Chapter 2 Review of the Accounting Process
Teaching Transparency Masters
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TRANSACTION ANALYSIS
Ø Each transaction is analyzed to determine its effect on the equation and on the specific financial position elements.
1. An attorney invested $50,000 to open a law office.
An investment by the owner causes both assets and owners’ equity to increase.
Assets = Liabilities + Owners’ Equity
+ $50,000 (cash) + $50,000 (investment by owner)
2. $40,000 was borrowed from a bank and a note payable was signed.
This transaction causes assets and liabilities to increase. A bank loan increases cash and creates an obligation to repay it.
Assets = Liabilities + Owners’ Equity
+ $40,000 (cash) + $40,000 (note payable)
3. Supplies costing $3,000 were purchased on account.
Buying supplies on credit also increases both assets and liabilities.
Assets = Liabilities + Owners’ Equity
+ $3,000 (supplies) + $3,000 (accounts payable)
Illustration 2-1
T2-1
TRANSACTION ANALYSIS(continued)
4. Services were performed on account for $10,000.
Transactions 4, 5, and 6 are revenue and expense transactions. Revenues and expenses (and gains and losses) are events that cause owners’ equity to change. Revenues and gains describe inflows of assets, causing owners’ equity to increase. Expenses and losses describe outflows of assets (or increases in liabilities), causing owners’ equity to decrease.
Assets = Liabilities + Owners’ Equity
+ $10,000 (receivables) + $10,000 (revenue)
5. Salaries of $5,000 were paid to employees.
Assets = Liabilities + Owners’ Equity
- $5,000 (cash) - $5,000 (expense)
6. $500 of supplies were used.
Assets = Liabilities + Owners’ Equity
- $500 (supplies) - $500 (expense)
7. $1,000 was paid on account to the supplies vendor.
This transaction causes assets and liabilities to decrease.
Assets = Liabilities + Owners’ Equity
- $1,000 (cash) - $1,000 (accounts payable)
Illustration 2-1 (continued)
T2-1 (continued)
ACCOUNTING EQUATION FOR A CORPORATION
Ø Owners' equity for a corporation, called shareholders' equity, is classified as either paid-in capital or retained earnings.
Assets = Liabilities + Shareholders’ Equityé
Common Shares / Retained Earnings
é
Revenues (+) / Expenses (-) / Dividends (-)
Gains (+) / Losses (-)
Graphic 2-1
T2-2
ACCOUNTING EQUATION
DEBITS AND CREDITS
INCREASES AND DECREASES
Assets = Liabilities + Common Shares + Retained Earnings
______
Debit Credit Debit Credit Debit Credit Debit Credit
+ - - + - + - +
é
¾¾¾¾¾¾
Revenues and Gains Exp.& Losses
Debit Credit Dr Cr.
- + + -
Graphic 2–2
T2-3
JOURNAL ENTRIES
July 1 Two individuals each invested $30,000 in the corporation. Each investor was issued 3,000 shares of common stock.
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, 2004, and July 1, 2005.
July 1 Paid $24,000 in advance for one year’s rent on the store building.
July 1 Purchased furniture and fixtures from Acme Furniture for $12,000 cash.
July 3 Purchased $60,000 of clothing inventory on account from the Birdwell Wholesale Clothing Company.
July 6 Purchased $2,000 of supplies for cash.
July 4-31 Sold merchandise costing $20,000 for $35,000 cash.
July 9 Sold clothing on account to St. Jude’s School for Girls for $3,500. The clothing cost $2,000.
July 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 20 Paid Birdwell Wholesale Clothing $25,000 on account.
July 20 Paid salaries to employees for the first half of the month, $5,000.
July 25 Received $1,500 on account from St. Jude’s.
July 30 The corporation paid its shareholders a cash dividend of $1,000.
Illustration 2-3
T2-4
GENERAL JOURNAL
GENERAL JOURNAL / PAGE 1Date / Account Title and Explanation / Post Ref. / Debit / Credit
2003
July 1 / Cash / 100 / 60,000
Common stock / 300 / 60,000
To record the issuance of common stock.
July 1 / Cash / 100 / 40,000
Notes payable / 220 / 40,000
To record the borrowing of cash and the
signing of notes payable.
