
Consulting services revenues earned
Collection of accounts receivable
Total increases
Balance
30,000 Purchase of supplies
4,200 Purchase of equipment
1,900 Payment of rent
Payment of salary
Payment of accounts payable
Payment of cash dividend
36,100 Total decreases
4,800
2,500
26,000
1,000
700
900
200
31,300
Journalizing & Posting Transactions
Assets
=
Liabilities
+
Equity
T- Account
(Left side)
(Right side)
Debit
Credit
Step 1: Analyze transactions
and source documents.
ACCOUNT NAME:
Date
Step 2: Apply doubleentry accounting
GENERAL JOURNAL
ACCOUNT No.
Description
PR
Debit
Credit
Balance
Step 4: Post entry to ledger
Date
Description
Page
Post.
Ref.
Debit
123
Credit
Step 3: Record journal entry
Journalizing Transactions
Transaction
Date
Titles of Affected
Accounts
GENERAL JOURNAL
Account Titles and Explanations PR
Date
2009
Dec. 1 Cash
Common stock
Investment by shareholders
2 Supplies
Dec.Transaction
explanation
Cash
Page 1
Debit
Credit
30,000
30,000
Dollar amount of debits
and credits 2,500
2,500
Balance Column Account
T-accounts are useful illustrations, but balance
column accounts are used in practice.
CASH
Date
ACCOUNT No. 101
Explanation
PR
Debit
Credit
Balance
2,500
26,000
30,000
27,500
1,500
5,700
2009
Dec. 1
Dec. 2
Dec. 3
Dec. 10
Initial investment
Purchased supplies
Purchased equipment
Collection from customer
30,000
4,200
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles and Explanation
2009
Dec. 1 Cash
Common stock
Investment by shareholders
Dec. 2 Supplies
Cash
1 Identify the
debit account
Purchased store supplies
for cash
Page 1
PR
Explanation
Credit
30,000
30,000
2,500
2,500
in ledger.
CASH
Date
Debit
ACCOUNT No.
PR
Debit
Credit
101
Balance
2009
Dec. 3
Purchased equipment
G1
20,000.00
########
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles and Explanation
2009
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Explanation
Credit
30,000
30,000
Dec. 2 Supplies
2
Enter
the date.
Cash
Purchased store supplies
CASH for cash
Date
Debit
2,500
2,500
ACCOUNT No.
PR
Debit
101
Credit
Balance
20,000.00
########
2009
Dec. 1
Dec. 3
Purchased equipment
G1
Posting Journal Entries
GENERAL JOURNAL
Page 1
Date
Account Titles & Elxplanations
PR
2009
Dec. 1 Cash
Common stock
Investment by shareholders
Dec. 2 Supplies
3 Enter theCash
amount and description.
Purchased store supplies
CASH for cash
Date
Explanation
PR
Debit
Credit
30,000
30,000
2,500
2,500
ACCOUNT No.
Debit
Credit
101
Balance
2009
30,000
Dec. 1
Dec. 3
Purchased equipment
G1
20,000
(20,000)
Posting Journal Entries
GENERAL JOURNAL
Page 1
Date
Account Titles and Explanation
PR
2009
Dec. 1 Cash
Common stock
Investment by shareholders
2Enter
Supplies
the journal reference.
Cash
Purchased store supplies
CASH for cash
Debit
30,000
30,000
Dec.
4
Date
Explanation
2,500
2,500
ACCOUNT No.
PR
Debit
G1
30,000
2009
Dec. 1
Credit
Credit
101
Balance
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles & Elxplanations
2009
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Debit
30,000
30,000
Dec.
2 Compute
Supplies the balance.
Cash
Purchased store supplies
CASH for cash
2,500
5
Date
Explanation
Credit
2,500
ACCOUNT No.
PR
Debit
G1
30,000
Credit
101
Balance
2009
Dec. 1
Dec. 3
Purchased equipment
G1
30,000
20,000
(20,000)
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles and Explanation
2009
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Debit
101
2 Supplies
Enter
the ledger reference.
Cash
Purchased store supplies
CASH for cash
2,500
6
Explanation
30,000
30,000
Dec.
Date
Credit
2,500
ACCOUNT No.
PR
Debit
G1
30,000
Credit
101
Balance
2009
Dec. 1
Dec. 3
Purchased equipment
G1
30,000
20,000
(20,000)
Analyzing Transactions
Shareholders invested $30,000 in FastForward on
Dec. 1.
Transaction:1
Analysis:
Assets
=
Liabilities
Cash
30,000
+
Equity
Common
Stock
30,000
Double entry:
(1)
Cash
101
301
Common stock
30,000
30,000
Posting:
(1)
Cash
30,000
101
Common Stock
(1)
301
30,000
Analyzing Transactions
Transaction:2
FastForward purchases supplies by paying $2,500
cash.
Analysis:
Cash
(2,500)
Assets
Supplies
=
Liabilities
+
Equity
Common
Stock
2,500
Double entry:
(2)
Supplies
Cash
126
101
2,500
2,500
Posting:
(2)
Supplies
2,500
126
(1)
Cash
30,000
101
(2)
2,500
Analyzing Transactions
Transaction:3
FastForward purchases equipment by paying $26,000
cash.
Analysis:
Assets
Cash Equipment
(26,000)
=
Liabilities
+
Equity
Common
Stock
26,000
Double entry:
(3)
Equipment
Cash
167
101
26,000
26,000
Posting:
(3)
Equipment
26,000
167
(1)
Cash
30,000
101
(2)
(3)
2,500
26,000
Analyzing Transactions
Transaction:4
FastForward purchases $7,100 of supplies on credit.
