ACC301 Chapter 3

Trial Balance

(NOT post-closing): The list of all open accounts in the ledger and their balances. The trial balance taken immediately after all adjustments have been posted is called an adjusted trial balance. A trial balance taken immediately after closing entries have been posted is called a post-closing (or after-closing) trial balance. Companies may prepare a trial balance at any time, though they usually do so at the end of an accounting period. -*The trial balance proves the mathematical equality of debits and credits after posting and also uncovers errors in journalizing and posting.*

Closing Entries

-Journal entries made at the end of a company's annual accounting period to transfer the balances of temporary accounts to a permanent owners' equity account (retained earnings or a capital account, depending on the company's form of organization). -The formal process by which the enterprise reduces all nominal accounts to zero and determines and transfers the net income or net loss to an owners' equity account. Also known as "closing the ledger," "closing the books," or merely "closing."

Ledger

-Ledger. The book (or computer printouts) containing the accounts. -A general ledger is a collection of all the asset, liability, owners' equity, revenue, and expense accounts. -A subsidiary ledger contains the details related to a given general ledger account.

Accounting cycle

-Standard set of accounting procedures to record transactions and prepare financial statements: 1. identify & measure transactions & other events 2. journalize 3. post 4. prepare unadjusted trial balance 5. make adjusting entries 6. prepare adjusted trial balance 7. prepare financial statements 8. close accounts

errors in trial balance

-even though trial balance columns may agree, numerous errors can exist. -For example, the trial balance may balance even when a company (1) fails to journalize a transaction, (2) omits posting a correct journal entry, (3) posts a journal entry twice, (4) uses incorrect accounts in journalizing or posting, or (5) makes offsetting errors in recording the amount of a transaction.

income statement

-financial statement -measures the results of operations during the period

Unearned Revenue

-revenues received in cash and recorded as liabilities before a company earns them. -Examples are rent, magazine subscriptions, and customer deposits for future service. -the opposite of prepaid expenses. - Thus, the adjusting entry for unearned revenues results in a debit (decrease) to a liability account and a credit (increase) to a revenue account.

income summary

-the clearing account to which all revenue & expense accounts (IS) are transferred -used only at end of fiscal year -revenues & expenses are matched in this account, which produces net income or net loss that's then transferred to an equity account (Retained Earnings for corporations, capital accounts for proprietorships & partnerships)

The Accounting Cycle Summarized

A summary of the steps in the accounting cycle shows a logical sequence of the accounting procedures used during a fiscal period: 1. Enter the transactions of the period in appropriate journals. 2. Post from the journals to the ledger (or ledgers). 3. Take an unadjusted trial balance (trial balance). 4. Prepare adjusting journal entries and post to the ledger(s). 5. Take a trial balance after adjusting (adjusted trial balance). 6. Prepare the financial statements from the second trial balance. 7. Prepare closing journal entries and post to the ledger(s). 8. Take a post-closing trial balance (optional). 9. Prepare reversing entries (optional) and post to the ledger(s). A company normally completes all of these steps in every fiscal period.

Account

Account. A systematic arrangement that shows the effect of transactions and other events on a specific element (asset, liability, and so on). Companies keep a separate account for each asset, liability, revenue, and expense, and for capital (owners' equity). Because the format of an account often resembles the letter T, it is sometimes referred to as a T-account. (See Illustration 3.3, .)

Accounting information system

Accounting information system - A system that collects and processes transaction data and then disseminates the financial information to interested parties. Accounting information systems vary widely from one business to another, depending on the nature of the business and its transactions, the size of the company, the volume of data to be handled, and the informational demands.

Accrued expenses

Accrued expenses - Expenses incurred but not yet paid or recorded at the statement date. Examples are interest, rent, taxes, and salaries. An accrued expense on the books of one company is often an accrued revenue to another company. - Prior to adjustment, both liabilities and expenses are understated. Therefore, the adjusting entry for accrued expenses results in a debit (increase) to an expense account and a credit (increase) to a liability account.

