2. The Accounting Cycle
The accounting cycle is the process by
which accountants prepare financial
statements for an entity for a specific
period of time.
3. The Accounting Cycle
1. Analyze business transactions
2. Journalize the
transactions
6. Prepare an adjusted trial
balance
7. Prepare financial
statements
8. Journalize and post
closing entries
9. Prepare a post-closing
trial balance
4. Prepare a trial balance
3. Post to ledger accounts
5. Journalize and post
adjusting entries
4. The Accounting Cycle
For a new business, begin by setting
up ledger accounts.
For an established business, begin
with account balances carried over
from the previous period.
5. Account:
•
•
An account is an individual accounting
record of increases and decreases
labeled as debits and credits.
There are separate accounts for each
classification type such as cash, salaries
expense, accounts payable, etc.
6. According to Pacioli, “ Double-entry
accounting is based on a simple concept: each
party in a business transaction will receive
something and give something in return. In
accounting terms, what is received is a debit
and what is given is a credit. The T account
is a representation of a scale or balance.”
Luca Pacioli
Developer of
Double-Entry
Accounting,
c1494
Scale or Balance
Receive
DEBIT
Give
CREDIT
Double entry accounting
7. Debits and Credits
Two of the most familiar accounting terms are “debits and
credits.” In the double-entry system, debits must always
It is often
equal credits for the accounting equation.
Debit (from the Latin word debere) means “left.”
abbreviated as “dr.”
It is
Credit (from the Latin word credere) means “right.”
often abbreviated as “cr.”
Recording done by debiting at least one account and
crediting another.
DEBITS must equal CREDITS.
8. Account Name
Debit / Dr. Credit / Cr.
Debits and Credits
An arrangement that shows
the effect of transactions on
an account.
Debit = “Left”
Credit = “Right”
Account
An Account can
be illustrated in a
T-Account
form.
9. Debits and Credits
If Debit entries are greater than Credit entries,
the account will have a debit balance.
Transaction #2
$15,000
Account Name
Debit / Dr. Credit / Cr.
$10,000 $3,000
8,000Transaction #3
Balance
Transaction #1
10. Debits and Credits
If Credit entries are greater than Debit entries,
the account will have a credit balance.
Account Name
Transaction #2
Transaction #3
Balance
Transaction #1
Debit / Dr. Credit / Cr.
$10,000 $3,000
8,000
$1,000
12. Balance Sheet Income Statement
Asset = Liability + Equity Revenue -Expense
Debit
Credit
Debits and Credits Summary
13. Basic Accounting Equation
Relationship among the assets, liabilities and
stockholders’ equity of a business:
The equation must be in balance after every
transaction. For every Debit there must be a Credit.
14. Ownership structure dictates the types of accounts
that are part of the equity section.
Proprietorship
or
Partnership
Capital Account
Drawing Account
Corporation
Common Stock
Additional Paid-in
Capital
Dividends Declared
Retained Earnings
Ownership Structure
16. 1. Transactions and Events
What to Record?
FASB states, “transactions and other events and
circumstances that affect a business enterprise.”
Types of Events:
•
•
External – between a business and its environment.
Internal – event occurring entirely within a business.
17. External
Not Recorded
External
Not Recorded
Internal
External
Not Recorded
1. A supplier of a company‘s raw material is
paid an amount owed on account.
2. A customer pays its open account.
3. A new chief executive officer is hired.
4. The biweekly payroll is paid.
5. Raw materials are entered into production.
6. A new advertising agency is hired.
7. The accountant determines the federal
income taxes owed based on the income
earned.
Internal
Review “Transactions and Events”
External Internal
18. Transactions are initially recorded (journalized) in
chronological order before they are transferred to
the ledger accounts.
A journal makes several contributions to recording
process:
1.Discloses in one place the complete effect of a
transaction
2. Provides a chronological record of transactions
3.Helps to prevent or locate errors as debit and
credit amounts for each entry can be compared
THE JOURNAL
19. JJOOUURNRNAALLIIZZIINNG
G
•
•
Entering transaction data in the journal is
known as journalizing.