Analysis:
Assets
=
Supplies
Liabilities
Accounts Payable
7,100
+
Equity
Common
Stock
7,100
Double entry:
(4)
Supplies
Accounts payable
126
201
7,100
7,100
Posting:
(4)
Supplies
2,500
7,100
126
Accounts Payable
(4)
201
7,100
Analyzing Transactions
FastForward provides consulting services and
Transaction:5 immediately collects $4,200 cash.
Analysis:
Assets
=
+
Liabilities
Cash
4,200
Equity
Revenue
4,200
Double entry:
(5)
Cash
101
403
Consulting Revenue
4,200
4,200
Posting:
403
Consulting Revenue
(5)
4,200
(1)
(5)
Cash
30,000
4,200
101
(2)
(3)
2,500
26,000
Analyzing Transactions
Transaction: 6
FastForward pays $1,000 cash for December rent.
Analysis:
Assets
=
+
Liabilities
Cash
(1,000)
Equity
(Expense)
(1,000)
Double entry:
(6) Rent Expense
Cash
640
101
1,000
1,000
Posting:
Rent Expense
(6)
1,000
640
(1)
(5)
Cash
30,000
4,200
101
(2)
(3)
(6)
2,500
26,000
1,000
Analyzing Transactions
Transactions 7: Payment of Salaries expenses in cash
Analysis: - Assets (Cash) = – Equity (Expenses)
Double entry: Debit Salaries Expenses and credit Cash
Transaction 8: Provide services and rents test facilities for credit
Analysis: + Assets (Accts Receivable) = + Equity (Revenues)
Double entry: Debit Accounts Receivable and Credit Consulting
Revenue and Credit Rental Revenue
Transaction 9: Receipt of cash from accounts receivable
Analysis: + Assets (Cash) = – Assets (Accounts Receivable)
Double entry: Debit Cash and credit Accounts Receivable
Analyzing Transactions
Transaction 10: Payment of accounts payable
Analysis: – Assets (Cash) = – Liability (Accounts Payable)
Double entry: Debit Accounts Payable and credit Cash
Transaction 11: Payment of cash dividend
Analysis: – Assets (Cash) = – Equity (Dividends)
Double entry: Debit Dividends and credit Cash
Transaction 12: Receipts of cash from a customer for future
consulting services
Analysis: + Assets (Cash) = + Liabilities (Unearned Revenue)
Double entry: Debit Cash and credit Unearned Consulting Revenue
Analyzing Transactions
Transaction 13: Pay cash for future insurance coverage
Analysis: – Assets (Cash) = + Assets (Prepaid Insurance)
Double entry: Debit Prepaid Insurance and credit Cash
Transaction 14: Purchase supplies for cash
Analysis: - Assets (Cash) = + Assets (Supplies)
Double entry: Debit Supplies and credit Cash
Transactions 15: Payment of utilities expenses in cash
Analysis: – Assets (Cash) = – Equity (Expenses)
Double entry: Debit Utilities Expense and credit Cash
Transactions 16: Payment of salaries expenses in cash
Analysis: – Assets (Cash) = – Equity (Expenses)
Double entry: Debit Salaries Expense and credit Cash
After processing its remaining transactions for December,
FastForward’s Trial Balance is prepared.
FastForward
Trial Balance
December 31, 2009
Cash
Accounts receivable
Supplies
Prepaid Insurance
Equipment
Accounts payable
Unearned consulting revenue
Common stock
Dividends
Consulting revenue
Rental revenue
Salaries expense
Rent expense
Utilities expense
Total
Debits
$ 4,350
9,720
2,400
26,000
Credits
$
6,200
3,000
30,000
200
5,800
300
1,400
1,000
230
$ 45,300
$ 45,300
The trial balance lists
all account balances
in the general ledger.
If the books are in
balance, the total
debits will equal the
total credits.
Six Steps for Searching for and Correcting
Errors
If the trial balance does not balance, the error(s)
must be found and corrected.
Make sure the trial balance
columns are correctly added.
Recompute each account
balance in the ledger.
Make sure account
balances are correctly
entered from the ledger.
Verify that each journal
entry is posted correctly.
See if debit or credit
accounts are mistakenly
placed on the trial balance.
Verify that each original
journal entry has equal
debits and credits.
Using a Trial Balance to Prepare Financial Statements
Point in
Time
Period of Time
Point in
Time
Income Statement
Statement of Retained Earnings
Statement of Cash Flows
Beginning
Balance
Sheet
Ending
Balance
Sheet
Income Statement
FASTFORWARD
Income Statement
For the Month Ended December 31, 2009
Revenues:
Consulting revenue
$ 5,800
Rental revenue
300
Total revenues
$ 6,100
Expenses:
Salaries expense
1,400
Rent Expense
1,000
Utilities Expense
230
Total expenses
2,630
Net income
$ 3,470
Statement of Retained Earnings
FASTFORWARD
Statement of Retained Earnings
For the Month Ended December 31, 2009
Balance, 12/1/09
$
Net income for December
3,470
3,470
Less: Dividends
(200)
Balance, 12/31/09
$
3,270
FASTFORWARD
Income Statement
For the Month Ended December 31, 2009
Revenues:
Consulting revenue
$
5,800
Rental revenue
300
Total revenues
$
6,100
Expenses:
Rent expense
1,000
Salaries expense
1,400
Utilities expense
230
Total expenses
2,630
Net income
$
3,470
Balance Sheet
FASTFORWARD
Statement of Retained Earnings
For the Month Ended December 31, 2009
Balance, 12/1/09
$
Net income for December
3,470
3,470
Less: Dividends
200
Balance, 12/31/09
$
3,270
FASTFORWARD
Balance Sheet
December 31, 2009
Assets
Cash
Supplies
Prepaid insurance
Equipment
Total assets
Liabilities
Accounts payable
Unearned revenue
Total liabilities
Equity
Common stock
Retained earnings
Total equity
Total liabilities and equity
$ 4,350
9,720
2,400
26,000
$ 42,470
$ 6,200
3,000
9,200
30,000
3,270
33,270
$ 42,470
Completing the
Accounting Cycle
What is a Worksheet?