Accrued revenues

Accrued revenues - Revenues earned but not yet received in cash or recorded at the statement date. Accrued revenues result from the passing of time (e.g., interest revenue and rent revenue) or from unbilled or uncollected services that a company performed (e.g., commissions and fees). - Prior to adjustment both assets and revenues are understated. Accordingly, an adjusting entry for accrued revenues results in a debit (increase) to an asset account and a credit (increase) to a revenue account.

Accumulated Depreciation

Accumulated Depreciation—Equipment is a contra asset account. A contra asset account offsets an asset account on the balance sheet. This means that the accumulated depreciation account offsets the Equipment account on the balance sheet. Its normal balance is a credit.

Adjusting Entries

Adjusting Entries. Entries made at the end of an accounting period to bring all accounts up to date on an accrual basis, so that the company can prepare correct financial statements.

Adjusting entry

Adjusting entry - Adjustments made at the end of the accounting period to ensure that a company has recorded revenues in the period in which it earns them and recognized expenses in the period in which it incurs them—in other words, that it has followed the revenue recognition and expense recognition principles. Companies often prepare adjustments after the balance sheet date but date the entries as of the balance sheet date.

Transaction

An external event involving a transfer or exchange between two or more entities.

Bad debts

Bad Debts. Proper recognition of revenues and expenses dictates recording bad debts as an expense of the period in which a company earned revenue instead of the period in which the company writes off the accounts or notes. The proper valuation of the receivable balance also requires recognition of uncollectible receivables. Proper recognition and valuation require an adjusting entry. - A company often expresses bad debts as a percentage of the revenue on account for the period. Or a company may compute bad debts by adjusting the Allowance for Doubtful Accounts to a certain percentage of the trade accounts receivable and trade notes receivable at the end of the period.

Book value

Book value - The difference between a depreciable asset's cost and its related accumulated depreciation. Book value of an asset generally differs from its market value because depreciation is a means of cost allocation, not of valuation.

Closing Process

Closing process - Accounting process at the end of the accounting period that reduces the balance of nominal (temporary) accounts to zero in order to prepare the accounts for the next period's transactions. In the closing process, the company transfers revenue and expense account balances to Income Summary, which matches expenses and revenues.

Contra asset account

Contra asset account - An account that offsets an asset account on the balance sheet. An example is the accumulated depreciation account, which companies use in order to disclose both the original cost of an asset and the total expired cost to date.

Depreciation

Depreciation - The process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. - depreciation is an estimate rather than a factual measurement of the expired cost. - A company records depreciation expense for each piece of equipment, such as trucks or machinery, and for all buildings. A company also establishes related accumulated depreciation accounts for the above, such as Accumulated Depreciation—Trucks, Accumulated Depreciation—Machinery, and Accumulated Depreciation—Buildings.

Double-entry accounting

Double-entry accounting - The universally used accounting system in which a company records the dual (two-sided) effect of each transaction in appropriate accounts. If a company records every transaction with equal debits and credits, then the sum of all the debits to the accounts must equal the sum of all the credits.

Event

Event. A happening of consequence. An event generally is the source or cause of changes in assets, liabilities, and equity. Events may be external or internal.

Internal Events

Events are of two types: (2) Internal events occur within an entity, such as using buildings and machinery in operations, or transferring or consuming raw materials in production processes.

External Events

Events are of two types: (1) External events involve interaction between an entity and its environment, such as a transaction with another entity, a change in the price of a good or service that an entity buys or sells, a flood or earthquake, or an improvement in technology by a competitor. consuming raw materials in production processes.

Financial Statements

Financial statements. Statements that reflect the collection, tabulation, and final summarization of the accounting data. Four statements are involved: (1) The balance sheet shows the financial condition of the enterprise at the end of a period. (2) The income statement measures the results of operations during the period. (3) The statement of cash flows reports the cash provided and used by operating, investing, and financing activities during the period. (4) The statement of retained earnings reconciles the *balance of the retained earnings account* from the beginning to the end of the period.

general journal

General journal - A complete record of a company's transactions or other financial events, listed chronologically and expressed in terms of debits and credits made to accounts.

General ledger

General ledger - A list of all of a company's asset, liability, stockholders' equity, revenue, and expense accounts.

Need for Depreciation Adjustment.

