Transcript Document
Accounting Process & Concepts
Business Transactions & Completing Accounting Cycle
By: Associate Professor Dr. GholamReza Zandi [email protected]
The Role of Accounting Records
Establishes accountability for assets and transactions.
Keeps track of routine business activities.
Obtains detailed information about a particular transaction.
Evaluates efficiency and performance within company.
Maintains evidence of a company’s business activities.
Cash Accounts Payable Capital Stock
The Ledger
Accounts are individual records showing increases and decreases .
The entire group of accounts is kept together in an accounting record called a ledger .
The Use of Accounts
Increases
are recorded on one side of the T account, and decreases are recorded on the other side.
Title of Account Left or Debit Side Right or Credit Side
Debit and Credit Entries
Receipts are on the debit side.
1/26 1/31 600 2,200 Cash 1/21 1/22 1/27 1/31 1/31 52,000 6,000 6,800 200 1,200 Payments are on the credit side.
The balance is the difference between the debit and credit entries in the account.
Debit and Credit Entries
Debits and credits affect accounts as follows:
A ASSETS = L LIABILITIES + OE EQUITIES Debit for Increase Credit for Decrease Debit for Decrease Credit for Debit for Increase Decrease Credit for Increase
Double Entry Accounting The Equality of Debits and Credits
A Debit balances = = L + OE Credit balances In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.
Let’s record selected transactions for Overnight Auto Service in the accounts.
January 20: Michael McBryan and his family invested $80,000 in Overnight Auto Service and received 8,000 shares of stock at $10 per share. Cash increases $80,000 with a debit.
Capital Stock increases $80,000 with a credit.
1/20 Cash 80,000 Capital Stock 1/20 80,000
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Jan. 21: Overnight purchased land for $52,000 cash.
Cash decreases $52,000 with a credit.
Land increases $52,000 with a debit.
1/20 Cash 80,000 1/21 52,000 1/21 Land 52,000
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Jan. 22: Overnight purchased a garage for $36,000 by paying $6,000 in cash and issuing a note payable for the remaining $30,000.
Building increases $36,000 with a debit . Cash decreases $6,000 with a credit. Notes Payable increases $30,000 with a credit.
Building Cash 1/21 1/22 52,000 6,000 Notes Payable
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Jan 23: Overnight Auto Service purchased tools and equipment for $13,800 on account.
Tools & Equipment increases $13,800 with a debit.
1/23 Tools & Equipment 13,800 Accounts Payable increases $13,800 with a credit.
Accounts Payable 1/23 13,800
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Jan 24: Overnight sold part of the tools and equipment to Ace Towing for $1,800, a price equal to Overnight’s cost. Ace agrees to pay Overnight on account in the future.
Tools & Equipment decreases $1,800 with a credit. 1/23 Tools & Equipment 13,800 Accounts Receivable increases $1,800 with a debit. Accounts Receivable
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The Journal
In an actual accounting system, transactions are initially recorded in the journal .
GENERAL JOURNAL Date 2015 Account Titles and Explanation Jan 20 Cash Capital Stock Owners invest cash in the business.
Debit Credit 80,000 80,000
Posting Journal Entries to the Ledger Accounts Posting simply means updating the ledger accounts for the effects of the transactions recorded in the journal.
Posting Journal Entries to the Ledger Accounts
GENERAL JOURNAL Date 2015 Account Titles and Explanation Jan 20 Cash Capital Stock Debit 80,000 Credit 80,000 Date 2015 Debit Cash Credit Balance 80,000 80,000
Posting Journal Entries to the Ledger Accounts
GENERAL JOURNAL Date 2015 Jan 20 Cash Account Titles and Explanation Capital Stock Debit Credit 80,000 80,000 Date 2015 Jan 20 Capital Stock Debit Credit Balance 80,000 80,000
Posting Journal Entries to the Ledger Accounts
GENERAL JOURNAL Date 2015 Account Titles and Explanation Jan 21 Land Cash Purchased land.
Debit 52,000 Credit 52,000 Let’s see what the cash account looks like after posting the cash portion of this transaction for Overnight Auto Service.
Ledger Accounts After Posting
Date 2015 Jan 20 21 General Ledger Cash Debit 80,000 Credit 52,000 Balance 80,000 28,000 This ledger format is referred to as a running balance .