• multiple-column form used for the
adjustment process and preparing
financial statements
• working tool for the accountant
• not a permanent accounting record
• Eases preparation of adjusting entries
and financial statements
Example of a Work Sheet
Remember:
• A work sheet is not a permanent
accounting record
• When it is used:
– financial statements are prepared from the
work sheet
– adjustments are journalized and posted from
the work sheet after financial statements, so
management can receive the financial
statements more quickly
To Prepare A Work Sheet:
1 Prepare the trial balance
2 Enter adjustments in the adjustments columns
3 Enter adjusted balances in adjusted trial balance
columns
4 Extend adjusted trial balance amounts to the
appropriate financial statement columns
5 Total the statement columns, compute net income
(loss), and complete the work sheet
FastForward
Work Sheet
For Month Ended December 31, 2011
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. - Equip.
Accounts payable
Salaries payable
Unearned revenue
C. Taylor, Capital
C. Taylor, Withdrawals
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
Unadjusted
Trial Balance
Dr.
Cr.
3,950
9,720
2,400
26,000
Adjustments
Dr.
6,200
3,000
30,000
600
5,800
300
1,400
1,000
230
45,300
45,300
Cr.
First, enter
the
unadjusted
trial balance
amounts to
the
worksheet!
Adjusted
Trial Balance
Dr.
Cr.
Here are our adjusting entries for
December
a) Insurance expense
100
Prepaid insurance
100
b) Supplies expense
1050
Supplies
1050
c) Depreciation expense 375
Accum. Depr. – Equip.
375
Here Are More Adjusting Entries
for December
d) Unearned revenue
250
Consulting Revenue
e) Salaries Expense
210
Salaries Payable
f) Accounts Receivable 1,800
Consulting Revenue
250
210
1,800
FastForward
Work Sheet
For Month Ended December 31, 2011
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. - Equip.
Accounts payable
Salaries payable
Unearned revenue
C. Taylor, Capital
C. Taylor, Withdrawals
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
Unadjusted
Trial Balance
Dr.
Cr.
3,950
9,720
2,400
26,000
Adjustments
Dr.
f
6,200
3,000 d
30,000
Adjusted
Trial Balance
Dr.
Cr.
Cr.
Next, enter the
adjustments!
1,800
b
a
1,050
100
c
375
e
210
d
f
250
1,800
250
600
5,800
300
1,400
1,000
230
45,300
45,300
c
e
a
375
210
100
b
1,050
3,785
3,785
Prepare the
adjusted trial
balance!
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. - Equip.
Accounts payable
Salaries payable
Unearned revenue
C. Taylor, Capital
C. Taylor, Withdrawals
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
FastForward
Work Sheet
For Month Ended December 31, 2011
Unadjusted
Trial Balance
Dr.
Cr.
3,950
9,720
2,400
26,000
Adjustments
Dr.
f
6,200
3,000 d
30,000
Cr.
1,800
b
a
1,050
100
c
375
e
210
Adjusted
Trial Balance
Dr.
Cr.
3,950
1,800
8,670
2,300
26,000
250
600
600
5,800
d
f
250
1,800
7,850
300
1,400
1,000
230
45,300
45,300
375
6,200
210
2,750
30,000
300
c
e
a
375
210
100
b
1,050
3,785
3,785
375
1,610
100
1,000
1,050
230
47,685
47,685
Then, extend theFastForward
adjusted trial balance
Work Sheet
amounts
theEnded
financial
For to
Month
Decemberstatements!
31, 2004
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. - Equip.
Accounts payable
Salaries payable
Unearned revenue
C. Taylor, Capital
C. Taylor, Withdrawals
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
Adjusted
Trial Balance
Dr.
Cr.
3,950
1,800
8,670
2,300
26,000
Income
Statement
Dr.
Cr.
Balance Sheet &
Statement of Equity
Dr.
Cr.
3,950
1,800
8,670
2,300
26,000
375
6,200
210
2,750
30,000
375
6,200
210
2,750
30,000
600
600
7,850
300
7,850
300
375
1,610
100
1,000
1,050
230
47,685
47,685
375
1,610
100
1,000
1,050
230
4,365
8,150
43,320
39,535
FastForward
Total statement columns,
compute income or loss,
Work Sheet
and
balance
columns.
For Month
Ended December
31, 2004
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. - Equip.
Accounts payable
Salaries payable
Unearned revenue
C. Taylor, Capital
C. Taylor, Withdrawals
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
Net income
Adjusted
Trial Balance
Dr.
Cr.
3,950
1,800
8,670
2,300
26,000
Income
Statement
Dr.
Cr.
Balance Sheet &
Statement of Equity
Dr.
Cr.
3,950
1,800
8,670
2,300
26,000
375
6,200
210
2,750
30,000
375
6,200
210
2,750
30,000
600
600
7,850
300
7,850
300
375
1,610
100
1,000
1,050
230
47,685
47,685
375
1,610
100
1,000
1,050
230
4,365
3,785
8,150
8,150
8,150
43,320
39,535
43,320
3,785
43,320
Prepare the Financial
Statements
FastForward
Income Statement
For the Month Ended December 31, 2011
Revenues:
Consulting revenue
$
7 850
Rental revenue
300
Total revenues
8 150
Operating expenses:
Depr. expense - Equip. $
375
Salaries expense
1 610
Insurance expense
100
Rent expense
1 000
Supplies expense
1 050
Utilities expense
230
Total expenses
4 365
Net income
$
3 785
Prepare the Income
Statement.
A work sheet
does not
substitute for
financial
statements.