July 1 / Prepaid rent / 130 / 24,000
Cash / 100 / 24,000
To record the payment of one year’s rent
in advance.
July 1 / Furniture and fixtures / 150 / 12,000
Cash / 100 / 12,000
To record the purchase of furniture and
fixtures.
July 3 / Inventory / 140 / 60,000
Accounts payable / 210 / 60,000
To record the purchase of merchandise
inventory.
July 6 / Supplies / 125 / 2,000
Cash / 100 / 2,000
To record the purchase of supplies.
July 4-31 / Cash / 100 / 35,000
Sales revenue / 400 / 35,000
To record cash sales for the month.
July 4-31 / Cost of goods sold / 500 / 20,000
Inventory / 140 / 20,000
To record the cost of cash sales.
July 9 / Accounts receivable / 110 / 3,500
Sales revenue / 400 / 3,500
To record credit sale.
July 9 / Cost of goods sold / 500 / 2,000
Inventory / 140 / 2,000
To record the cost of a credit sale.
July 16 / Cash / 100 / 1,000
Unearned rent revenue / 230 / 1,000
To record the receipt of rent in advance.
July 20 / Accounts payable / 210 / 25,000
Cash / 100 / 25,000
To record the payment of accounts payable.
July 20 / Salaries expense / 510 / 5,000
Cash / 100 / 5,000
To record the payment of salaries for the
first half of the month.
July 25 / Cash / 100 / 1,500
Accounts receivable / 110 / 1,500
To record the receipt of cash on account.
July 30 / Retained earnings / 310 / 1,000
Cash / 100 / 1,000
To record the payment of a cash dividend.
Illustration 2-4
T2-4 (continued)
GENERAL LEDGER
Cash 100 Prepaid Rent 130
GJ 1 60,000 24,000 GJ 1 GJ 1 24,000
GJ 1 40,000
Note Payable 220 Common Stock 300
40,000 GJ 1 60,000 GJ 1
T2-5
UNADJUSTED TRIAL BALANCE
dress right clothing corporationUnadjusted Trial Balance
July 31, 2003
Account Title / Debits / Credits
Cash / 68,500
Accounts receivable / 2,000
Supplies / 2,000
Prepaid rent / 24,000
Inventory / 38,000
Furniture and fixtures / 12,000
Accounts payable / 35,000
Note payable / 40,000
Unearned rent revenue / 1,000
Common stock / 60,000
Retained earnings / 1,000
Sales revenue / 38,500
Cost of goods sold / 22,000
Salaries expense / 5,000 / ____
Totals / 174,500 / 174,500
Illustration 2-6
T2-6
ADJUSTING ENTRIES
Even when all external transactions and events are analyzed, journalized, and posted correctly to the appropriate ledger accounts, some account balances will require updating.
Adjusting EntriesExpenses / Revenues
Prepayments
(initially recorded as assets or liabilities) / Debit Expense
Credit Asset / Debit Liability
Credit Revenue
Prepayments
(initially recorded as expenses or revenues) / Debit Asset
Credit Expense / Debit Revenue
Credit Liability
Accruals / Debit Expense
Credit Liability / Debit Asset
Credit Revenue
Graphic 2-3
T2-7
PREPAYMENTS
Prepayments occur when the cash flow precedes either expense or revenue recognition.
Ø prepaid expenses
Prepaid expenses represent assets recorded when a cash disbursement creates a benefit beyond the current reporting period.
To record the cost of supplies used during the month of July.
July 31
Supplies expense 800
Supplies 800
Supplies Supplies expense
2,000
800 800
______
Balance 1,200
T2-8
PREPAYMENTS(continued)
To record the cost of expired rent for the month of July.
July 31
Rent expense ($24,000 ÷ 12) 2,000
Prepaid rent 2,000
To record amortization of furniture and fixtures for the month of July.
July 31
Amortization expense 200
Accumulated amortization -
furniture and fixtures 200
Ø unearned revenues
Unearned revenues represent liabilities recorded when cash is received from customers in advance of providing a good or service.
To record the amount of unearned rent revenue earned during July.
July 31
Unearned rent revenue 250
Rent revenue 250
T2-8 (continued)
ACCRUALS
Accruals involve transactions where the cash outflow or inflow occurs in a period subsequent to expense or revenue recognition.
