Intermediate Financial Accounting I The Accounting Information System

Intermediate Financial Accounting I

The Accounting Information System

Accounting Cycle 2

Objectives of the Chapter

I. Learning the accounting process in preparing financial statements.

II. Introduce the accrual accounting concept and the adjusting entries.

III.Introduce the worksheet (including the trial balance, the adjustments and the adjusted trial balance, the I/S and the B/S columns), the preparation of financial statements from the worksheet and the closing entries.

Accounting Cycle 3

I. Accounting Process

1.Identification and measurement of business transactions and other events;

2.Journalization (general or special journals);

3.Post (to ledger accounts and subsidiaries);

4.Prepare worksheet (including unadjusted T/B, adjustments; adjusted T/B, I/S, B/S…);

5.Prepare financial statements;

Accounting Cycle 4

Accounting Process (contd.)

6. Prepare and post adjusting entries;

7. Prepare and post closing entries;

8. Prepare post-closing trial balance (T/B) (optional);

9. Prepare and post reversing entries.

The Accounting Cycle (Source: Kieso, et al., 14th E, Illustration 3-6)

Accounting Cycle 5

Accounting Cycle 6

1. Identifying Accounting Events

External Events: Purchase of assets, sales of goods, loss from flood, …

Internal Events: Consumption of prepaid rent, use of depreciable assets, transfer of raw material to W-I-P, …

Accounting Cycle 7

1. Identifying Accounting Events (contd.)

Events are recognized as accounting events and would be recorded if:

a. have occurred;

b. affect the financial position of the business;

c. can be measured in monetary terms (measurable);

d. relevant, reliable.

Accounting Cycle 8

Examples

1. Two months of prepaid insurance expired.2. Purchase of a machine.3. Sales of merchandise.4. Changes in managerial policies.5. Value of human resources.6. The development of a new product.7. Sign a contract to buy a building.8. Investment from owners.9. Distribution to owners.

Accounting Cycle 9

2. Journalization

Introduction of the Double-Entry System and Journal Entries:

A. Double-entry system;

B. T-account;

C. Increases and decrease in the accounts.

Accounting Cycle 10

A. Double-Entry System

Each transaction affects at least two accounts and the balance of the accounting equation must be maintained.

Example: Purchases inventory and charges to accounts payable.

Assets = Liabilities + EquityInventory Accounts Payable + +

Accounting Cycle 11

A. Double-Entry System (contd.)

Assets = Liabilities + Equity Revenues Expenses1 + -2 + +3 + +4 - -5 - -6 + +7 - -89

10

Accounting Cycle 12

B. Introduction of the T-account

Inventory

Debit Credit

Accounts Payable

Debit Credit

Accounting Cycle 13

DebitA Credit

CreditRevenue

Debit

DebitExpense

Credit

C. Increases and Decreases in the Accounts

CreditL Debit

CreditE Debit

Accounting Cycle 14

Examples of the Journal Entries:

Journal Page 1

Date Accounts andExplanation

Ref. Debit Credit

Apr. 2 Cash…………………Common stock….

Issued common stock to owners

50,00050,000

Apr. 3 Land………………...Cash……………..

Paid Cash for Land

40,00040,000

Accounting Cycle 15

Special Journals (Cash Disbursements and Receipts)

Cash Disbursements Journal

Acct Title Ref. Debit Credit9 4 246 G. Winkle 80.00 80.009 7 247 Stephens

Wholesale 163.00 163.009 16 248 Harris

Insurance 96.00Prepaid Insurance 96.00

9 22 249 City of Norwich 62.00 62.00

9 28 250 Burkett Supply 105.00 105.00

506.00 225.00 185.00 96.00

DateCheck

No.

Selling & Administra-tive Exp. Dr.

Other AccountsPayee

A/P Dr.

Cash Cr.

Accounting Cycle 16

Special Journals (Cash Disbursements and Receipts)

Cash Receipts Journal

Acct Title Ref. Debit Credit9 1 Collection from R.

Wood on Account 150.00 150.009 5 Sale of Merchandise

to Customers 250.00 250.009 12 Collection from J.

Smith on Account 75.00 75.009 19 Receipt of Dividend

from Ford Motor Co. 120.00Dividend Rev. 120.00

9 25 Sale of Merchandise to Customers 400.00 400.00

995.00 225.00 650.00 120.00

DateSales

Cr.Other Accounts

Explanation A/R Cr.Cash Dr.

Accounting Cycle 17

3. Posting(to ledger accounts and subsidiaries)

Date Item Jrnl. Ref. Debit Credit Debit CreditApr. 2 J.1 50,000 50,000

3 J.1 40,000 10,000

BalanceAccount: Cash Account No. 101

The Ledger: all individual accounts (assets, liability, and stockholder’s equity accounts) combined make up the ledger.

