The Accounting Equation

A = L + OE
- An asset is a resource controlled by the entity
as a result of past events and from which future
economic benefits are expected to flow to the
entity
- A liability is a present obligation of the entity
arising from past events, the settlement of which
is expected to result in an outflow from the entity
of resources embodying economic benefits
Accounting Equation, Debits and
Credits, Increases and Decreases

Permanent Accounts—assets, liabilities, paid-in capital, retained earnings

Temporary Accounts-revenues, gains, expenses, losses
During the Accounting Period

Source Transaction Record in Post to

documents Analysis Journal Ledger

At the End of the Accounting Period

Financial Adjusted Record & Post Unadjusted

Statements Trial Balance Adjusting Trial Balance
Entries

The
At the End Accounting
of the Year Processing
Close Temporary Post-Closing
Cycle
Accounts Trial Balance
C3 The Accounting Cycle
Prepare
Start post-closing
trial balance

Analyze POST
transactions
Closing
Entries
Journalize
Prepare
Post statements

Prepare Prepare
Adjusting
unadjusted POST adjusted
Entries
trial balance trial balance
3-17
The Accounting Processing
Cycle
On July 1, two individuals each invested $30,000 in a new
business, Dress Right Clothing Corporation. Each
investor was issued 3,000 shares of common stock.

Two accounts are affected:

Cash (an asset) increases by $60,000.


 Common stock (a shareholders’ equity) increases

by $60,000.

July 1
Cash 60,000
Common stock 60,000
General Ledger

The “T” account is a shorthand format of an account

used by accountants to analyze transactions.
It is not part of the bookkeeping system.
Posting Journal Entries
After
Afterrecording
recordingall
allentries
entriesfor
forthe
theperiod,
period,Dress
DressRight’s
Right’s
Unadjusted
UnadjustedTrial
TrialBalance
Balance would
wouldbebeas
asfollows:
follows:

AATrial
Trial
Balance
Balance is isaa
list
list of
of all
all
accounts
accounts
and
andtheir
their
balances
balancesat at
aaparticular
particular
date.
date.

Debits = Credits
The Adjustment Process
Accounts are adjusted at the end of a period to
record internal transactions and events that are
not yet recorded.

Two basic principles for recognizing Revenues

and Expenses:
1. The revenue recognition principle requires
revenue be recorded when earned, not before
and not after.
2. The matching principle requires expenses be
recorded in the same period as the revenues
earned as a result of these expenses.
Accrual Basis versus Cash Basis
Accrual basis accounting —uses the adjusting
process to recognize revenue when earned and to
match expenses with revenues. This means the
economic effects of revenues and expenses are
recorded when earned or incurred, not when cash is
received or paid. Accrual basis is consistent with
GAAP.
Cash basis accounting —revenues are recognized
when cash is received and expenses are recognized
when cash paid. Cash basis is not consistent with
GAAP.
Accrual accounting also increases the comparability
of financial statements from one period to another.
Adjusting Accounts
An adjusting entry is recorded to bring an asset
or liability account balance to its proper amount.

The adjusting process is based on ACCRUAL

ACCOUNTING of Revenue Recognition and
Matching Principle.

Adjusting accounts is a 3-step process:

(1) Determine the current account balance,
(2) Determine what the current account balance
should be, and
(3) Record adjusting entry to get from step 1
to step 2.
P1
Supplies

During 2009, Scott Company purchased $15,500 of

supplies. Scott recorded the expenditures as
Supplies (Asset). On December 31, a count of the
supplies indicated $2,655 on hand.
What adjustment is required?
Dec. 31 Supplies Expense 12,845
Supplies 12,845
To record supplies used during 2009
Supplies 126 Supplies Expense 652
Bought 15,500 Dec. 31 12,845 Dec. 31 12,845
Bal. 2,655

3-25
Adjusting Entries
At the end of the period, adjusting entries are
required to satisfy the realization principle and
the matching principle.

