Ch. 2 - Intermediate Accounting I - The Accounting Process / Journal Entries
Journal Entries: Close revenues to income summary Close expenses to income summary Close income summary to retained earnings
*Close revenues to income summary* Jul 31 Sales revenue...........x Rent revenue.............y . Income summary.......p --- *Close expenses to income summary* Jul 31 Income summary....z . COGS.............................a . Salaries Expense.......b . Supplies expense.....c . Rent expense.............d . Depreciation exp.....e . Interest expense.......f --- *Close income summary to retained earnings* Expenses: z (on the left) Revenues: p (on the right) Bottom right: p-z = Net Income, NI Jul 31 Income summary..........NI . Retained earnings.....NI After this entry is posted to the accounts, the temporary accounts have zero balances and retained earnings has increased by the amount of the net income. It is important to remember that the temporary accounts are closed only at year-end and not at the end of any interim period. Closing the temporary accounts during the year would make it difficult to prepare the annual income statement p 79-80
What is the difference between paid-in capital and common stock?
*STILL DON'T HAVE THE ANSWER TO THIS ONE BUT I'LL ASK PROFESSOR* In my financial accounting class, I learned A = L + SE = L + CS + RE In managerial, I learned A = L + SE = A + PIC + RE
During the accounting period
1. Obtain info about external transactions from *source documents* 2. *Analyze* the transaction 3. Record the transaction in a *journal* 4. *Post* from journal to *general ledger* accounts
What are the two methods of reporting comprehensive income?
1. Single statement - a single, continuous statement of comprehensive income 2. in 2 separate, but consecutive statements
At the end of the accounting period
5. Prep *unadjusted trial balance* 6. Record *adjusting entries* and post to the *GL* accounts 7. Prep *adjusted trial balance* 8. Prep *financial statements*
At year-end
9. *Close* temp accounts to *retained earnings* 10. Prep *post-closing trial balance*
Accounting Equation
A = L + SE
A = L + SE Expanded equation
A = L + SE A = L + CS + RE A = L + CS + Rev + Gains - Exp - Losses - Dividends
Income Statement
A financial statement showing the revenue and expenses for a fiscal period Textbook: summarizes the profit-generating activities of co. during a period of time. Foobar Corporation Income Statement For Month of Jul 2018 Sales revenue (COGS) =Gross Profit Operating Expenses: (Salaries) (Supplies) (Rent) (Depreciation) =Total operating expenses Operating Income Other income (expenses): Rent revenue (Interest Expense) =Net Income p 75
Balance Sheet
A financial statement that reports assets, liabilities, and owner's equity on a specific date. It's a snapshot Barfoo Co Balance Sheet At July 31, 2018 Assets Current Assets: Cash A/R Supplies Inventory Prepaid rent =Total current assets Property and equipment: Furniture and fixture Less: accum dep =Total assets Liabilities and Stockholders' Equity Current liabilities: A/P Salaries/P Deferred rent revenue Interest payable Note payable =Total CLs LT Liabilities: N/P SE: Common stock, 6000 shares issued and outstanding Retained earnings =Total SE =Total L and SE *Retained earnings = BRE + NI - Dividends
General journal
A journal with two amount columns in which all kinds of entries can be recorded DRs and CRs
General Ledger
A ledger that contains all accounts needed to prepare financial statements
Subsidiary Ledger
A ledger with detailed data that is summarized in a controlling account in the general ledger contains a group of subsidiary accounts associated with a particular general ledger control account
Alt. Method Recording Cash Dividend
A previous additional consideration indicated that an alternative method of recording a cash dividend is to debit a temporary account called dividends, rather than debiting retained earnings. If this approach is used, an additional closing entry is required to close the dividend account to retained earnings, as follows: Retained earnings .. 1,000 . Dividends ................. 1,000 As you can see, the net result of a cash dividend is the same—a reduction in retained earnings and a reduction in cash.