Ledger Accounts After Posting
Date 2015 Jan 20 21 General Ledger Cash Debit 80,000 Credit 52,000 Balance 80,000 28,000 T accounts are simplified versions of the ledger account that only show the debit and credit columns.
What is Net Income?
Net income is not an asset
it’s an increase in owners’ equity from profits of the business.
A Increase = L Decrease + OE Increase As income is earned, either an asset is increased or a liability is decreased. Net income always results in the increase of Owners’ Equity
Retained Earnings
A = L + OE Capital Stock Retained Earnings The balance in the Retained Earnings account represents the total net income of the corporation over the entire lifetime of the business, less all amounts which have been distributed to the stockholders as dividends.
The Income Statement: A Preview
The income statement summarizes the profitability of a business for a specified period of time .
Accounting Periods
Time Period Principle To provide users of financial statements with timely information, net income is measured for relatively short accounting periods of equal length.
Revenue and Expenses
The price for goods sold and services rendered during a given accounting period.
Increases owners’ equity.
The costs of goods and services used up in the process of earning revenue.
Decreases owner’s equity.
The Matching Principle: When To Record Revenue
Matching Principle
Revenue
should be recognized at the time goods are sold and services are rendered.
The Matching Principle: When To Record Expenses
Matching Principle
Expenses
should be recorded in the period in which they are used up.
The Accrual Basis of Accounting
Current Accounting Period Jan. 1, 2015 Dec. 1, 2015 Future Accounting Period Jan. 1, 2016 Dec. 1, 2016 Cash is received or paid here But . . .
OR The income statement reports revenue or expenses here But . . .
The income statement reports revenue or expense here Cash is received or paid here
Debit and Credit Rules for Revenue and Expenses
Expenses decrease owners’ equity.
EQUITIES Debit for Decrease Credit for Increase Revenues increase owners’ equity.
EXPENSES Debit for Increase Credit for Decrease REVENUES Debit for Decrease Credit for Increase
Dividends
Payments to owners decrease owners’ equity.
EQUITIES Debit for Decrease Credit for Increase Owners’ investments increase owners’ equity.
DIVIDENDS Debit for Increase Credit for Decrease CAPITAL STOCK Debit for Decrease Credit for Increase
Let’s analyze the revenue and expense transactions for Overnight Auto Service for the month of February. We will also analyze a dividend transaction.
FEB. 1: Paid Daily Tribune $360 cash for
newspaper advertising to be run during February.
Advertising Expense increases $360 with a debit.
Cash decreases $360 with a credit. Advertising Expense 2/1 360 1/31 bal Cash 16,600 2/1 360
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FEB. 2: Purchased radio advertising from KRAM to be aired in February. The cost was $470, payable within 30 days.
Advertising Expense increases $470 with a debit.
Advertising Expense 2/1 2/2 360 470 Accounts payable increases $470 with a credit. Accounts Payable 1/31 bal 2/2 7,000 470
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FEB. 4: Purchased various supplies for $1,400, payable within 30 days. The supplies are expected to be used over the next 3 to 4 months.
Shop Supplies increases $1,400 with a debit.
Shop Supplies Accounts payable increases $1,400 with a credit. Accounts Payable 1/31 bal 2/2 2/4 7,000 470 1,400
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FEB 15: Overnight collected $4,980 cash for repairs made to vehicles of Airport Shuttle Service.
Cash increases $4,980 with a debit.
Repair Service Revenue increases $4,980 with a credit.
1/31 bal 2/15 Cash 16,600 4,980 2/1 360 Repair Service Revenue 1/31 bal.
2/15 2,200 4,980
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FEB 28: Overnight billed Harbor Cab Co. $5,400 for maintenance and repair services provided in February, with payment to be received by March 10.
Accounts receivable increases $5,400 with a debit.
Accounts Receivable 1/31 bal 1,200 2/28 5,400 Repair Service Revenue increases $5,400 with a credit.
Repair Service Revenue 1/31 bal.
2,200 2/15 4,980 2/28 5,400
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FEB 28: Overnight paid employee’s wages earned in February, $4,900.
Wages Expense increases $4,900 with a debit.
1/31 bal.
Wages Expense 1,200 2/28 4,900 Cash decreases $4,900 with a credit. 1/31 bal 2/15 Cash 16,600 2/1 4,980 2/28 360 4,900
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FEB 28: Overnight recorded a $1,600 utility bill for February. The entire amount is due March 15.
Utilities Expense increases $1,600 with a debit.
1/31 bal.