Prepayments Accruals Estimates

Transactions where Transactions where Accountants must often

cash is paid or received cash is paid or received make estimates in order
before a related after a related expense to comply with the
expense or revenue is or revenue is accrual accounting
recognized. recognized. model.
C2, P1
Adjusting Accounts
Framework for
Adjustments
Adjustments

Paid
Paid (or
(or received) cash before
received) cash before Paid
Paid (or
(or received) cash after
received) cash after
expense
expense (or(or revenue)
revenue) recognized
recognized expense
expense (or
(or revenue)
revenue) recognized
recognized

Prepaid
Prepaid Unearned
Unearned Accrued
Accrued Accrued
Accrued
(Deferred)
(Deferred) (Deferred)
(Deferred) expenses
expenses revenues
revenues
expenses*
expenses* revenues
revenues
*including depreciation
3-27
Prepaid (Deferred) Expenses
P1

Supplies
During 2009, Scott Company purchased $15,500 of
supplies. Scott recorded the expenditures as
Supplies. On December 31, a count of the supplies
indicated $2,655 on hand.
What adjustment is required?
Dec. 31 Supplies Expense 12,845
Supplies 12,845
To record supplies used during 2009
Supplies 126 Supplies Expense 652
Bought 15,500 Dec. 31 12,845 Dec. 31 12,845
Bal. 2,655

3-28
P1
Depreciation

Depreciation is the process of computing

expense from allocating the cost of plant and
equipment over their expected useful lives.

Straight-Line Asset Cost - Salvage Value

Depreciation =
Expense Useful Life

3-29
Depreciation
Recall the Furniture and Fixtures for $12,000 listed on
Dress Right’s unadjusted trial balance. Assume the
following:

Asset Cost $ 12,000

Salvage Value -
Useful Life 60 months

Let’s calculate the depreciation expense for the month

ended July 31, 2011.
Depreciation
Recall the Furniture and Fixtures for $12,000 listed on
Dress Right’s unadjusted trial balance.
Asset Cost $ 12,000
Salvage Value -
Useful Life 60 months

July $12,000 - $0
Depreciation = = $200 per month
Expense 60 months

July 31
Depreciation expense 200
Accumulated depreciation-
furniture and fixtures 200
Depreciation
After posting, the accounts look like this:
Furniture and Fixtures Depreciation Expense
Beg. bal. - Beg. bal. -
12,000 200
Bal. 12,000 Bal. 200

Accumulated Depreciation
- Beg. bal.
200
200 Bal.
P1
Unearned (Deferred) Revenues

Cash
Cash received
received in
in
advance
advance ofof Buy your season tickets for
providing
providing all home basketball games NOW!
products
products or
or
services. “Go Big Blue”
services.

Revenue
Liability
Debit Unadjusted Credit
Adjustment Balance Adjustment

3-33
P1 Unearned (Deferred) Revenues

On October 1, 2009, Ox University sold 1,000 season

tickets to its 20 home basketball games for $100 each.
Ox University makes the following entry:

Oct. 1 Cash 100,000

Unearned Revenue 100,000
Basketball revenue received in advance

Unearned Revenue
Oct.1 100,000

3-34
P1
Unearned (Deferred) Revenues

On December 31, Ox University has

played 10 of its regular home games,
winning 2 and losing 8.

Dec. 31 Unearned Revenue 50,000

Basketball Revenue 50,000
To recognize 10-games of revenue
Unearned Revenue Basketball Revenue
Dec. 31 50,000 Oct. 1 100,000 Dec. 31 50,000
Bal. 50,000

3-35
P1
Accrued Expenses
We’re about one-half
done with this job and
Costs
Costs incurred
incurred in
in aa want to be paid for
period
period that
that are
are our work!
both
both unpaid
unpaid and
and
unrecorded.
unrecorded.

Expense Liability
Debit Credit
Adjustment Adjustment

3-36
P1
Accrued Expenses

Barton,
Barton, Inc.
Inc. pays
pays its
its employees
employees every
every Friday.
Friday. Year-
Year-
end,
end, 12/31/09,
12/31/09, falls
falls on
on aa Wednesday.
Wednesday. As As of
of 12/31/09,
12/31/09, the
the
employees
employees have
have earned
earned salaries
salaries of
of $47,250
$47,250 for
for Monday
Monday
through
through Wednesday.
Wednesday.

Last pay Next pay

date date
12/26/09

12/1/09 12/31/09 Record

Record adjusting
adjusting
Year end journal
journal entry.
entry.