FastForward
Income Statement
For the Month Ended December 31, 2011
Revenues:
Consulting revenue
$
7 850
Rental revenue
300
Total revenues
8 150
Operating expenses:
Depr. expense - Equip. $
375
Salaries expense
1 610
Insurance expense
100
Rent expense
1 000
Supplies expense
1 050
Utilities expense
230
Total expenses
4 365
Net income
$
3 785
Prepare the Statement of
Changes in Owner’s Equity.
FastForward
Statement of Changes in Owner's Equity
For the Month Ended December 31, 2011
C. Taylor, Capital 12/1/04
Add: Net income
$
Investment by owner
Total
Less: Withdrawal by owner
C. Taylor, Capital 12/31/04
$
3 785
30 000
$
-033 785
33 785
600
33 185
FastForward
Statement of Changes in Owner's Equity
For the Month Ended December 31, 2011
C. Taylor, Capital 12/1/04
Add: Net income
$
Investment by owner
Total
Less: Withdrawal by owner
C. Taylor, Capital 12/31/04
$
3 785
30 000
$
-0-
Prepare the
Balance Sheet.
33 785
33 785
600
33 185
FastForward
Balance Sheet
December 31, 2011
Assets
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Less: accum. depr.
Total assets
$
$
26 000
(375)
3 950
1 800
8 670
2 300
$
25 625
42 345
$
9 160
$
33 185
42 345
Liabilities
Accounts payable
$
Salaries payable
Unearned consulting revenues
Total liabilities
6 200
210
2 750
Owner's Equity
C.Taylor, Capital
Total liabilities and equity
Which of these characteristics are
true about a work sheet?
–
–
–
–
a permanent accounting record
an optional device used by accountants
a part of the general ledger
a part of the journal
Answer!
–
–
–
–
permanent accounting record
optional device used by accountants
part of the general ledger
part of the journal
Although it’s optional, the work sheet is a very useful tool!
TEMPORARY VS.
PERMANENT ACCOUNTS
TEMPORARY (NOMINAL)
PERMANENT (REAL)
These accounts are closed
These accounts are not closed
All revenue accounts
All asset accounts
All expense accounts
All liability accounts
Owner’s drawing
Owner’s capital account
Now, let’s talk about closing entries and income summary!
CLOSING ENTRIES
• Closing entries
– Transfer net income (loss) and owner’s drawings to
owner’s capital
– Journalizing and posting is a required step in the
accounting cycle
• Income Summary
– A temporary account
– Used in closing revenue and expense accounts
– Minimizes the details in the permanent owner’s capital
account
Closing Process
• Resets revenue, expense
and withdrawal account
balances to zero at the
end of the period.
• Helps summarize a
period’s revenues and
expenses in the Income
Summary account.
Identify accounts for closing.
Record and post closing
entries.
Prepare post-closing trial
balance.
Temporary and Permanent
Accounts
Income
Summary
Liabilities
Permanent
Accounts
The closing process
applies only to
temporary accounts.
Owner’s
Capital
Temporary
Accounts
Assets
Withdrawals
Expenses
Revenues
Recording Closing Entries
 Close Revenue accounts to
Income Summary.
 Close Expense accounts to
Income Summary.
 Close Income Summary
account to Owner’s Capital.
 Close Withdrawals to
Owner’s Capital.
Let’s see how the
closing process
works!
Closing Process
Revenue Accounts
25,000
Expense Accounts
10,000
25,000
10,000
Income Summary
Withdrawals Account
5,000
Owner's Capital
30,000
30,000
Balances before closing.
5,000
Closing Process
Expense Accounts
10,000
Close Revenue
accounts to Income
Summary.
Revenue Accounts
25,000
25,000
-
10,000
Income Summary
25,000
Owner's Capital
30,000
30,000
25,000
Withdrawals Account
5,000
5,000
Closing Process
Expense Accounts
10,000
10,000
Close Expense
accounts to Income
Summary.
Revenue Accounts
25,000
25,000
-
-
Income Summary
10,000
25,000
Owner's Capital
30,000
30,000
15,000
The balance in Income
Summary equals net
income.
Withdrawals Account
5,000
5,000
Closing Process
Expense Accounts
10,000
10,000
Close Income
Summary to Owner’s
Capital.
Revenue Accounts
25,000
25,000
-
-
Income Summary
10,000
25,000
15,000
Owner's Capital
30,000
15,000
45,000
-
Withdrawals Account
5,000
5,000
Closing Process
Expense Accounts
10,000
10,000
Revenue Accounts
25,000
25,000
-
-
Income Summary
10,000
25,000
15,000
Owner's Capital
5,000
30,000
15,000
45,000
40,000
-
Close Withdrawals
account to Owner’s
Capital.
Withdrawals Account
5,000
5,000
5,000
-
FastForward
Adjusted Trial Balance
December 31, 2011
Cash
$
3 950
Accounts receivable
1 800
Supplies
8 670
Prepaid insurance
2 300
Equipment
26 000
Accumulated depreciation-Equip.
$
Accounts payable
Salaries payable
Unearned consulting revenue
C. Taylor, Capital
C. Taylor, Withdrawals
600
Consulting revenue
Rental revenue
Depreciation expense-Equipment
375
Salaries expense
1 610
Insurance expense
100
Rent expense
1 000
Supplies expense
1 050
Utilities expense
230
Totals
$
47 685 $
375
6 200
210
2 750
30 000
7 850
300
47 685
Using the
adjusted trial
balance, let’s
prepare the
closing entries
for
FastForward.
FastForward
Adjusted Trial Balance
December 31, 2011
Cash
$
3 950
Accounts receivable
1 800
Supplies
8 670
Prepaid insurance
2 300
Equipment
26 000
Accumulated depreciation-Equip.