Closing Process
A step in the accounting cycle that occurs at the end of the period. The closing process consists of journalizing and posting the closing entries to set the balances of the revenues, expenses, Income Summary, and Dividends accounts to zero for the next period. Serves 2 purposes: 1.* temporary accounts (rev, exp, gains, losses) reduced to 0 balance*, ready to measure activity in the upcoming period 2. those *temp account balances are closed (transferred) to retained earnings* to show that changes have happened in that account during the period. Often, an immediate step is to close Revs and Expenses to income summary, and then income summary is closed to RE
Estimates
A third classification of adjusting entries. Accountants often estimate future events to comply w/ accrual accountiing. Depreciation, for example, is often an estimate. You probably don't know -exactly- how much that old truck is losing value over the years. Bad debt expense is also an estimate (See Ch 7)
Elements of a Journal
Account titles Account numbers Supporting explanations DR entries CR entries Example: Cash......................40,000 . Note payable........40,000
double-entry accounting
Accounting system in which each transaction affects at least two accounts and has at least one debit and one credit.
Accruals
Accrued revenues and accrued expenses Revenues earned or expenses incurred before cash has been exchanged
How to convert cash basis income to accrual basis income
Add increases in assets, deduct increases in liabilities Vice versa
Dividends account
An alt. method of recording a cash dividend is to DR a temp account called dividends. The dividends account is later closed (transferred) to retained earnings along with the other temporary accounts at the end of the fiscal year. The journal to record the dividend using this approach is as follows: Dividends....................1000 . Cash...................................1000
Periodic Inventory System
An inventory system in which a company does not maintain detailed records of goods on hand throughout the period and determines the cost of goods sold only at the end of an accounting period. Alt. definition: Inventory system that periodically adjusts for purchases and sales of inventory at the end of the reporting period based on a physical count of inventory on hand The periodic system is an alternative to the perpetual inventory system. It required that cost of perchandise purchased be recorded in a temp account called *purchases*. When inventory is sold, inventory account isn't decreased, and COGS isn't recorded. COGS for a period is determined and the inventory account is adjusted only at the end of a reporting period. For example, purchase of $60,000 of merchandise on account by Dress Right Clothing is recorded as follow. Purchases.......................60,000 . A/P.......................................60,000 No COGS entry is recorded when sales are made in the periodic system. At the end of Jul, EI is determined by physical count of goods on hand or estimation to be $38,000 and cost of goods sold for the month is determined as follows: BI $0 Plus: purchases 60,000 Less: EI (38,000) =COGS of $22,000 This is the entry to record COGS and adjust inventory to the actual amount on hand (in this case from 0 to $38,000) COGS.......................22,000 Inventory.................38,000 . Purchases..........................60,000 CH. 8 and 9 of textbook covers in detail
Assume that Dress Right loaned another corporation $30,000 at the beginning of August, evidenced by a note receivable. Terms of the note call for the payment of principal, $30,000, and interest at 8% in three months. An external transaction records the cash disbursement—a debit to note receivable and a credit to cash of $30,000. What adjusting entry would be required at the end of August?
August 31 Interest revenue................................200 . Interest revenue.................................200 ($30,000 x 8% x 1/12) Page 71
Retained Earnings Formula
Beginning Retained Earnings + Net Income - Dividends BRE + NI - D
*Conversion from cash basis to accrual basis*
Cash basis accounting creates net operating cash flow, which is cash receipts - cash disbursements during a reporting period from transactions related to providing goods and services to customers Accrual basis accounting recognizes accomplishments and resource sacrifices during the period. Who the heck cares when we actually get/spend cash?
current assets
Cash, converted to cash, or used up w/in 1 year or 1 operating cycle (whichever is longer)
Journal
Chronological record of all economic events affecting a firm. Each journal entry has DRs and CRs When you think about it, in publishing, *journalism* can be the act of writing for a newspaper, such as *The Chronicle.* That's where *chronological* comes
Owner's Equity
Classified as either paid-in capital or retained earnings
The adjusting entry required to record an accrued revenue is a ___, a ___, and a ____ to a ____
DR, asset, receivable, CR, revenue
DEAD CRCL
Debit Expenses Assets Dividends (Losses too!) Credit Revenues Common Stock Liabilities (Gains too!)