Separate journal entries are made for each
•
transaction.
A complete entry consists of:
1. The date of the transaction,
2. The accounts and amounts to be debited and
credited,
3. A brief explanation of transaction.
1. Journalizing
20. TECHNIQUE OF JOURNALIZING
The date of the transaction is entered into the date
column.
The debit account title is entered at the extreme left
margin of the Account Titles and Explanation column. The
credit account title is indented on the next line.
GENERAL JOURNAL J1
Date Account Titles and Explanation Ref. Debit Credit
2005
Sept. 1 Cash
R. Neal, Capital
(Invested cash in business)
15,000
15,000
1 Computer Equipment 7,000
Cash
(Purchased equipment for
cash)
7,000
21. When three or more accounts are required in one
journal entry, the entry is referred to as a compound
entry.
COMPOUND JOURNAL ENTRY
2
1
3
22. Posting – the process of transferring amounts from the
journal to the ledger accounts.
Date Explanation
Acct. No. 100
Credit Balance
Jan. 3 Sale of stock
General Ledger
Cash
Ref. Debit
GJ1 100,000 100,000
General Journal GJ1
Date Account Title Ref. Debit Credit
Jan. 3 Cash 100 100,000
Common stock 100,000
3. Posting
23. Trial Balance – a list of each account and its balance;
used to prove equality of debit and credit balances.
Cost of goods sold 30,000
385000 385000
Account Debit Credit
Cash 140000
Accounts receivable 35,000
Inventory 30,000
Building 150,000
Accounts payable $60,000
Note payable 150,000
Common stock 100,000
Retained earnings
Sales 75,000
4. Trial Balance
24. 5. Adjusting Entries
Adjustments (adjusting entries) - end-of-period entries
that assign the financial effects of implicit transactions
to the appropriate time periods.
Adjustments are usually made when the financial
statements are about to be prepared.
Adjusting entries - needed to ensure that the revenue
recognition and matching principles are followed.
Revenues - Revenues are the economic resources flowing
into a business as a result of operational activities (such
as providing goods or services to other economic
entities). Sales revenue, service revenue, and investment
revenues are subdivisions of revenues. Increase in
Revenues will increase Owner' Equity.
25. cont’d
Expenses - Expenses are the outflow of a
business’s economic resources resulting from the
operational activities (such as purchasing goods or
receiving services from other economic entities).
They are the cost of doing business. Expenses can
be termed in different ways according to the
business activities.
Cost of goods sold, administrative expenses, selling
expenses, financial expenses are special terms of
expenses. Increase in expenses will decrease
owner' equity. Revenues and expenses are the
subdivisions of Owner' Equity.
26. Classes of Adjusting Entries
Prepayments
1. Prepaid Expenses.
Expenses paid in cash and
recorded as assets before
they are used or
consumed.
2. Unearned Revenues.
Revenues received in cash
and recorded as liabilities
before they are earned.
Accruals
3. Accrued Revenues.
Revenues earned but
not yet received in
cash or recorded.
4. Accrued Expenses.
Expenses incurred but
not yet paid in
cash or recorded.
27. Payment of cash that is recorded as an asset because
service or benefit will be received in the future.
Adjusting Entries – “Prepaid Expenses”
insurance
supplies
advertising
Cash Payment Expense RecordedBEFORE
rent
maintenance on equipment
fixed assets
Method: create Asset accounts to account for them.
Prepayments often occur in regard to:
28. Example: On Jan. 1st, Phoenix Corp. paid $12,000 for 12
months of insurance coverage. Show the journal entry to
record the payment on Jan. 1st.
Adjusting Entries – “Prepaid Expenses”
12,000
Prepaid insurance 12,000
Cash
Jan. 1
Prepaid Insurance
Debit Credit
12,000
Cash
Debit Credit
12,000
29. Example: On Jan. 1st, Phoenix Corp. paid $12,000 for 12
months of insurance coverage. Show the adjusting journal
entry required at Jan. 31st.