$
Accounts payable
Salaries payable
Unearned consulting revenue
C. Taylor, Capital
C. Taylor, Withdrawals
600
Consulting revenue
Rental revenue
Depreciation expense-Equipment
375
Salaries expense
1 610
Insurance expense
100
Rent expense
1 000
Supplies expense
1 050
Utilities expense
230
Totals
$
47 685 $
375
6 200
210
2 750
30 000
7 850
300
47 685
Close Revenue
accounts to Income
Summary.
 Close Revenue Accounts to
Income Summary
Dec. 31 Consulting revenue
Rental revenue
Income summary
7,850
300
8,150
Now, let’s look at the ledger accounts after posting this
closing entry.
 Close Expense Accounts to
Income Summary
Dec. 31 Income summary
Depreciation expense-Equipment
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
4,365
375
1,610
100
1,000
1,050
230
Now, let’s look at the ledger accounts after posting this
closing entry.
 Close Expense Accounts to
Income Summary
Depreciation
Expense- Eq.
375
375
-
Rent Expense
1,000
1,000
-
Salaries Expense
1,610
1,610
-
Supplies Expense
1,050
1,050
-
Insurance Expense
100
100
-
Utilities Expense
230
230
-
Income Summary
4,365
7,850
300
3,785
Net Income
FastForward
Adjusted Trial Balance
December 31, 2011
Cash
$
3 950
Accounts receivable
1 800
Supplies
8 670
Prepaid insurance
2 300
Equipment
26 000
Accumulated depreciation-Equip.
$
Accounts payable
Salaries payable
Unearned consulting revenue
C. Taylor, Capital
C. Taylor, Withdrawals
600
Consulting revenue
Rental revenue
Depreciation expense-Equipment
375
Salaries expense
1 610
Insurance expense
100
Rent expense
1 000
Supplies expense
1 050
Utilities expense
230
Totals
$
47 685 $
375
6 200
210
2 750
30 000
7 850
300
47 685
Close Income
Summary to Owner’s
Capital.
 Close Income Summary to
Owner’s Capital
Dec.
31 Income summary
C. Taylor, Capital
3,785
3,785
Now, let’s look at the ledger accounts after posting this
closing entry.
 Close Income Summary to
Owner’s Capital
 Close Income Summary to Owner’s
Capital
C. Taylor, Capital
30,000
3,785
33,785
Income Summary
4,365
7,850
3,785
300
-
FastForward
Adjusted Trial Balance
December 31, 2011
Cash
$
3 950
Accounts receivable
1 800
Supplies
8 670
Prepaid insurance
2 300
Equipment
26 000
Accumulated depreciation-Equip.
$
Accounts payable
Salaries payable
Unearned consulting revenue
C. Taylor, Capital
C. Taylor, Withdrawals
600
Consulting revenue
Rental revenue
Depreciation expense-Equipment
375
Salaries expense
1 610
Insurance expense
100
Rent expense
1 000
Supplies expense
1 050
Utilities expense
230
Totals
$
47 685 $
375
6 200
210Close Withdrawals
2 750 to Owner’s Capital.
30 000
7 850
300
47 685
 Close Withdrawals to
Owner’s Capital
Dec.
31 C. Taylor, Capital
600
C. Taylor, Withdrawals
600
Now, let’s look at the ledger accounts after posting this
closing entry.
 Close Withdrawals to
Owner’s Capital
C. Taylor,
Withdrawals
600
600
-
C. Taylor, Capital
600
30,000
3,785
33,185
ABOUT CLOSING ENTRIES
Be Careful!
•Avoid doubling revenue and expense balances
– watch debits and credits
•Remember: owner’s drawing does not move
to the Income Summary account. Owner’s
drawing is not an expense and it is not a factor
in determining net income.
RESULTS OF POSTING
CLOSING ENTRIES
• Temporary accounts
– All temporary accounts will have zero balances after
posting the closing entries
– Temporary accounts (revenues and expenses) are
totaled, balanced and double ruled
• Owner’s capital
– Total equity of the owner at the end of the accounting
period
– No entries are journalized and posted to owner’s
capital during the year
• Permanent accounts (assets, liabilities, and owner’s
capital) are not closed
POST-CLOSING TRIAL BALANCE
After all closing entries have been journalized
the post-closing trial balance is prepared from
the ledger.
The purpose of this trial balance is to
prove the equality of the permanent account
balances that are carried forward into the next
accounting period.
Post-Closing Trial Balance
• List of permanent
accounts and their
balances after posting
closing entries.
• Total debits and credits
must be equal.
Let’s look at
FastForward’s postclosing trial balance.
Post-Closing Trial Balance
FastForward
Post-Closing Trial Balance
December 31, 2011
Cash
$
3 950
Accounts receivable
1 800
Supplies
8 670
Prepaid insurance
2 300
Equipment
26 000
Accumulated depreciation-Equipment
$
Accounts payable
Salaries payable
Unearned consulting revenue
C.Taylor, Capital
Totals
$ 42 720 $
375
6 200
210
2 750
33 185
42 720
Post-closing Trial Balance
Summary of Steps in the Accounting
Cycle
1 Analyze business transactions
2 Journalize the transactions
3 Post to ledger accounts
4 Prepare a trial balance
5 Journalize and post adjusting
entries
STEPS IN THE ACCOUNTING
CYCLE
6 Prepare an adjusted trial balance
7 Prepare financial statements: Income
Statement, Owner’s Equity Statement,
Balance Sheet
8 Journalize and post closing entries
9 Prepare a post-closing trial balance
1. Correcting Entries
• Correcting Entries
– errors should be corrected as soon as discovered
– correcting entries are unnecessary if records are free of
errors
– can be journalized and posted whenever an error is
discovered
– involve any combination of balance sheet and income
statement accounts
Illustrative Example Of Correcting
Entry
May 10
10
20
Incorrect Entry
Cash
Service Revenue
(To record collection from
customer an account)
Correct Entry
Cash
Accounts Receivable
(To record collection from
customer an account)
Correcting Entry
Service Revenue
Accounts Receivable
(To correct entry of May 10)
50
50
50
50
50
50
Another Illustrative Example Of
Correcting Entry
May 18
18
June 3
Incorrect Entry
Delivery Equipment
Accounts Payable
(To record purchase of
equipment on account)
Correct Entry
Office Equipment
Accounts Payable
(To record purchase of
equipment on account)
Correcting Entry
Office Equipment
Delivery Equipment
Accounts Payable
(To correct entry of May 18)
45
45
450
450
450
45
405
Question: The closing entry
process consists of closing:
all asset and liability accounts
– out the owner's capital account
– all permanent accounts
– all temporary accounts
–
Which answer is correct?