Generally accepted accounting principles (GAAP) view the acquisition of productive facilities as a long-term prepayment for services. The need for making periodic adjusting entries for depreciation is, therefore, the same as we described for other prepaid expenses. That is, a company recognizes the expired cost (expense) during the period and reports the unexpired cost (asset) at the end of the period. The primary causes of depreciation of a productive facility are actual use, deterioration due to the elements, and obsolescence.

The Accounting Equation

In a double-entry system, for every debit there must be a credit, and vice versa. This leads us, then, to the basic equation in accounting Assets = Liabilities + Owners Equity

journal (also called "the book of original entry")

In practice, companies do not record transactions and selected other events originally in the ledger. A transaction affects two or more accounts, each of which is on a different page in the ledger. Therefore, in order to have a complete record of each transaction or other event in one place, a company uses a journal (also called "the book of original entry")

Double-entry accounting

Increases to all asset and expense accounts occur on the left (or debit side) and decreases on the right (or credit side). - Conversely, increases to all liability and revenue accounts occur on the right (or credit side) and decreases on the left (or debit side).

reversing entries

Journal entries, made at the beginning of the next accounting period, that are the exact opposite of the adjusting entries made in the previous period. Making reversing entries is an optional step in the accounting cycle.

Posting

Posting - The process of transferring the essential facts and figures from the book of original entry (the journal) to the ledger accounts, using debits and credits made to accounts.

Posting

Posting. The process of transferring the essential facts and figures from the book of original entry to the ledger accounts.

Prepaid expenses

Prepaid expenses - Assets paid for and recorded before a company uses them. Prepaid expenses expire either with the passage of time (e.g., rent and insurance) or through use and consumption (e.g., supplies). Companies typically recognize prepaid expenses by making adjusting entries to record the expenses that apply to the current accounting period and to show the unexpired costs in the asset accounts. - Prior to adjustment, assets are overstated and expenses are understated. Thus, the prepaid expense adjusting entry results in a debit to an expense account and a credit to an asset account.

Real and Nominal Accounts

Real and Nominal Accounts. Real (permanent) accounts are asset, liability, and equity accounts; they appear on the balance sheet. Nominal (temporary) accounts are revenue, expense, and dividend accounts; except for dividends, they appear on the income statement. Companies periodically close nominal accounts; they do not close real accounts.

special journals

Records of transactions possessing a common characteristic, such as cash receipts, sales, purchases, cash payments. Using such journals reduces bookkeeping time.

Prepaid Expenses (Supplies)

Supplies. A business enterprise may use several different types of supplies. For example, a CPA firm will use office supplies such as stationery, envelopes, and accounting paper. - Supplies are generally debited to an asset account when they are acquired. Recognition of supplies used is generally deferred until the adjustment process. At that time, a physical inventory (count) of supplies is taken. The difference between the balance in the Supplies (asset) account and the cost of supplies on hand represents the supplies used (expense) for the period.

T

T/F: cash-basis accounting isn't permitted by GAAP. Accrual basis is preferred bc it gives a timely and accurate prediction of future cash flows

Journal

The "book of original entry" where the company initially records transactions and selected other events. Various amounts are transferred from the book of original entry, the journal, to the ledger. Entering transaction data in the journal is known as journalizing.

Identifying and Recording Transactions and Other Events

The FASB uses the phrase "transactions and other events and circumstances that affect a business enterprise" to describe the sources or causes of changes in an entity's assets, liabilities, and equity.

Financial Statement and ownership Structure

The enterprise's ownership structure dictates the types of accounts that are part of or affect the equity section. A corporation commonly uses Common Stock, Paid-in Capital in Excess of Par, Dividends, and Retained Earnings accounts. A proprietorship or a partnership uses an Owner's Capital account and an Owner's Drawings account. An Owner's Capital account indicates the owner's or owners' investment in the company. An Owner's Drawings account tracks withdrawals by the owner(s).

Identifying and Recording Transactions and Other Events

The first step in the accounting cycle is analysis of transactions and selected other events. The first problem is to determine what to record. Although GAAP provides guidelines, no simple rules exist that state which events a company should record. Although changes in a company's personnel or managerial policies may be important, the company should not record these items in the accounts. On the other hand, a company should record all cash sales or purchases—no matter how small.

