2 Review of the Accounting Process PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. The Accounting Equation A = L + OE + Owner Investments 2-2 - Owner Withdrawals + Revenues + Gains - Expenses - Losses Accounting Equation for a Corporation A = L + SE + Paid-in Capital + Retained Earnings + Revenues - Expenses - Dividends + Gains - Losses 2-3 Accounting Equation, Debits and Credits, Increases and Decreases Permanent Accounts—assets, liabilities, paid-in capital, retained earnings Temporary Accounts-revenues, gains, expenses, losses 2-4 During the Accounting Period Source documents Transaction Analysis Record in Journal Post to Ledger At the End of the Accounting Period Financial Statements Adjusted Trial Balance Record & Post Adjusting Entries At the End of the Year Close Temporary Accounts 2-5 Post-Closing Trial Balance Unadjusted Trial Balance The Accounting Processing Cycle 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 Common stock 2-6 60,000 60,000 General Ledger GENERAL LEDGER Account: Acct. No. ## Balance Date Item Post. Ref. Debit Credit DR (CR) The “T” account is a shorthand format of an account used by accountants to analyze transactions. It is not part of the bookkeeping system. 2-7 Posting Journal Entries 2-8 After recording all entries for the period, Dress Right’s Unadjusted Trial Balance would be as follows: Dress Right Clothing Corporation Unadjusted Trial Balance July 31, 2011 Account Title Cash Accounts receivable Supplies Prepaid rent Inventory Furniture and fixtures Accounts payable Notes payable Unearned rent revenue Common stock Retained earnings Sales revenue Cost of goods sold Salaries expense Total 2-9 Debits $ 68,500 2,000 2,000 24,000 38,000 12,000 Credits $ 35,000 40,000 1,000 60,000 A Trial Balance is a list of all accounts and their balances at a particular date. 1,000 38,500 22,000 5,000 $ 174,500 $ 174,500 Debits = Credits 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 cash is paid or received before a related expense or revenue is recognized. Transactions where cash is paid or received after a related expense or revenue is recognized. Accountants must often make estimates in order to comply with the accrual accounting model. 2 - 10 Prepaid Expenses Expense Asset Unadjusted Balance Credit Adjustment Debit Adjustment Today, I will pay for my first 6 months’ rent. Prepaid Expenses Items paid for in advance of receiving their benefits 2 - 11 Depreciation Depreciation is the process of allocating the cost of plant and equipment over their expected useful lives. Straight-Line Depreciation 2 - 12 Asset Cost - Salvage Value = Useful Life 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. 2 - 13 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 Depreciation Expense $12,000 - $0 = = $200 per month 60 months July 31 Depreciation expense 200 Accumulated depreciationfurniture and fixtures 200 2 - 14 Depreciation After posting, the accounts look like this: Furniture and Fixtures Beg. bal. 12,000 Bal. 12,000 Depreciation Expense Beg. bal. 200 Bal. 200 Accumulated Depreciation Beg. bal. 200 200 Bal. 2 - 15 Unearned Revenues Liability Debit Adjustment Unadjusted Balance Buy your season tickets for all home basketball games NOW! “Go Big Red” 2 - 16 Revenue Credit Adjustment Unearned Revenue Cash received in advance of performing services Accrued Liabilities Expense Debit Adjustment I won’t pay you until the job is done! 2 - 17 Liability Credit Adjustment Accrued Liabilities Liabilities recorded when an expense has been incurred prior to cash payment. Accrued Receivables Asset Debit Adjustment Yes, you can pay me in May for your April 15 tax return. 