The closing entry process
consists of closing
all asset and liability accounts
– out the owner's capital account
– all permanent accounts
– all temporary accounts
–
Standard Balance Sheet
Classifications
• Financial statements become more useful when the
elements are classified into significant subgroups.
• A classified balance sheet generally has the
following standard classifications (see next
slide):
Classified Balance Sheet
Categories of a Classified Balance Sheet
Assets
Liabilities and Equity
Current Assets
Current Liabilities
Noncurrent Assets
Noncurrent Liabilities
Long-Term Investments Equity
Plant Assets
Intangible Assets
Current items are those expected to come due (both
collected and owed) within the longer of one year or the
company’s normal operating cycle.
Snowboarding Components
Balance Sheet
December 31, 2011
ASSETS
Current assets
Cash
$
6 500
Short-term investments
2 100
Accounts receivable
4 400
Merchandise inventory
27 500
Prepaid expenses
2 400
Total current assets
$
Long-term investments
Notes receivable
1 500
Investments in stocks and bonds
18 000
Land held for future expansion
48 000
Total investments
Plant assets
Store equipment
$
33 200
Less accumulated depreciation
8 000
25 200
Buildings
170 000
Less accumulated depreciation
45 000
125 000
Land
73 200
Total plant assets
Intangible assets
Total assets
$
42 900
Current assets are expected to be sold,
collected, or used within one year or the
67 500
company’s operating cycle.
223 400
10 000
343 800
Snowboarding Components
Balance Sheet
December 31, 2011
ASSETS
Current assets
Cash
Short-term investments
Accounts receivable
Merchandise inventory
Prepaid expenses
Total current assets
Long-term investments
Notes receivable
Investments in stocks and bonds
Land held for future expansion
Total investments
Plant assets
Store equipment
Less accumulated depreciation
Buildings
Less accumulated depreciation
Land
Total plant assets
Intangible assets
Total assets
$
6 500
2 100
4 400
27 500
2 400
$
42 900
1 500
18 000
48 000
67 500
$
33 200
Long-term investments
are expected to
8 000
25 200
be held for the longer170of
000 one year or the
45 000
125 000
operating cycle. 73 200
$
223 400
10 000
343 800
Snowboarding Components
Balance Sheet
December 31, 2011
ASSETS
Current assets
Cash
Short-term investments
Accounts receivable
Merchandise inventory
Prepaid expenses
Total current assets
Long-term investments
Notes receivable
Investments in stocks and bonds
Land held for future expansion
Total investments
Plant assets
Store equipment
Less accumulated depreciation
Buildings
Less accumulated depreciation
Land
Total plant assets
Intangible assets
Total assets
$
6 500
2 100
4 400
27 500
2 400
$
42 900
$
223 400
10 000
343 800
Plant assets are tangible long-lived
1 500
assets used to produce or sell
products
18 000
and services. 48 000
67 500
$
33 200
8 000
170 000
45 000
25 200
125 000
73 200
Snowboarding Components
Balance Sheet
December 31, 2011
ASSETS
Current assets
Cash
Short-term investments
Accounts receivable
Merchandise inventory
Prepaid expenses
Total current assets
Long-term investments
Notes receivable
Investments in stocks and bonds
Land held for future expansion
Total investments
Plant assets
Store equipment
Less accumulated depreciation
Buildings
Less accumulated depreciation
Land
Total plant assets
Intangible assets
Total assets
$
6 500
2 100
4 400
27 500
2 400
$
42 900
1 500
18 000
48 000
67 500
Intangible assets are long-term
$
33 200
resources used to produce
or sell
8 000
25 200
170 000
products and services
and125that
lack
45 000
000
physical form. 73 200
223 400
$
10 000
343 800
Snowboarding Components
Balance Sheet
December 31, 2011
LIABILITIES
Current liabilities
Accounts payable
Wages payable
Notes payable
Current portion of long-term liabilities
Total current liabilities
Long-term liabilities:
Notes payable (net of current portion)
Total liabilities
EQUITY
T. Hawk, Capital
Total liabilities and equity
$
15 300
3 200
3 000
7 500
$
29 000
$
150 000
179 000
$
164 800
343 800
Current liabilities are obligations due within
the longer of one year or the company’s
operating cycle.
Snowboarding Components
Balance Sheet
December 31, 2011
LIABILITIES
Current liabilities
Accounts payable
Wages payable
Notes payable
Current portion of long-term liabilities
Total current liabilities
Long-term liabilities:
Notes payable (net of current portion)
Total liabilities
EQUITY
T. Hawk, Capital
Total liabilities and equity
$
15 300
3 200
3 000
7 500
$
29 000
$
150 000
179 000
$
164 800
343 800
Long-term liabilities are obligations not due
within the longer of one year or the
company’s operating cycle.