Posting (Steps)

The procedure of transferring journal entries to the ledger accounts is called posting. Posting involves the following steps. 1. In the ledger, enter in the appropriate columns of the debited account(s) the date, journal page, and debit amount shown in the journal. 2. In the reference column of the journal, write the account number to which the debit amount was posted. 3. In the ledger, enter in the appropriate columns of the credited account(s) the date, journal page, and credit amount shown in the journal. 4. In the reference column of the journal, write the account number to which the credit amount was posted.

Transaction analysis

The purpose of transaction analysis is (1) to identify the type of account involved, and (2) to determine whether a debit or a credit is required. You should always perform this type of analysis before preparing a journal entry.

Adjusting Entries for Accruals

The second category of adjusting entries is accruals. Companies make adjusting entries for accruals to record unrecognized revenues earned and expenses incurred in the current accounting period. Without an accrual adjustment, the revenue account (and the related asset account) or the expense account (and the related liability account) are understated. Thus, the adjusting entry for accruals will increase both a balance sheet and an income statement account. Illustration 3.27 shows adjusting entries for accruals.

Financial Statements and Ownership Structure

The stockholders' equity section of the balance sheet reports common stock and retained earnings. The income statement reports revenues and expenses. *The statement of retained earnings reports dividends.* Because a company transfers dividends, revenues, and expenses to retained earnings at the end of the period, a change in any one of these three items affects stockholders' equity.

Debits and Credits

The terms debit (Dr.) and credit (Cr.) mean left and right, respectively. These terms do not mean increase or decrease, but instead describe where a company makes entries in the recording process. That is, when a company enters an amount on the left side of an account, it debits the account. - When it makes an entry on the right side, it credits the account. When comparing the totals of the two sides, an account shows a debit balance if the total of the debit amounts exceeds the credits. An account shows a credit balance if the credit amounts exceed the debits.

Post-closing trial balance

The trial balance after closing entries are made; consists only of asset, liability, and owners' equity accounts (the real accounts).

Adjusting Entries

The use of adjusting entries makes it possible to report on the balance sheet the appropriate assets, liabilities, and owners' equity at the statement date. Adjusting entries also make it possible to report on the income statement the proper revenues and expenses for the period. However, the trial balance—the first pulling together of the transaction data—may not contain up-to-date and complete data. This occurs for the following reasons. 1. Some events are not journalized daily because it is not expedient. Examples are the consumption of supplies and the earning of wages by employees. 2. Some costs are not journalized during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transactions. Examples of such costs are building and equipment deterioration and rent and insurance. 3. Some items may be unrecorded. An example is a utility service bill that will not be received until the next accounting period.

Transactions

Transactions are types of external events. They may be an exchange between two entities where each receives and sacrifices value, such as purchases and sales of goods or services. Or, transactions may be transfers in one direction only.

reversing entries

_______________ are most often used to reverse two types of adjusting entries: accrued revenues and accrued expenses

gross profit on sales

accounted for by merchandising companies but not service companies

Adjusted trial balance

adjusted trial balance - A trial balance prepared from a company's ledger accounts after journalizing and posting all adjusting entries. It shows the effects of all financial events that occurred during the accounting period.

worksheet

an informal device used to organize info that may be needed to compile financial statements

balance sheet

consists of "real" permanent accounts: assets, liabilities, stockholders' equity

Adjusting Entries for Deferrals

deferrals are either prepaid expenses or unearned revenues. Adjusting entries for deferrals, required at the statement date, record the portion of the deferral that represents the expense incurred or the revenue earned in the current accounting period. - If a company does not make adjustments for deferrals, the assets and liabilities are overstated, and the related expenses and revenues are understated.

General journal entry

general journal entry consists of four parts: (1) the accounts and amounts to be debited (Dr.), (2) the accounts and amounts to be credited (Cr.), (3) a date, and (4) an explanation. - A company enters debits first, followed by the credits (slightly indented). The explanation begins below the name of the last account to be credited and may take one or more lines. A company completes the "Ref." column at the time it posts the accounts.

nominal accounts

temporary accounts like revenues, expenses, dividend accounts; except for dividends, they appear on the income statement

Journalizing

the recording of transactions in a separate book before they are entered in a ledger; this book keeps a record of details of the transactions