2 - 18 Revenue Credit Adjustment Accrued Receivables Revenue earned in a period prior to the cash receipt. Estimates Accountants often must make estimates of future events to comply with the accrual accounting model. • Examples – Depreciation – Uncollectible accounts $ 2 - 19 Estimates Assume that Dress Right’s management determines that of the $2,000 of accounts receivable recorded at July 31, only $1,500 will ultimately be collected. Prepare the adjusting entry for July 31. July 31 Bad debt expense Allowance for uncollectible accounts 2 - 20 500 500 DRESS RIGHT CLOTHING CORPORATION Adjusted Trial Balance July 31, 2011 Account Title Debits Credits Cash $ 68,500 Accounts receivable 2,000 Allowance for uncollectible accounts $ 500 Supplies 1,200 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 Common stock 60,000 Retained earnings 1,000 Sales revenue 38,500 Rent revenue 250 Cost of goods sold 22,000 Salaries expense 10,500 Supplies expense 800 Rent expense 2,000 Depreciation expense 200 Interest expense 333 Bad debt expense 500 Totals $ 181,033 $ 181,033 2 - 21 This is the Adjusted Trial Balance for Dress Right after all adjusting entries have been recorded and posted. Dress Right will use these balances to prepare the financial statements. The Income Statement Dress Right Clothing Corporation Income Statement For Month Ended July 31, 2011 Sales revenue Cost of goods sold Gross profit Other expenses: Salaries $ Supplies Rent Depreciation Bad debt Total operating expenses Operating income Other income (expense): Rent revenue Interest expense Net income $ 38,500 22,000 16,500 10,500 800 2,000 200 500 14,000 2,500 250 (333) $ (83) 2,417 The income statement summarizes the results of profit-generating activities of the company. 2 - 22 TheDressBalance Sheet Right Clothing Corporation Balance Sheet At July 31, 2011 Assets Current assets: Cash Accounts receivable Less: Allowance for uncollectible accounts Supplies Inventory Prepaid rent Total current assets Property and equipment: Furniture and fixtures Less: Accumulated depreciation Total assets $ $ 2,000 500 68,500 1,500 1,200 38,000 22,000 131,200 12,000 200 $ 11,800 143,000 The balance sheet presents the financial position of the company on a particular date. 2 - 23 TheDressBalance Sheet Right Clothing Corporation Balance Sheet At July 31, 2011 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Salaries payable Unearned rent revenue Interest payable Note payable Total current liabilities Long-term liabilities: Note payable Shareholders' equity: Common stock Retained earnings Total shareholders' equity Total liabilities and shareholders' equity $ 35,000 5,500 750 333 10,000 51,583 30,000 $ 60,000 1,417 $ 61,417 143,000 Notice that assets of $143,000 equals total liabilities plus shareholders’ equity of $143,000. 2 - 24 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 From rent Cash outflows: For rent For supplies To suppliers for merchandise To employees Net cash used by operating activities Cash flows from Investing Activities: Purchase of furniture and fixtures Cash flows from Financing Activities: Issue of capital stock Increase in notes payable Payment of cash dividend Net cash provided by financing activities Net increase in cash $ 36,500 1,000 (24,000) (2,000) (25,000) (5,000) $ (18,500) (12,000) $ 60,000 40,000 (1,000) $ 99,000 68,500 The statement of cash flows discloses the changes in cash during a period. 2 - 25 The Statement of Shareholders’ Equity Dress Right Clothing Corporation Statement of Shareholders' Equity For the Month of July 2011 Balance at July 1, 2011 Issue of capital stock Net income for July 2011 Less: Dividends Balance at July 31, 2011 Total Common Retained Shareholders' Stock Earnings Equity $ $ $ 60,000 60,000 2,417 2,417 (1,000) (1,000) $ 60,000 $ 1,417 $ 61,417 The statement of shareholders’ equity presents the changes in permanent shareholder accounts. 2 - 26 The Closing Process Income Summary 2 - 27 Liabilities Permanent Accounts Shareholders’ Equity Temporary Accounts Assets Dividends Expenses Revenues The closing process applies only to temporary accounts. Post-Closing Trial Balance DRESS RIGHT CLOTHING CORPORATION Post-Closing Trial Balance July 31, 2011 Account Title Debits Credits Cash $ 68,500 Accounts receivable 2,000 Allowance for uncollectible accounts $ 500 Supplies 1,200 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 Common stock 60,000 Retained earnings 1,417 Totals $ 143,700 $ 143,700 2 - 28 Lists permanent accounts and their balances. Total debits equal total credits.