Snowboarding Components
Balance Sheet
December 31, 2011
LIABILITIES
Current liabilities
Accounts payable
Wages payable
Notes payable
Current portion of long-term liabilities
Total current liabilities
Long-term liabilities:
Notes payable (net of current portion)
Total liabilities
EQUITY
T. Hawk, Capital
Total liabilities and equity
$
15 300
3 200
3 000
7 500
$
29 000
$
150 000
179 000
$
164 800
343 800
Equity is the owner’s claim on the assets.
Cash Flow
and Financial Planning
Learning Goals
1. Tax depreciation procedures and the effect of
depreciation on the firm’s cash flows.
2. Firm’s statement of cash flows, operating cash flow,
and free cash flow.
3. The financial planning process,
1. long-term (strategic) financial plans
2. short-term (operating) plans.
4. Cash-planning process and the cash budget.
5. Pro forma income statement and balance sheet
Analyzing the Firm’s Cash Flows
• Cash flow is the primary focus of the financial manager.
• An important factor affecting cash flow is depreciation.
• From an accounting perspective - statement of cash
flows.
• From a financial perspective,
– Managerial decision-making - operating cash flow
– Participants in the capital market - free cash flow
Depreciation
• Depreciation is the systematic charging of a portion of
the costs of fixed assets against annual revenues over
time.
• Depreciation for tax purposes - the modified
accelerated cost recovery system (MACRS).
• Other depreciation methods are often used for
reporting purposes.
Depreciation: Depreciation & Cash Flow
• Financial managers are much more concerned with
cash flows rather than profits.
• To adjust the income statement to show cash flows
from operations, all non-cash charges should be added
back to net profit after taxes.
• By lowering taxable income, depreciation and other
non-cash expenses create a tax shield and enhance
cash flow.
Depreciation: MACRS
Depreciable Value & Depreciable Life
• The depreciable value of an asset is its full cost, including
outlays for installation.
• No adjustment is required for expected salvage value.
• For tax purposes, the depreciable life of an asset is
determined by its MACRS recovery predetermined period.
• MACRS property classes and rates are shown in Table 3.1
and Table 3.2 on the following slides.
Depreciation
First Four Property Classes under MACRS
Rounded Depreciation Percentages by Recovery
Year Using MACRS for First Four Property Classes
Depreciation: An Example
• Baker Corporation acquired, for an installed cost of $40,000, a
machine having a recovery period of 5 years. Using the
applicable MACRS rates, the depreciation expense each year is
as follows:
Depreciation
• Question:
– If as a business owner you could design a depreciation
schedule to look the way you wanted it to, what would it
look like?
Developing the Statement of Cash
Flows
• The statement of cash flows summarizes the firm’s
cash flow over a given period of time.
• The statement of cash flows is divided into three
sections:
– Operating flows
– Investment flows
– Financing flows
Developing the Statement of Cash Flows:
Classifying Inflows and Outflows of Cash
• The statement of cash flows essentially
summarizes the inflows and outflows of cash
during a given period.
Inflows and Outflows of Cash
Baker Corporation Income Statement ($000)
for the Year Ended December 31, 2009
Baker Corporation Balance
Sheets ($000) (cont.)
Baker Corporation Balance Sheets
($000)
Baker Corporation Statement of Cash Flows
($000) for the Year Ended December 31,
2009
Interpreting Statement of Cash Flows
• The net increase (or decrease) in cash and marketable
securities should be equivalent to the difference
between the cash and marketable securities on the
balance sheet at the beginning of the year and the end
of the year.
Operating Cash Flow
• A firm’s Operating Cash Flow (OCF) is the cash flow a
firm generates from normal operations—from the
production and sale of its goods and services.
• OCF may be calculated as follows:
NOPAT = EBIT x (1 – T)
OCF = NOPAT + Depreciation
OCF = [EBIT x (1 – T)] + Depreciation
Operating Cash Flow (cont.)
• Substituting for Baker Corporation, we get:
OCF = [$370 x (1 - .40) + $100 = $322
• Thus, we can conclude that Baker’s operations
are generating positive operating cash flows.
Free Cash Flow
• Free Cash Flow (FCF) is the amount of cash flow available to
debt and equity holders after meeting all operating needs and
paying for its net fixed asset investments (NFAI) and net current
asset investments (NCAI).
FCF = OCF – NFAI - NCAI
• Where:
NFAI = Change in net fixed assets + Depreciation
NCAI = Change in CA – Change in A/P and Accruals
Free Cash Flow (cont.)
• Using Baker Corporation we get:
NFAI = [($1,200 - $1,000) + $100] = $300
NCAI = [($2,000 - $1,900) + ($800 - $700)] = $0
FCF = $322 – $300 - $0 = $22
• This FCF can be used to pay its creditors and
equity holders.
The Financial Planning Process
• Financial planning involves guiding, coordinating, and
controlling the firm’s actions to achieve its objectives.
– cash planning and profit planning.
• Cash planning involves the preparation of the firm’s
cash budget.
• Profit planning involves the preparation of both cash
budgets and pro forma financial statements.
The Financial Planning Process:
Long-Term (Strategic) Financial Plans
• Long-term strategic financial plans lay out a
company’s planned financial actions and the
anticipated impact of those actions over periods
ranging from 2 to 10 years.
The Financial Planning Process:
Long-Term (Strategic) Financial Plans (cont.)
• Long-term financial plans consider a number of
financial activities including:
–
–
–
–
–
Proposed fixed asset investments
Research and development activities
Marketing and product development
Capital structure
Sources of financing
• These plans are generally supported by a series of
annual budgets and profit plans.
Short-Term Financial
Planning
Cash Planning: Cash Budgets
• The cash budget or cash forecast is a statement of the firm’s
planned inflows and outflows of cash.
• It is used to estimate short-term cash requirements with
particular attention to anticipated cash surpluses and shortfalls.
• Surpluses must be invested and deficits must be funded.