Adjusting Entries – “Prepaid Expenses”
1,000
Insurance expense 1,000
Prepaid insurance
Jan. 31
12,000 1,000
Prepaid Insurance Insurance expense
Debit Credit Debit Credit
1,000
11,000
30. Receipt of cash that is recorded as a liability because
the revenue has not been earned.
Adjusting Entries – “Unearned Revenues”
rent
airline tickets
school tuition
Cash Receipt Revenue RecordedBEFORE
magazine subscriptions
customer deposits
Method: create a liability to account for it.
Unearned revenues often occur in regard to:
31. Example: On Nov. 1st, Phoenix Corp. received $24,000 from
city School for 3 months rent in advance. Show the journal
entry to record the receipt on Nov. 1st.
24,000
Cash 24,000
Unearned rent revenue
Nov. 1
Debit Credit
Cash
24,000
Unearned Rent Revenue
Debit Credit
24,000
Adjusting Entries – “Unearned Revenues”
32. Example: On Nov. 1st, Phoenix Corp. received $24,000 from
city High School for 3 months rent in advance. Show the
adjusting journal entry required on Nov. 30th.
8,000
Unearned rent revenue 8,000
Rent revenue
Nov. 30
Rent Revenue
Debit Credit
8,000
Unearned Rent Revenue
Adjusting Entries – “Unearned Revenues”
Debit Credit
8,000 24,000
16,000
33. Revenues Received in Advance
The transactions regarding prepaid expenses and
unearned revenues are really mirror images of each
other.
Liabilities
(Unearned
Revenues)
Revenues
Earned
Seller
Adjustments
Buyer
Assets
(Prepaid
Expenses)
Expenses
Incurred
Adjustments
Appear in
Balance Sheet
Appear in
Income Statement
Appear in
Balance Sheet
Appear in
Income Statement
34. Adjusting Entries – “Accrued Revenues”
BEFORE Cash ReceiptRevenue Recorded
Revenues earned but not yet received in cash or
recorded.
Adjusting entry results in:
Method: Create an Asset Account to account for it.
Accrued revenues often occur in regard to:
rent
interest
services performed
35. Example: On July 1st, Phoenix Corp. invested $300,000 in
securities that return 5% interest per year. Show the
journal entry to record the investment on July 1st.
Investments
Cash
300,00
0 300,000
July 1
Investments
Debit Credit
300,000
Cash
Debit Credit
300,000
Adjusting Entries – “Accrued Revenues”
36. Example: On July 1st, Phoenix Corp. invested $300,000 in
securities that return 5% interest per year. Show the
adjusting journal entry required on July 31st.
1,250
Interest receivable 1,250
Interest revenue
July 31
Interest Receivable
Debit Credit
1,250
Interest Revenue
Debit Credit
1,250
Adjusting Entries – “Accrued Revenues”
37. Adjusting Entries – “Accrued Expenses”
rent
interest
taxes
BEFORE Cash Payment, if any*Expense Recorded
salaries
bad debts*
Expenses incurred but not yet paid in cash or
recorded.
Adjusting entry results in:
Method: Create a Liability Account to account for it.
Accrued expenses often occur in regard to:
38. Cash
Notes payable
200,00
0 200,000
Feb. 2
Debit Credit
Cash
200,000
Notes Payable
Debit Credit
200,000
Adjusting Entries – “Accrued Expenses”
Example: On Feb. 2nd, Phoenix Corp. borrowed $200,000 at a
rate of 9% per year. Interest is due on first of each month.
Show the journal entry to record the borrowing on Feb. 2nd.
39. Example: On Feb. 2nd, Phoenix Corp. borrowed $200,000 at a
rate of 9% per year. Interest is due on first of each month.
Show the adjusting journal entry required on Feb. 28th.
1,500
Interest expense 1,500
Interest payable
Feb. 28
Interest Expense
Debit Credit
1,500
Interest Payable
Debit Credit
1,500
Adjusting Entries – “Accrued Expenses”
40. Shows the balance of all accounts, after adjusting
entries, at the end of the accounting period.