3-37
P1
Accrued Expenses

Barton,
Barton, Inc.
Inc. pays
pays its
its employees
employees every
every Friday.
Friday. Year-
Year-
end,
end, 12/31/09,
12/31/09, falls
falls on
on aa Wednesday.
Wednesday. As As of
of 12/31/09,
12/31/09, the
the
employees
employees have
have earned
earned salaries
salaries of
of $47,250
$47,250 for
for Monday
Monday
through
through Wednesday.
Wednesday.
Dec. 31 Salaries Expense 47,250
Salaries Payable 47,250
To accrue 3-days' salary
Salaries Expense Salaries Payable
Other salaries Dec. 31 47,250
657,500
Dec. 31 47,250
Bal. 704,750

3-38
P1 Accrued Revenues
Smith
Smith && Jones,
Jones, CPAs,
CPAs, had
had $31,200
$31,200 ofof work
work
completed
completed but
but not
not yet
yet billed
billed to
to clients.
clients.
Let’s
Let’s make
make the
the adjusting
adjusting entry
entry necessary
necessary on
on
December
December 31,
31, 2009,
2009, the
the end
end of
of the
the company’s
company’s fiscal
fiscal
year.
year.

Dec. 31 Accounts Receivable 31,200

Service Revenue 31,200
To accrue revenue earned
Accounts Receivable Service Revenue
Other receivables Other revenues
1,325,268 6,589,500
Dec. 31 31,200 Dec. 31 31,200
Bal. 1,356,468 Bal . 6,620,700

3-39
Estimates
Accountants often must make estimates of
future events to comply with the accrual
accounting model.

 Examples
 Depreciation
 Uncollectible accounts

$
DRESS RIGHT CLOTHING CORPORATION
Adjusted Trial Balance
July 31, 2011
Account Title Debits Credits
Cash $ 68,500
Accounts receivable 2,000 This is the Adjusted
Allowance for uncollectible accounts $ 500
Supplies 1,200 Trial Balance for
Prepaid rent
Inventory
22,000
38,000
Dress Right after all
Furniture and fixtures 12,000 adjusting entries have
Accumulated depr.-furniture & fixtures 200
Accounts payable 35,000 been recorded and
Note payable 40,000
Unearned rent revenue 750 posted.
Salaries payable 5,500
Interest payable 333
Common stock 60,000
Retained earnings 1,000 Dress Right will use
Sales revenue
Rent revenue
38,500
250
these balances to
Cost of goods sold 22,000 prepare the financial
Salaries expense 10,500
Supplies expense 800 statements.
Rent expense 2,000
Depreciation expense 200
Interest expense 333
Bad debt expense 500
Totals $ 181,033 $ 181,033
The Income Statement

The income statement summarizes the results

of profit-generating activities of the company.
The Balance Sheet
Dress Right Clothing Corporation
Balance Sheet
At July 31, 2011
Assets
Current assets:
Cash $ 68,500
Accounts receivable $ 2,000
Less: Allowance for uncollectible accounts 500 1,500
Supplies 1,200
Inventory 38,000
Prepaid rent 22,000
Total current assets 131,200
Property and equipment:
Furniture and fixtures 12,000
Less: Accumulated depreciation 200 11,800
Total assets $ 143,000

The balance sheet presents the financial

position of the company on a particular date.
The Balance Sheet
Dress Right Clothing Corporation
Balance Sheet
At July 31, 2011
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 35,000
Salaries payable 5,500
Unearned rent revenue 750
Interest payable 333
Note payable 10,000
Total current liabilities 51,583
Long-term liabilities:
Note payable 30,000
Shareholders' equity:
Common stock $ 60,000
Retained earnings 1,417
Total shareholders' equity 61,417
Total liabilities and shareholders' equity $ 143,000

Notice that assets of $143,000 equals total

liabilities plus shareholders’ equity of $143,000.
C3 The Closing Process: Temporary and
Permanent Accounts

Temporary (nominal) accounts accumulate data related to

one accounting period. They include all income statement
accounts, the dividends account, and the Income Summary
account. These accounts are “closed” at the end of the period
to get ready for the next accounting period.

Permanent (real) accounts report activities related to one or

more future accounting periods. They carry ending balances
to the next accounting period and are not “closed.”
3-45
The Statement of Cash Flows
Dress Right Clothing Corporation
Statement of Cash Flows
For the Month of July 2011
Cash flows from Operating Activities:
Cash inflows:
From customers $ 36,500
From rent 1,000
Cash outflows:
For rent (24,000)
For supplies (2,000)
To suppliers for merchandise (25,000)
To employees (5,000)
Net cash used by operating activities $ (18,500)
Cash flows from Investing Activities:
Purchase of furniture and fixtures (12,000)
Cash flows from Financing Activities:
Issue of capital stock $ 60,000
Increase in notes payable 40,000
Payment of cash dividend (1,000)
Net cash provided by financing activities 99,000
Net increase in cash $ 68,500