Ø accrued liabilities
Accrued liabilities represent liabilities recorded when an expense has been incurred prior to cash payment.
To record accrued salaries at the end of July.
July 31
Salaries expense 5,500
Salaries payable 5,500
To accrue interest expense for July on notes payable.
$40,000 x 10% x 1/12 = $333 (rounded)
July 31
Interest expense 333
Interest payable 333
T2-9
Ø accrued receivables
Accrued receivables involve situations when the revenue is earned in a period prior to the cash receipt. 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.
To accrue interest revenue earned in August on notes receivable.
August 31
Interest receivable 200
Interest revenue ($30,000 x 8% x 1/12) 200
T2-9 (continued)
ESTIMATES
Estimates often are made to comply with the accrual accounting model. One estimate that does not fit neatly into either the prepayment or accrual classification is bad debt expense.
To record bad debt expense for July.
July 31
Bad debt expense 500
Allowance for uncollectible accounts 500
T2-10
ADJUSTED TRIAL BALANCE
dress right clothing corporationAdjusted Trial Balance
July 31, 2003
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 amortization -
furniture and fixtures / 200
Accounts payable / 35,000
Notes 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
Amortization expense / 200
Interest expense / 333
Bad debt expense / 500 / _____
Totals / 181,033 / 181,033
Illustration 2-8
T2-11
THE INCOME STATEMENT
DRESS RIGHT CLOTHING CORPORATION
Income Statement
For the Month of July 2003
Sales revenue $38,500
Cost of goods sold 22,000
Gross profit 16,500
Operating expenses:
Salaries expense $10,500
Supplies expense 800
Rent expense 2,000
Amortization expense 200
Interest expense 333
Bad debt expense 500
Total operating expenses 14,000
Operating income 2,500
Other income (expense):
Rent revenue 250
Interest expense (333) (83)
Net income $2,417
Illustration 2-9
T2-12
THE BALANCE SHEET
DRESS RIGHT CLOTHING CORPORATION
Balance Sheet
At July 31, 2003
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 132,200
Property and equipment:
Furniture and fixtures 12,000
Less: Accumulated amortization (200) 11,800
Total assets $143,000
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, 6,000 shares issued and outstanding $60,000
Retained earnings 1,417 *
Total shareholders’ equity 61,417
Total liabilities and shareholders’ equity $143,000
* Beginning retained earnings + net income - dividends
0 + $2,417 - $1,000 = $2,417
Illustration 2-10
T2-13
THE STATEMENT OF CASH FLOWS
DRESS RIGHT CLOTHING CORPORATION
Statement of Cash Flows
For the Month of July 2003
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 of 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 common 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
Illustration 2-11
T2-14
THE STATEMENT OF SHAREHOLDERS' EQUITY
DRESS RIGHT CLOTHING CORPORATION
Statement of Shareholders' Equity
For the Month of July 2003
Total
Common Retained Shareholders’
Stock Earnings Equity
Balance at July 1, 2003 - 0 - - 0 - - 0 -
Issue of common stock $ 60,000 $ 60,000
Net income for July 2003 $ 2,417 2,417
Less: Dividends ______(1,000) (1,000)
Balance at July 31, 2003 $ 60,000 $ 1,417 $ 61,417
Illustration 2-12
T2-15
THE CLOSING PROCESS
To close the revenue accounts to income summary
Sales revenue 38,500
Rent revenue 250
Income summary 38,750
To close the expense accounts to income summary
Income summary 36,333
Cost of goods sold 22,000
Salaries expense 10,500
Supplies expense 800
Rent expense 2,000
Amortization expense 200
Interest expense 333
Bad debt expense 500
Income Summary
Expenses Revenues
______
Net income
To close income summary to retained earnings
Income summary 2,417
Retained earnings 2,417
After this entry is posted to the accounts, the temporary accounts have zero balances and retained earnings has increased by net income.
T2-16
POST-CLOSING TRIAL BALANCE
dress right clothing corporationPost-Closing Trial Balance
July 31, 2003
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 amortization - furniture
and fixtures / 200
Accounts payable / 35,000
Notes 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
Illustration 2-13