each event or transaction has a ____ effect on the accounting equation
Dual
Steps of the processing cycle
During the accounting period Step 1 Step 2 Step 3 Step 4 Obtain information about external transactions from source documents. Analyze the transaction. Record the transaction in a journal. Post from the journal to the general ledger accounts. At the end of the accounting period Step 5 Step 6 Step 7 Step 8 Prepare an unadjusted trial balance. Record adjusting entries and post to the general ledger accounts. Prepare an adjusted trial balance. Prepare financial statements. At the end of the year Step 9 Step 10 Close the temporary accounts to retained earnings. Prepare a post-closing trial balance. --- 1. Get all the docs. Bills? Cash register tapes? 2. Analyze the trans 3. Record trans in journal 4. Post fr/ journal to GL accounts 5. Prep unadjusted trial bal 6. Record adjusting entries, post to the ledger accounts 7. Adjusted trial balance 8. Financial statements 9. Close temp accounts to Retained Earnings (@ yr end only) 10. Prep a post-closing trial balance (at yr-end only) 11. And, holy crap, we're done! --- Recap: 1. Data, data, data 2. Analyze 3. Record in J 4. Post in GL 5. UA TB 6. Adjust, post to L 7. A TB 8. Financial statements 9. Shut the-- temp accounts to RE (y end) 10. PC TB (y end) 11. Crack open a nonalcoholic, caffeinated beverage because the new year has begun
Post Reference
E.g., 100s are assets 200 liabilities 300 shareholders' equity 400 revenues 500 expenses
Why do we adjust entries?
Even once you do all this: -analyze transactions -correct -journalize -post to appropriate ledger accounts The account balances will still need to be updated, and entry adjustments are *required* under *accrual accounting*. These entires help make sure *revenues are recognized in period goods/services are transferred to customers* regardless of when cash is received. *Expenses are incurred during a period* regardless of when cash payment is made. As a result, the income statement is a more complete image of the co's operating performacne and a better measure for predicting future operating cash flows WAdjusting entries *bring financial data up-to-date before financial statement preparation* Adjusting entries are needed for: 1. Prepayments 2. Accruals 3. Estimates
True/False: If DR = CR, then there is no chance of errors
False. You can have two errors offsetting each other, or you may have coded in the wrong account, such as cash instead of A/R.
True/False: Temporary accounts can be closed at the end of any interim period
False. Only at year-end. Otherwise, you'd make it hard to prepare an annual income statement
Statement of Cash Flows
Financial statement that reports cash receipts and disbursements related to a firm's three major activities: operations, investments, and financing. How we use and get cash
On July 16th, the jewelry store paid the Dress Shop $1000 in advance for 2 month's rent. The transaction was to DR cash and CR deferred rent revenue. At end of Jul, how much of the $1000 must be recognized for the Dress Shop (we are the dress shop)? Page 69 --- Alternative approach
From July 16th to July 31st, 1/2 of a month's rent has expired, or $250 (2 weeks) / $1000 (1 month) July 31 Deferred rent revenue................. 250 . Rent revenue........................................250 --- Alternative approach July 16 Cash.....................................................1000 . Rent revenue....................................1000 July 31 Rent revenue.................................750 . Deferred rent revenue................750 P 70
Two-Statement Method of Reporting Comprehensive Income
Income statement, immediately followed by statement of comprehensive income. The SoCI begins with net income, followed by OCI items to arrive at comprehensive income.
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. https://www.accountingtools.com/articles/what-is-a-reversing-entry.html *I DON'T UNDERSTAND THIS CONCEPT. REVIEW IT LATER* Appendix 2b, p 88
July 31 Adjusting entry; we bought $2000 worth of supplies in July, and now only $1,200 of supplies remain. What's the journal entry to recognize that we used up supplies?
Jul 31 Supplies expense..........................800 . Supplies..............................................800
6 Purchased $2,000 of supplies for cash.
Jul 6 Supplies...............2000 . Cash......................2000
July 1 Purchased furniture and fixtures from Acme Furniture for $12,000 cash.
July 1 Furnitures and fixtures........12,000 . Cash..............................................12000
July 1 Paid $24,000 in advance for one year's rent on the store building.
July 1 Prepaid rent..............24,000 . Cash.....................................24,000
July 1 Two individuals each invested $30,000 in the corporation. Each investor was issued 3,000 shares of common stock.
July 1 Cash..................................... 60,000 . Common stock.................... 60,000 This first transaction is an investment by owners that increases an asset, cash, and also increases shareholders' equity. Increases in assets are recorded as debits and increases in shareholders' equity are recorded as credits. We use the paid-in capital account called common stock because stock was issued in exchange for cash paid in.