Another Example of Posting (Kieso, et al., 14th edition, Illustration 3-8)

Accounting Cycle 18

Accounting Cycle 19

Accounts ReceivableNo. 3

20x1Mar 31 Balance 672.00Apr 30 CR8

1,136.00Apr 30 S6 2,662.00

General Ledger (T-Account Format)

Examples of Posting using T-accounts (Kieso, et al., 14th edition, Illustrations 3-9 and 3-10)

Accounting Cycle 20

Accounting Cycle 21

Accounts ReceivableSUBSIDIARY LEDGER Ellen Odom202

20x1Mar 31 Balance 520Apr 2 S6 910

Nita Doty204

20x1Mar 31 Balance 30 Apr 18 CR8 750Apr 6 S6 750

Joe Leo206

20x1Mar 31 Balance 122 Apr 16 CR8 200Apr 4 S6 816

Rex Road208

20x1Apr 1 S6 186 Apr 7 CR8

186

Subsidiary Ledger

21

Accounting Cycle 22

Examples of Controlling Accounts

General LedgerControlling Acct. Type of Subsidiary Record

Accounts Receivable

Accounts Payable

Capital Stock

Notes Receivable

Individual customers’ ledger accounts, or a file of uncollected sales invoices.

Individual ledger accounts, or a file of unpaid purchase invoices.

A record of the stock certificates and number of shares held by each shareholder.

A file of uncollected N/R, or a “register” or book in which the notes are listed.

Accounting Cycle 23

Examples of Controlling Accounts (contd.)

General LedgerControlling Acct. Type of Subsidiary Record

Raw Material on Hand

Equipment

Land

Separate record card for each item of material used in manufacturing.

Separate record card for each item of equipment. This is often known as a plant ledger.

Separate record card for each parcel of land owned.

Accounting Cycle 24

The Flows of Accounting Data

TransactionOccurs

Source Documents Prepared

Transaction Analysis

Takes Place

Transaction Entered in Journal

Amounts Posted to Ledger

Accounting Cycle 25

XYZ Corp.Trail Balance

4/30/20x1Cash 33,300Accounts receivable 2,000Office supplies 500Land 18,000Accounts payable 100Common Stock 50,000Dividends 2,100Service revenue 8,500Rent Expense 1,100Salary Expense 1,200Utilities Expense 400 .

Total 58,600 58,600 .

25

Accounting Cycle 26

II. Accrual Accounting

The time-period concept, the revenue recognition and matching principles.

Accrual versus cash basis accounting.

Adjusting entries.

Accounting Cycle 27

The Time-Period Concept, the Revenue Recognition & Matching Principles

The time-period concept:

Income and financial position of a business are reported periodically, not until the end of life of a business.

Income Measurement And Profit Analysis 28

Revenue Recognition Principle (SFAS No. 5) (-An Accrual Basis) Revenue is recognized when it is earned and

realized or realizable (SFAC 5, par. 83). Earned : the entity has substantially accomplished

what it must do to be entitled to compensation. Realized: goods are exchanged for cash or claims. Realizable: assets received as compensation are

readily convertible into cash or claims to cash. In general, these conditions are met at time of sale (delivery) or

when services are rendered regardless whether cash is collected or not (SFAC 5, par. 84).

.

Income Measurement And Profit Analysis 29

Revenue Recognition Principle

Other conditions for revenue recognition (Staff Accounting Bulletin No. 101(1999)):

Persuasive evidence of a sale. Price is fixed or determinable. Collectibility is reasonably assured. Delivery has occurred or services

have been rendered.

Accrual Accounting and the Financial Statements 30

The Expense Recognition (Matching) Principle

If revenues are recognized in a period, all related expenses should be recognized in the same period regardless whether expenses are paid or not.

The related expenses include traceable costs (e.g. product costs), period costs, (e.g. interest and rent expenses) and estimated expenses (e.g. depreciation expense and bad debt expense).


Accrual vs. Cash Basis Accounting Accrual-basis accounting:

Revenues are recognized based on revenue recognition principle (i.e., recognized when realized and earned regardless whether cash is collected or not).

Expenses are recognized based on matching principle (i.e., recognized when incur regardless whether they are paid or not).

Note: revenue and expense recognize before cash settlement.

Accrual vs. Cash Basis Accounting (contd.) Cash-basis accounting:

The accountant does not record a transaction until cash is received or paid.

Cash-basis accounting is NOT acceptable for financial reporting.