6. Adjusted Trial Balance
Assets
(Various)
Unbilled Services Receivable
Inventory
Prepaid Rent
Prepaid Insurance
Buildings
Equipment
Land
Liabilities
(Various)
Accrued Wages Payable
Accrued Interest Payable
Unearned Revenue
Owner’s Equity
Stock
Retained Earnings
41. 7. Preparing Financial Statements
Financial Statements are prepared directly from the
Adjusted Trial Balance.
Balance
Sheet
Income
Statement
Statement
of Cash
Flows
Statement
of
Retained
Earnings
42. Adjusted Trial Bal. Debit Credit
140000
35,000
190,000
Cash
Accounts receivabl
Building
Note payable
Common stock
150000
100,000
38,000
10,000
185,000
17,000
Retained earnings
Dividends declared
Sales
Interest income
Cost of goods sold
Salary expense
47,000
25,000
Depreciation expen 43,000
490000 490000
Balance Sheet
Assets
$ 140,000
35,000
190,000
$ 365,000
Cash
Accounts receivable
Building
Total assets
Liabilities
Note payable
Stockholders' equity
Common stock
Retained earnings
Total liab. & equity
150,000
100,000
115,000
$ 365,000
7. Preparing Financial Statements
Balance SheetAssume the following
Adjusted Trial Balance
43. Adjusted Trial Balance Debit Credit
$ 490,000 $ 490,000
Cash $ 140,000
Accounts receivable 35,000
Building 190,000
Note payable $ 150,000
Common stock 100,000
Retained earnings 38,000
Dividends declared 10,000
Sales 185,000
Interest income 17,000
Cost of goods sold 47,000
Salary expense
Depreciation expense
25,000
43,000
Income Statement
Revenues:
$ 185,000
17,000
202,000
Sales
Interest income
Total revenue
Expenses:
Cost of goods sold 47,000
Salary expense 25,000
Depreciation expense 43,000
Total expenses 115,000
Net income $ 87,000
7. Preparing Financial Statements
Income StatementAssume the following
Adjusted Trial Balance
44. Adjusted Trial Balance Debit Credit
$ 140,000
35,000
190,000
$ 150,000
100,000
38,000
10,000
185,000
17,000
47,000
25,000
Cash
Accounts receivable
Building
Note payable
Common stock
Retained earnings
Dividends declared
Sales
Interest income
Cost of goods sold
Salary expense
Depreciation expense 43,000
$ 490,000 $ 490,000
Statement of Retained Earnings
$ 38,000
87,000
Beginning balance
+ Net income
- Dividends
Ending balance
(10,000)
115,000
7. Preparing Financial Statements
Statement of
Retained Earnings
Assume the following
Adjusted Trial Balance
45. 8. Closing Entries
•
•
•
•
To reduce the balance of the income statement
(revenue and expense) accounts to zero.
To transfer net income or net loss to owner’s
equity.
Balance sheet (asset, liability, and equity)
accounts are not closed.
Dividends are closed directly to the Retained
Earnings account.
46. 8. Closing Entries
Example: Assume the following adjusted trial balance.
Depreciation expense 4 3 , 0 0 0
4 9 0 0 0 0 4 9 0 0 0 0
A c c o u n t Debit Credit
Cash 140000
Accounts receivable 35,000
Building 190,000
Note payable 1 5 0 0 0 0
C o m m o n stock 1 0 0 , 0 0 0
Retained earnings 38,000
Dividends declared 10,000
Sales 1 8 5 , 0 0 0
Interest income 17,000
Cost of goods sold 47,000
Salary expense 25,000
47. Example: Prepare the Closing journal entries from
the adjusted trial balance on previous slide.
8. Closing Entries
Sales
202,000
185,000
17,000
115,000
47,000
25,000
43,000
87,000
87,000
10,000
Interest income
Income summary
Income summary
Cost of goods sold
Salary expense
Depreciation expense
Income summary
Retained earnings
Retained earnings
Dividends declared 10,000