July 1 Borrowed $40,000 from a local bank and signed two notes. The first note for $10,000 requires payment of principal and 10% interest in six months. The second note for $30,000 requires the payment of principal in two years. Interest at 10% is payable each year on July 1, 2017, and July 1, 2018.
July 1 Cash.......................40,000 . Notes payable......................40,000 This transaction causes increases in both cash and the liability, notes payable. Increases in assets are debits and increases in liabilities are credits. The notes require payment of $40,000 in principal and $6,500 ([$10,000 3 10% 3 6 ⁄12 5 $500] 1 [$30,000 3 10% 3 2 years 5 $6,000]) in interest. However, at this point we are concerned only with the external transaction that occurs when the cash is borrowed and the notes are signed. Later we discuss how the interest is recorded.
16 Subleased a portion of the building to a jewelry store. Received $1,000 in advance for the first two months' rent beginning on July 16.
July 16 Cash.............................1,000 . Deferred rent revenue (liability)....1000 We cannot recognize revenue even though cash has been received. Revenue can only be recognized once the service has been provided (Dress Right doesn't recognize the revenue until it has provided the jewelry store with the use of facilities; that is, as the rental period expires. On receipt of the cash, a liability called deferred rent revenue increases and is credited. This liability represents Dress Right's obligation to provide use of facilities to the jewelry store.
20 Paid Birdwell Wholesale Clothing $25,000 on account.
July 20 Accounts Payable...............25,000 . Cash................................................25,000
20 Paid salaries to employees for the first half of the month, $5,000.
July 20 Salaries expense..........................5,000 . Cash.......................................................5,000
25 Received $1,500 on account from St. Jude's.
July 24 Cash...........................1,500 . A/R...............................1,500
Jul 3 Purchased $60,000 of clothing inventory on account from the Birdwell Wholesale Clothing Company.
July 3 Inventory...................60,000 . A/P..............................60,000
30 The corporation paid its shareholders a cash dividend of $1,000.
July 30 Retained Earnings.....................1,000 . Cash...................................................1,000
July 31 Furniture with useful life of 5 years (60 months). One month has passed. Journal entry to record the depreciation (p 68)
July 31 Depreciation Exp ($12,000/60mo)........................200 . Accumulated depreciation-furnitures and fixtures....200
July 31 Company paid $24,000 at beginning of year for rent. At July 2016 end, 1 month of prepaid rent expired. --- Alternative approach to record prepayments: Recording external transaction directly into the expense or revenue account Dres Right paid $24,000 cash for 1 year's rent on its building. The entry included a DR to prepaid rent. Co could have debited rent expense instead.
July 31 Rent expense ($24k / 12 mo) .........................2,000 . Prepaid rent................................................................2,000 --- Alternative approach July 1 Rent expense.......................24,000 . Cash..........................................24,000 The adjusting entry records prepaid rent as of end of July ($22,000, because it's $24k/12mo = $2k rent per month) Alternative approach July 31 Prepaid rent.........................22,000 . Rent expense.........................22,000 The net effect will be same--prepaid rent has DR balance at Jul end of $22,000., and rent expense will have DR balance of $2,000 What's important is that *an adjusting entry is recorded to ensure the right amounts are reflected in both the expense and asset -before financial statements are prepared*
Assuming salaries for 2nd half of July are $5,500, what's the adjusting entry?
July 31 Salaries expense.........................5,500 . Salaries payable..........................5,500
4-31 During the month, sold merchandise costing $20,000 for $35,000 cash.