Adjusting Entries

Due to the periodicity concept, financial reports are prepared periodically.

Based on revenue recognition principle, adjusting entries are prepared at the end of a period to recognize revenues earned during the period but not yet recorded (i.e., accrued revenues).


Adjusting Entries (contd.)

Based on the matching principle, the accrued expenses (i.e., expenses incurred but not yet paid/recorded) and estimated expenses (i.e., depreciation expense and bad debt expense) are recorded at the end of a period.

Types of Adjusting Entries (Kieso, et al. textbook, 14th edition, illustration 3-20)

Accounting Cycle 35

Accounting Cycle 36

Adjusting Entries and Reversing Entries

Types of Adjusting Entries

Can or Cannot Have Reversing Entries

1. Accruals 2. Deferrals 3. Estimated Expenses

Can B/S approach: Cannot I/S approach: Can Cannot (except for I/T Exp.)

Adjusting Entries for Accruals (Kieso, et al. 14th edition, illustration 3-27)

Accounting Cycle 37

Accounting Cycle 38

1. Accruals: Unrecorded Revenue or Expenses

a. Accrued expense: A one-year note payable was issued on 11/1/x1

to purchase an equipment. The face amount of the note is $2,400. The annual interest rate is 10% and interests are paid on 4/30/x2 and 11/1/x2.

11/1/x1Equipment 2,400

Notes Payable 2,400

Adj. Entry12/31/x1

Accounting Cycle 39

Accruals: (contd.) b. Accrued revenue:

A one year note was received from a credit sale with a face amount of $3,000 and an annual interest rate of 12% on 9/1/x1. Interests are received on 3/1/x2 and 9/1/x2.

9/1/x1N/R 3,000

Sales 3,000

Adj. Entry12/31/x1

Adjusting Entries for Deferrals (Kieso, et al. textbook, 14th edition, illustration 3-21)

Accounting Cycle 40

Accounting Cycle 41

2. Deferrals: Postponing the Recognition of Revenues or Expenses

a. Unearned revenues Receiving $2,400 for one-year

advanced rent payment from tenant on 12/1/x1

(B/S Approach) (I/S Approach)12/1/x1 Cash 2400

Unearned Rent240012/31/x1

Unearned Rent 200Rent Revenue

200

12/1/x1 Cash 2400

Rent Revenue240012/31/x1

Rent Revenue 2200Unearned Rent

2200

Accounting Cycle 42

Deferrals (contd.)

b. Prepaid expenses Prepaid 12 month insurance of $1,200

on 11/1/x1(B/S Approach) (I/S Approach)

11/1/x1 Prepaid Ins. 1200

Cash120012/31/x1

Ins. Exp. 200Prepaid Ins.

200

11/1/x1 Ins. Exp. 1200

Cash120012/31/x1

Prepaid Ins. 1000Ins. Exp. 1000

Accounting Cycle 43

3. Estimated Expenses (no reversing entry except for I/T)

Examples - Depreciation Exp.:

12/31 Depreciation Exp. XXXAccumulated Depr. XXX

Bad Debt Exp.:12/31 B/D Exp. XXX

Allowance for B/D XXX

Income Tax12/31 Income Tax Exp. XXX

Income Tax Payable XXX

Accounting Cycle 44

III. Worksheet Example

A. The adjusting entries information for the worksheet example.

B. Preparing financial statements from a worksheet.

C. Closing and reversing entries.

Accounting Cycle 45

A. Adjusting Entries Information The following items are the adjusting entries

information for the worksheet example (source: Kieso, et al. textbook):

(a) Furniture and equipment is depreciated at the rate of 10% per year based on original cost of $67,000.

Depreciation Expense --Furniture and Equipment 6,700

Accumulated Depreciation --Furniture and Equipment

6,700

Accounting Cycle 46

A. Adjusting Entries Information (contd.)

(b) Estimated bad debts, one-quarter of 1% of sales ($400,000).

Insurance Expense 360Prepaid Insurance

360

Bad Debts Expense 1,000Allowance for Doubtful Accounts

1,000(c) Insurance expired during the year, $360.

Accounting Cycle 47


(d) Interest accrued on notes receivable as of December 31, $800.

Interest Receivable 800Interest Revenue

800(e) The Rent Expense account contains

$500 rent paid in advance, which is applicable to next year.

Prepaid Rent Expense 500Rent Expense

500

Accounting Cycle 48


(f) Property taxes accrued December 31, $2,000.