2/28 Utilities Expense 200 1,600 Accounts Payable increases $1,600 with a credit. Accounts Payable 1/31 bal 2/2 2/4 2/28 7,000 470 1,400 1,600
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FEB 28: Overnight Auto Services declares and pays a dividend of 40 cents per share to the owners of its 8,000 shares of capital stock —a total of $3,200.
Dividends increase $3,200 with a debit.
Cash decreases $3,200 with a credit.
1/31 bal.
2/28 Dividends 3,200 1/31 bal 2/15 Cash 16,600 4,980 2/1 2/28 2/28 360 4,900 3,200
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Now, let’s look at the Trial Balance for Overnight Auto Service for the month of February.
All balances are taken from the ledger accounts on Feb 28 after considering all of Overnight’s transactions for the month.
The Accounting Cycle in Perspective
Accountants spend much of their time focusing on the more analytical aspects of their discipline.
Adjusting Entries
Adjusting entries are needed whenever revenue or expenses affect more than one accounting period .
Every adjusting entry involves a change in either a revenue or expense and an asset or liability .
Types of Adjusting Entries
Converting assets to expenses
Converting liabilities to revenue
Accruing unpaid expenses
Accruing uncollected revenue
Converting Assets to Expenses
Prior Periods End of Current Period Current Period Future Periods Transaction Paid cash in advance of incurring expense (creates an asset).
Adjusting Entry Recognizes portion of asset consumed
as expense, and Reduces balance of asset account.
Converting Assets to Expenses
$18,000 Insurance Policy Coverage for 12 Months $1,500 Monthly Insurance Expense Mar. 1 Feb.28
On March 1, Overnight Auto Services purchased a one-year insurance policy for $18,000.
Converting Assets to Expenses
Initially, costs that benefit more than one accounting period are recorded as assets . GENERAL JOURNAL Date Account Titles and Explanation Mar. 1 Unexpired Insurance Cash Purchase a one-year insurance policy.
Debit 18,000 Credit 18,000
Converting Assets to Expenses
The costs are expensed as they are used to generate revenue.
GENERAL JOURNAL Date Account Titles and Explanation Monthly Adjusting Entry for Insurance Mar. 31 Insurance Expense Unexpired Insurance Debit 1,500
Adjusting entry to record insurance expense for March.
Credit 1,500
Converting Assets to Expenses
Balance Sheet Cost of assets that benefit future periods.
Income Statement Cost of assets used this period to generate revenue.
3/1 Unexpired Insurance 18,000 3/31 1,500 Bal.
16,500 Insurance Expense
The Concept of Depreciation
Depreciation is the systematic allocation of the cost of a depreciable asset to expense.
Fixed Asset ( debit ) On date when initial payment is made . . .
Cash ( credit ) The asset’s usefulness is partially consumed during the period.
Depreciation Expense ( debit ) At end of period . . .
Accumulated Depreciation ( credit )
Depreciation Is Only an Estimate
On Jan. 22, 2015, Overnight Auto Service purchased a building with a useful life of 240 months for $36,000. Using the straight-line method, calculate the monthly depreciation expense.
Depreciation expense (per period) = Cost of the asset Estimated useful life $150/month = $36,000 240
Depreciation Is Only an Estimate
Overnight Auto Service would make the following adjusting entry.
GENERAL JOURNAL Date Account Titles and Explanation Feb 28 Depreciation Expense: Building Accumulated Depreciation: Building To record one month's depreciation.
Contra-asset Debit 150 Credit 150
Depreciation Is Only an Estimate
Overnight depreciates its $12,000 of tools and equipment over 60 months. Calculate monthly depreciation and make the journal entry. GENERAL JOURNAL Date Account Titles and Explanation Debit Feb 28 Depreciation Expense: Tools and Equipment 200 Accumulated Depreciation: Tools and Equipment To record one month's depreciation.
Credit 200 $12,000
60 months = $200 per month
Depreciation Is Only an Estimate
We will assume that Overnight did
not
record any depreciation expense in January because it operated for only a small part of the month.
December 31, 2015 Balance Sheet Presentation
Building Less: Accum. depr.
Tool and Equipment Less: Accum. depr.
$ 36,000 1,650 $ 18,000 2,200 34,350 15,800
Cost - Accumulated Depreciation = Book Value
Converting Liabilities to Revenue
Prior Periods End of Current Period Current Period Future Periods Transaction Collect cash in advance of earning revenue (creates a liability).