Cash Planning: Cash Budgets (cont.)
• The cash budget begins with a sales forecast, which is simply a
prediction of the sales activity during a given period.
Cash Planning: Cash Budgets (cont.)
The General Format of the Cash Budget
Cash Planning: Cash Budgets An Example:
Coulson Industries
• Coulson Industries, a defense contractor, is developing a cash
budget for October, November, and December. Halley’s sales in
August and September were $100,000 and $200,000
respectively. Sales of $400,000, $300,000 and $200,000 have
been forecast for October, November, and December.
Historically, 20% of the firm’s sales have been for cash, 50% have
been collected after 1 month, and the remaining 30% after 2
months. In December, Coulson will receive a $30,000 dividend
from stock in a subsidiary.
Cash Planning: Cash Budgets An Example:
Coulson Industries (cont.)
• Based on this information, we are able to develop the following
schedule of cash receipts for Coulson Industries.
A Schedule of Projected Cash Receipts for Coulson Industries ($000)
Cash Planning: Cash Budgets An
Example: Coulson Industries (cont.)
• Coulson Company has also gathered the relevant
information for the development of a cash
disbursement schedule. Purchases will represent 70%
of sales—10% will be paid immediately in cash, 70% is
paid the month following the purchase, and the
remaining 20% is paid two months following the
purchase. The firm will also expend cash on rent,
wages and salaries, taxes, capital assets, interest,
dividends, and a portion of the principal on its loans.
The resulting disbursement schedule thus follows.
Schedule of Projected Cash Disbursements
for Coulson Industries ($000)
Cash Planning: Cash Budgets An
Example: Coulson Industries (cont.)
• The Cash Budget for Coulson Industries can be derived
by combining the receipts budget with the
disbursements budget. At the end of September,
Coulson’s cash balance was $50,000, notes payable
was $0, and marketable securities balance was $0.
Coulson also wishes to maintain a minimum cash
balance of $25,000. As a result, it will have excess cash
in October, and a deficit of cash in November and
December. The resulting cash budget follows.
A Cash Budget for Coulson
Industries ($000)
Profit Planning: Pro Forma Statements
• Pro forma financial statements are projected, or forecast,
financial statements – income statements and balance
sheets.
Profit Planning:
Pro Forma Financial Statements
Profit Planning: Pro Forma Financial
Statements (cont.)
Vectra Manufacturing’s Balance Sheet, December 31,
2009
Profit Planning: Pro Forma Financial
Statements (cont.)
• Step 1: Start with a Sales Forecast
– The first and key input for developing pro forma financial
statements is the sales forecast for Vectra Manufacturing.
2010 Sales Forecast for Vectra Manufacturing
Profit Planning: Pro Forma Financial
Statements (cont.)
• Step 1: Start with a Sales Forecast (cont.)
– The previous sales forecast is based on an increase
in price from $20 to $25 per unit for Model X and
from $40 to $50 per unit for Model Y.
– These increases are required to cover anticipated
increases in various costs, including labor, materials,
& overhead.
Profit Planning: Pro Forma Financial
Statements (cont.)
• Step 2: Preparing the Pro Forma Income Statement
– A simple method for developing a pro forma income
statement is the “percent-of-sales” method.
Profit Planning: Pro Forma Financial
Statements (cont.)
A Pro Forma Income Statement, Using the Percent-of-Sales Method, for Vectra
Manufacturing for the Year Ended December 31, 2010
Profit Planning: Pro Forma Financial
Statements (cont.)
• Step 2: Preparing the Pro Forma Income Statement (cont.)
– Clearly, some of the firm’s expenses will increase with the level of
sales while others will not.
– As a result, the strict application of the percent-of-sales method is
a bit naïve.
– The best way to generate a more realistic pro forma income
statement is to segment the firm’s expenses into fixed and variable
components.
– This may be demonstrated as follows.
Profit Planning: Pro Forma Financial
Statements (cont.)
Profit Planning: Pro Forma Financial
Statements (cont.)
• Step 3: Preparing the Pro Forma Balance Sheet
– Probably the best approach to use in developing the pro
forma balance sheet is the judgmental approach.
– Under this simple method, the values of some balance sheet
accounts are estimated and the company’s external financing
requirement is used as the balancing account.
Profit Planning: Pro Forma Financial
Statements (cont.)
• Step 3: Preparing the Pro Forma Balance Sheet (cont.)
1. A minimum cash balance of $6,000 is desired.
2. Marketable securities will remain at their current level of $4,000.
3. Accounts receivable will be approximately $16,875 which represents 45 days of
sales on average [(45/365) x $135,000].
4. Ending inventory will remain at about $16,000. 25% ($4,000) represents raw
materials and 75% ($12,000) is finished goods.
5. A new machine costing $20,000 will be purchased. Total depreciation will be
$8,000. Adding $20,000 to existing net fixed assets of $51,000 and subtracting
the $8,000 depreciation yields a net fixed assets figure of $63,000.
Profit Planning: Pro Forma Financial
Statements (cont.)
• Step 3: Preparing the Pro Forma Balance Sheet (cont.)
6. Purchases will be $40,500 which represents 30% of annual sales (30% x
$135,000). Vectra takes about 73 days to pay on its accounts payable.
As a result, accounts payable will equal $8,100 [(73/365) x $40,500].
7. Taxes payable will be $455 which represents one-fourth of the 1998 tax
liability.
8. Notes payable will remain unchanged at $8,300.
9. There will be no change in other current liabilities, long-term debt, and
common stock.
10. Retained earnings will change in accordance with the pro forma income
statement.
Profit Planning: Pro Forma Financial
Statements (cont.)
A Pro Forma Balance
Sheet, Using the
Judgmental Approach, for
Vectra Manufacturing
(December 31, 2010)