Property Tax Expense 2,000 Property Tax Payable 2,000

(g) Income taxes accrued December 31, $3,440

Income tax expense 3,440 Income tax payable 3,440

Accounting Cycle 49

Uptown Cabinet Corp.(source: Kieso, et al. Illu. 3C-1)TEN-COLUMN WORK SHEET (with Periodic Inventory System)

For the Year Ended December 31, 2010

Accounts

CashN/RA/RAllow. for double Accounts

Inventory, 1/1/12

Prepaid insurance

Furniture & equip.

Accu. Depr. -- furniture & equip.

Dr. Cr. Dr. Cr. Dr. Cr. 1200 120016000 1600041000 41000

2000 (b) 1000 300036000 36000900 (c) 360540

67000 67000

12000 (a)670018700

Adjusted Trial Balance Adjustments Trial Balance

49

Accounting Cycle 50

TEN-COLUMN WORK SHEET (contd.)

Accounts

N/PA/PB/PCommon stock

R/E, 1/1/12SalesPurchasesSales Salaries exp.

Advertising exp.

Traveling exp.

Office Sal. exp.

T&T exp.

Dr. Cr. Dr. Cr. Dr. Cr.

2000020000

1350013500

3000030000

5000050000

1420014200

400000400000320000 32000020000 200002200 22008000 800019000 19000600 600

Trial Balance Adjustments Adj. T-B

50

Accounting Cycle 51


Accounts

Rent exp.Property tax exp.

Interest exp.

TotalsDep. Exp-fur. & equ.

Bad debts exp.

Insurance exp.

Int. receivable

Int. revenue

Prepaid rent exp.

Property tax pay.

Totals

Dr. Cr. Dr. Cr. Dr. Cr. 4800 (e) 50043003300 (f) 2000 5300 1700 1700541700541700

(a) 6700 6700(b) 1000 1000(c) 360 360(d) 800 800

(d) 800 800(e) 500 500

(f) 2000 2000 2000

11360 11360552200552200


51

Accounting Cycle 52


Accounts

Inv., 12/31/12

TotalsIncome bef. I/T


Income tax exp.

Income tax payable

Net income Totals

Dr. Cr. Dr. Cr. Dr. Cr.

(g) 3440(g) 3440


52

Accounting Cycle 53

Uptown Cabinet Corp.TEN-COLUMN WORK SHEET (contd.)

Accounts

CashN/RA/RAllow. for double Accounts

Inventory, 1/1/12

Prepaid insurance

Furniture & equip.

Accu. Depr. -- furniture & equip.

Dr. Cr. Dr. Cr. Dr. Cr. 1200 120016000 1600041000 41000

3000 300036000 36000540 540

67000 67000

1870018700

Adjusted Income Trial Balance Statement Balance Sheet

53

Accounting Cycle 54


Accounts

N/PA/PB/PCommon stock

R/E, 1/1/12SalesPurchasesSales Salaries exp.

Advertising exp.

Traveling exp.

Office Sal. exp.

T&T exp.

Dr. Cr. Dr. Cr. Dr. Cr

2000020000

1350013500

3000030000

5000050000

1420014200

400000 400000320000 32000020000 200002200 22008000 800019000 19000600 600

Adj. T-B I/S B/S

54

Accounting Cycle 55


Accounts

Rent exp.Property tax exp.

Interest exp.

TotalsDep. Exp-fur. & equ.

Bad debts exp.

Insurance exp.

Int. receivable

Int. revenue

Prepaid rent exp.

Property tax pay.

Totals

Dr. Cr. Dr. Cr. Dr. Cr. 4300 43005300 53001700 1700

6700 67001000 1000360 360800 800

800 800500 500

20002000552200552200

Adj. T-B I/S B/S

55

Accounting Cycle 56


Accounts

Inv., 12/31/12



Income tax exp.

Income tax payable

Net income Totals

Dr. Cr. Dr. Cr. Dr. Cr

4000040000

425160440800 15640 440800440800

156403440

3440 12200

12200 15640 15640167040

167040

Adj. T-B I/S B/S

56

Accounting Cycle 57

B. Preparing Financial Statements from a Worksheet

Net sales $400,000Cost of goods sold

Inventory, 1/1/x2 $ 36,000Purchases 320,000Cost of goods avail. for sale 356,000Subtract inv., 12/31/x2 40,000

Cost of goods sold 316,000Gross profit on sales 84,000

(Source: Illustration 3-39 of Kieso, et al. 14th edition)Uptown Cabinet Corp.INCOME STATEMENT

For the Year Ended December 31, 2012

Accounting Cycle 58

INCOME STATEMENT (contd.)Selling expenses

Sales salaries exp. 20,000Adv. exp. 2,200Traveling exp. 8,000

Total selling exp. 30,200Administrative exp.