Adjusting Entry Recognizes portion
earned as revenue, and Reduces balance of liability account.
Converting Liabilities to Revenue
$3,000 Rental Contract Coverage for 3 Months $1,000 Monthly Rental Revenue Dec. 1 Feb. 28 On December 1, Overnight received $3,000 in advance for a three-month rental contract.
Converting Liabilities to Revenue
Initially, revenues that benefit more than one accounting period are recorded as liabilities.
GENERAL JOURNAL Date Dec 1 Cash Account Titles and Explanation Unearned Rent Revenue Collected $3,000 in advance for rent.
Debit 3,000 Credit 3,000
Converting Liabilities to Revenue
Over time, the revenue is recognized as it is earned .
GENERAL JOURNAL Date Account Titles and Explanation Monthly Adjusting Entry for Rent Revenue Dec 31 Unearned Rent Revenue Rental Revenue Debit 1,000 Adjusting entry to record rental revenue for December.
Credit 1,000
Converting Liabilities to Revenue
Balance Sheet Liability for future periods.
Unearned Rental Revenue Income Statement Revenue earned this period.
Rental Revenue
Accruing Unpaid Expenses
Prior Periods End of Current Period Current Period Future Periods
Adjusting Entry Recognizes expense incurred, and Records liability for future payment.
Transaction Pay cash in settlement of liability.
Accruing Unpaid Expenses
$1,950 Wages Expense Friday, Jan. 3 Monday, Dec. 30 Tuesday, Dec. 31 On Dec. 31, Overnight owes wages of $1,950. Payday is Friday, Jan. 3.
Accruing Unpaid Expenses
Initially, an expense and a liability are recorded.
GENERAL JOURNAL Date Account Titles and Explanation Dec 31 Wages Expense Debit 1,950 Wages Payable Adjusting entry to accrue wages owed to employees.
Credit 1,950
Accruing Unpaid Expenses
Balance Sheet Liability to be paid in a future period.
Income Statement Cost incurred this period to generate revenue.
Wages Payable Wages Expense
Accruing Unpaid Expenses
$2,397 Weekly Wages $1,950 Wages Expense $447 Wages Expense Monday, Dec. 30 Tuesday, Dec. 31 Friday, Jan. 3 Let’s look at the entry for Jan. 3.
Accruing Unpaid Expenses
The liability is extinguished when the debt is paid.
GENERAL JOURNAL Date Account Titles and Explanation Jan 3 Wages Expense (for Jan.) Wages Payable (accrued in Dec.) Cash Weekly payroll for Dec. 30 - Jan. 3.
Debit 447 1,950 Credit 2,397
Accruing Uncollected Revenue
Prior Periods End of Current Period Current Period Future Periods Adjusting Entry
Recognizes revenue earned but not yet
recorded, and Records receivable.
Transaction Collect cash in settlement of receivable.
Accruing Uncollected Revenue
$750 Repair Service Revenue Dec. 15 Dec. 31 Jan. 15 On Dec. 31, Airport Shuttle owes Overnight half of it maintenance agreement. The one month fee of $1,500 is to be paid is to be paid on the 15 th day of January.
Accruing Uncollected Revenue
Initially, the revenue is recognized and a receivable is created.
GENERAL JOURNAL Date Account Titles and Explanation Dec 31 Accounts Receivable Debit 750 Repair Service Revenue Adjusting entry to record accrued service revenue.
Credit 750
Accruing Uncollected Revenue
Balance Sheet Receivable to be collected in a future period.
Income Statement Revenue earned this period.
Accounts Receivable 12/31 750 Repair Service Revenue 12/31 750
Accruing Uncollected Revenue
$1,500 Monthly Interest $750 Service Revenue $750 Service Revenue Dec. 15 Dec. 31 Jan. 15 Let’s look at the entry for January 15.
Accruing Uncollected Revenue
The receivable is collected in a future period.
GENERAL JOURNAL Date Account Titles and Explanation Debit Jan 15 Cash Repair Service Revenue (for Jan.) 1,500 Accounts Receivable (accrued Dec. 31) To record cash collected for monthly maintenance fee.
Credit 750 750
Accruing Income Taxes Expense: The Final Adjusting Entry
As a corporation earns taxable income, it incurs income taxes expense, and also a liability to governmental tax authorities.