The statement of cash flows discloses the

changes in cash during a period.
The Statement of
Shareholders’ Equity
Dress Right Clothing Corporation
Statement of Shareholders' Equity
For the Month of July 2011
Total
Common Retained Shareholders'
Stock Earnings Equity
Balance at July 1, 2011 $ - $ - $ -
Issue of capital stock 60,000 60,000
Net income for July 2011 2,417 2,417
Less: Dividends (1,000) (1,000)
Balance at July 31, 2011 $ 60,000 $ 1,417 $ 61,417

The statement of shareholders’ equity

presents the changes in permanent
shareholder accounts.
C3 The Accounting Cycle
Prepare
Start post-closing
trial balance

Analyze POST
transactions
Closing
Entries
Journalize
Prepare
Post statements

Prepare Prepare
Adjusting
unadjusted POST adjusted
Entries
trial balance trial balance
3-48
The Closing Process
Revenues Assets

Shareholders’
Liabilities
Dividends
Expenses

Equity
Temporary Permanent
Accounts Accounts

Income
The closing process applies
Summary
only to temporary accounts.
P4
Recording Closing Entries

1. Close revenue accounts to Inc. Summary;

2. Close expense accounts to Inc. Summary;
3. Close the income summary to RE;
4. Close dividends account to RE.

3-50
P4
Recording Closing Entries

Salaries Expenses Consulting Revenues

$ 18,100 $ 25,000
Examine the
accounts
presented.
Income Summary Retained Earnings

$ 7,000

3-51
P4
Recording Closing Entries

Salaries Expenses Consulting Revenues

$ 18,100 $ 25,000 $ 25,000

Income Summary Close revenues

$ 25,000 with a debit to the
revenue account
and a credit to
Income Summary.

3-52
P4
Recording Closing Entries

Salaries Expenses Consulting Revenues

$ 18,100 $ 18,100 $ 25,000 $ 25,000

Income Summary Close expense

accounts with a
$ 18,100 $ 25,000
credit to expenses
and a debit to
Income Summary.

3-53
P4
Recording Closing Entries

Salaries Expenses Consulting Revenues

$ 18,100 $ 18,100 $ 25,000 $ 25,000

Income Summary
Determine the
$ 18,100 $ 25,000 balance in the
$ 6,900 Income Summary
account.

3-54
P4
Recording Closing Entries

Salaries Expenses Close the Income

$ 18,100 $ 18,100 Summary to
Retained Earnings.

Income Summary Retained Earnings

$ 18,100 $ 25,000 $ 7,000

$ 6,900
$ 6,900 $ 6,900

3-55
P4
Recording Closing Entries

The dividends account is closed to

Retained Earnings.

Dividends Retained Earnings

$ 2,000 $ 2,000 $ 2,000 $ 7,000
6,900

3-56
P4
Recording Closing Entries

The dividends account is closed to

Retained Earnings.

Dividends Retained Earnings

$ 2,000 $ 2,000 $ 2,000 $ 7,000
6,900
$ 11,900
Determine the ending
balance in Retained
Earnings.
3-57
C3 The Accounting Cycle
Prepare
Start post-closing
trial balance

Analyze POST
transactions
Closing
Entries
Journalize
Prepare
Post statements

Prepare Prepare
Adjusting
unadjusted POST adjusted
Entries
trial balance trial balance
3-58
P5 Post Closing Trial Balance
 Trial Balance prepared after the
closing entries have been posted.
 The purpose is to insure that all
nominal or temporary accounts
have been closed.
 The only accounts on this trial
balance should be assets,
liabilities, and equity accounts.

3-59
Post-Closing Trial Balance
DRESS RIGHT CLOTHING CORPORATION
Post-Closing Trial Balance
July 31, 2011
Account Title Debits Credits
Cash $ 68,500 Lists permanent
Accounts receivable 2,000
Allowance for uncollectible accounts $ 500
accounts and their
Supplies 1,200 balances.
Prepaid rent 22,000
Inventory 38,000
Furniture and fixtures 12,000
Accumulated depr.-furniture & fixtures 200
Accounts payable 35,000
Note payable 40,000
Unearned rent revenue 750
Salaries payable 5,500
Interest payable 333 Total debits equal
Common stock 60,000
total credits.
Retained earnings 1,417
Totals $ 143,700 $ 143,700
Conversion From Cash Basis to
Accrual Basis

Increases Decreases

Assets Add Deduct

Liabilities Deduct Add