July 4-31 Cash..........................................................35,000 . Sales revenue......................................35,000 Cost of goods sold (expense)......20,000 . Inventory...............................................20,000 You need 2 entries: one to recognize cash + sales revenue One to recognize the cost of the inventory COGS
9 Sold clothing on account to St. Jude's School for Girls for $3,500. The clothing cost $2,000.
July 9 A/R...................3,500 Sales Revenue...3,500 COGS...............2,000 Inventory................2,000 COGS is an expense
Single Statement Method of Reporting Comprehensive Income
Net income is a subtotal WITHIN the statement, followed by OCI items, ending in a final total of comprehensive income
Deferrals
Prepaid expenses and unearned revenues Cash received or paid before revenues have been earned or expenses have been incurred
What is the interest if: Principal = $40,000 Time = 1 month Interest rate = 10%
Principal x Interest rate x Time = Interest $40,000 x 10% x (1/12) = $333 (rounded) July 31 Interest expense................................333 . Interest payable...................................333
Special journals
Records of transactions possessing a common characteristic, such as cash receipts, sales, purchases, cash payments. Using such journals reduces bookkeeping time. e.g. Cash receipts journal Cash disbursements journal Sales journal Purchases journal
temporary accounts
Revenue, expense, and dividend accounts whose balances a company transfers to Retained Earnings at the end of an accounting period. Temp accounts represent changes in the retained earnings component of shareholders' equity for a corporation caused by revenue, expense, gain, and loss transactions. The different types of events that affect retained earnings should be kept separate to ease the prepping of financial statements. Balances in temp accounts are periodically (usually annually) ZEROED OUT (CLOSED) and the net effect is recorded in the PERMANENT retained earnings account
Source documents
Sales invoices Bills from suppliers Cash register tapes These documents provide essential info about each transaction to an accountant
current liabilities
Satisfied w/in 1 year or 1 operating cycle (whichever is longer)
paid-in capital
The amount stockholders paid in to the corporation in exchange for shares of ownership. Investopedia.com Paid-in or Paid-up capital is essentially 2 accounts: Paid-in capital = par value of stock + excess over par Example: Calculate paid-in capital if par value of the stock = $1 and it sold for $7 and there are 500k shares owned Par value of stock $500k = $1 par value x 500k shares owned Excess over par of $3,000,000 = Say you have $1 par value but you sell 500k shares for $7. ($7 - $1) x 500k shares Paid-in capital = $500k + $3,000,000 = $3,500,000
Operating Cycle
The average time required to purchase inventory, sell it on account, and then collect cash from customers—that is, go from cash to cash. This is usually <1 year for most companies Cash --> RM --> FG --> Receivables --> Cash
Posting
Transferring data from the journal to the ledger Journal --> Ledger
True/False: Adjusting entries are required in accrual accounting
True
True/False: Adjusting entries basically convert from cash to accrual basis accounting
True
True/False: Interest rates are always stated as the annual rate
True
True/False: You don't include $'s in journal entries
True
Prepayment
When cash flow happens BEFORE expense or revenue recognition
T account
a tool for analyzing a business's financial position by showing, in a single table, debts on the L, credits on the R
Post-Closing Trial Balance
a trial balance prepared after the closing entries are posted Foobar Co Post-Closing TB Jul 31, 1213 Account Title....Dr....CR Cash A/R Supplies Prepaid Rent Inventory Furniture and fixtures Accum dep - furnit and fixt A/P N/P Deferred rent revenue Salaries payable Interest payable CS RE Totals
Comprehensive Income
an income measure that includes gains and losses that are excluded from the determination of net income
Economic Events
any event that directly affects the financial position of the company
other comprehensive income
certain gains and losses that are excluded from the calculation of net income, but included in the calculation of comprehensive income
Q: The adjusting entry required for a prepaid expense is a ___ to a ____ and a ____ to a _____
debit, expense, credit, asset
Statement of Shareholders' Equity
discloses the sources of changes in the permanent shareholders' equity accounts that occurred during the period from investments by owners, distributions to owners, net income, and OCI p 79
internal events
do not involve an exchange transaction but do affect the company's financial position
external events
exchange between the company and a separate economic entity.
prepaid expenses
expenses paid in cash before they are used or consumed These are costs of assets acquired in one period and expensed in another period. E.g., prepaid rent expense
Accrued Liabilities
expenses that have been incurred but have not been paid at the end of the accounting period
Accrued Receivables
involve situations when the revenue is earned in a period prior to the cash receipt
Special journal
record of a repetitive type of transaction, e.g., a sales journal. We focus more on *general journals* however in this class
permanent accounts
represent assets, liabilities, and shareholders' equity at a point in time (i.e., these are B.S. accounts)
retained earnings
the amount of net income retained in the corporation and NOT distributed to stockholders
Debit
the left side of an account
credit
the right side of an account