GENERAL JOURNAL Date Account Titles and Explanation Dec. 31 Income Taxes Expense Debit 4,020 Credit Income Taxes Payable 4,020 Adjusting entry to record income taxes accrued in December.
Adjusting Entries and Accounting Principles
Costs are matched with revenue in two ways:
Direct association of costs with specific revenue transactions.
Systematic allocation of costs over the “useful life” of the expenditure.
The Concept of Materiality
An item is “material” if knowledge of the item might reasonably influence the decisions of users of financial statements.
Many companies immediately charge the cost of immaterial items to expense.
Supplies Light bulbs
Effects of the Adjusting Entries
Adjustment Type I Converting Assets to Expenses Type II Converting Liabilities to Revenue Type III Accruing Unpaid Expenses Type IV Accruing Uncollected Revenue Income Statement Revenue Expenses Net Income Assets Balance Sheet Liabilities Owners' Equity No effect Increase Decrease Decrease No effect Decrease Increase No effect Increase No effect Decrease Increase No effect Increase Decrease No effect Increase Decrease Increase No effect Increase Increase No effect Increase
After these adjustments are posted to the ledger, Overnight’s ledger accounts will be up-to date (except for the balance in the Retained Earnings account).
Financial Statements
Publicly owned companies – those with shares listed on a stock exchange – have obligations to release annual and quarterly information to their stockholders and to the public.
The annual report includes comparative financial statements and other information relating to the company’s financial position, business operations, and future prospects.
The financial statements contained in the annual report must be audited by a firm of certified public accountants (CPAs).
The financial statements for Overnight Auto Service for 2015.
The Income Statement
Net income also appears on the Statement of Retained Earnings .
The Statement of Retained Earnings
The Balance Sheet
Relationships among the Financial Statements
Drafting the Notes that Accompany Financial Statements
Notes to the Financial Statements Examples of Items Disclosed
Lawsuits pending
Scheduled plant closings
Governmental investigations
Significant events occurring after the balance sheet date
Specific customers that account for a large portion of revenue
Unusual transactions and related party transactions
Closing the Temporary Accounts
Close Revenue accounts to Income Summary.
Close Expense accounts to Income Summary.
Close Income Summary account to Retained Earnings.
Close Dividends to Retained Earnings.
The closing process gets the temporary accounts ready for the next accounting period.
Closing the Temporary Accounts
Closing Entries for Revenue Accounts
Since both revenue accounts have credit balances, the closing entry requires a debit to the Revenue accounts.
GENERAL JOURNAL Date Account Titles and Explanation Dec 31 Repair Service Revenue Income Summary To close the revenue accounts.
Debit 172,000 3,000 Credit 175,000
Closing Entries for Revenue Accounts
Closing Entries for Expense Accounts
Net Income
Closing the Income Summary Account
Since Income Summary has a $39,942 credit balance, the closing entry requires a debit to Income Summary.
GENERAL JOURNAL Date Account Titles and Explanation Dec 31 Income Summary Retained Earnings To close Income Summary.
Debit 39,942 Credit 39,942
Closing the Income Summary Account
Retained Earnings 39,942 Income Summary 135,058 39,942 175,000 39,942 The balance in Income Summary is now zero .
Closing the Dividends Account
Since the Dividends account has a debit balance, the closing entry requires a credit to the Dividends account. GENERAL JOURNAL Date Account Titles and Explanation Dec 31 Retained Earnings Dividends To close the Dividends account.
Debit 14,000 Credit 14,000
Closing the Dividends Account
Dividends 14,000 14,000 Retained Earnings 14,000 39,942 25,942
After-Closing Trial Balance
Evaluating the Business
Evaluating Profitability Evaluating Liquidity Net Income Percentage = Net Income Total Revenue Return on Equity = Net Income Avg. Stockholders’ Equity Working Capital = Current Assets – Current Liabilities Current Ratio = Current Assets Current Liabilities
Preparing Financial Statements Covering Different Periods of Time
Many companies prepare financial statements at various points throughout the year.
Annually Interim Financial Statements Quarterly Monthly Jan. 1 Dec. 31
Ethics, Fraud, and Corporate Governance
A company should disclose any facts that an intelligent person would consider necessary for the statements to be interpreted properly .
Public companies are required to file annual reports with the Securities and Exchange Commission (SEC). The SEC requires that companies include a section labeled “Management Discussion and Analysis” (MD&A) because the financial statements and related notes may be inadequate for assessing the quantity and sustainability of a company’s earnings.