Office Salaries exp. $19,000T&T exp. 600Rent exp. 4,300Property tax exp. 5,300Depr. exp.-fur. & equip. 6,700Bad debts exp. 1,000Insurance exp. 360

Total administrative exp. 37,260

58

Accounting Cycle 59

INCOME STATEMENT (contd.)

Total selling & admin. exp. 67,460

Income from operations16,540

Other revenues and gainsInterest revenue

800

17,340Other exp. And losses

Interest exp. 1,700

Income bef. income taxes15,640

Income taxes 3,440

Net income$12,200

Earnings per share$1.22

59

Accounting Cycle 60

(Source: Illustration 3-40 of KWW textbook, 14th edition)Uptown Cabinet Corp.

STATEMENT OF RETAINED EARNINGSFor the Year Ended December 31, 2012

B. Preparing Financial Statements from a Worksheet (contd.)

Retained earnings, Jan. 1, 2012

$14,200

Add net income for 20x12

12,200

Retained earnings, Dec. 31, 2012

$26,400 60

Accounting Cycle 61

(Source: Illustration 3-41 of KWW textbook, 14th edition)Uptown Cabinet Corp.

BALANCE SHEETAs of December 31, 2012

B. Preparing Financial Statements from a Worksheet (contd.)

AssetsCurrent assets

Cash$ 1,200

Notes receivable $16,000Accounts receivable 41,000Interest receivable 800 $57,800

Less allow. for doub. acct. 3,00054,800

Merchandise inv. on hand40,000

61

Accounting Cycle 62

BALANCE SHEET (contd.)Prepaid insurance

540Prepaid rent

500Total current assets97,040

Property, plant & equip.Furniture & equipment 67,000Less accu. Depr. 18,700

Total property, plant & equip. 48,300

Total assets$145,340

Liabilities and Stockholders’ EquityCurrent liabilities

Notes payable$ 20,000

Accounts payable13,500

Property tax payable2,000

Income taxes payable 3,440

62

Accounting Cycle 63

BALANCE SHEET (contd.)Total current liabilities38,940

Long-term liabilitiesB/P, due June 30, 20x7

30,000Total liabilities 68,940

Stockholders’ equityCommon stock, $5.00 par value, issued & outstanding, 10,000 shares $50,000Retained earnings 26,400

Total stockholders’ equity 76,400

Total liabilities & stockholders’ equity $145,340

63

Accounting Cycle 64

(Source: p. 98 of Kieso, et al., textbook, 13th edition)General Journal

December 31, 2012

C. Closing and Reversing Entries

Closing Entries

Inventory (12/31) 40,000Cost of Goods Sold 316,000

Inventory (1/1)36,000

Purchases320,000(To record ending inv. bal. & to determine CGS)

Interest Revenue 800Sales 400,000

CGS316,000

Sales Sal. Exp.20,000

Adv. Exp.2,200

64

Accounting Cycle 65

Closing Entries (contd.)Traveling Exp.

8,000Office Salaries Exp.

19,000T&T Exp.

600Rent Exp.

4,300Property Tax Exp.

5,300Depr. Exp. - Fur. & Equip.

6,700Bad Debts Exp.

1,000Insurance Exp.

360Interest Exp.

1,700Income Tax Exp.

3,440Income Summary

12,200(To close revenues and expenses to Income Summary)

Income Summary 12,200Retained Earnings

12,200(To close Income Summary to Retained Earnings)

65

Accounting Cycle 66

January 1, 2012

C. Closing and Reversing Entries

Reversing Entries (Optional)

(D)Interest Revenue 800

Interest Receivable800

(E)Rent Expense 500

Prepaid Rent Expense500

(F)Property Tax Payable 2,000

Property Tax Expense2,000

(G)Income Tax Payable 3,440

Income Tax Expense3,440

66

Accounting Cycle 67

Closing Entries for Periodic Inventory System( with Purchase Returns and Allow): An Example

Inventory & Related Accounts

Inventory Purchases Pur. R&AB.B 12,600 44,650 3,700

Freight-In Income Summary4,350 CGS

Assuming Ending Inv. = 17,200CGS= Beg. Inv + Net Purchases - Endings Inv.Net Purchases = Pur. -Pur. R&A - Pur. Dis + Freight-In

Accounting Cycle 68

IFRS Insights (Source: Kieso, etc. 14th e, p153-155) Companies around the world use the same

accounting process as shown in this chapter.

Despite some differences in standards between IFRS and GAAP, the double entry accounting system is the basis of accounting systems worldwide.

IFRS is growing in acceptance around the world. Approximately 40% of Global Fortune 500 companies use IFRS.