Assets=Liabilities + Owner s Equity. Owner s Equity= Owner s Capital (Investments) Drawings + Profit OR Loss

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1 Chapter 1~3 Important formulas Assets=Liabilities + Owner s Equity An expansion: Owner s Equity= Owner s Capital (Investments) Drawings + Profit OR Loss [Note: Owner s capital includes investments by the owner of the company. For example, when the owner is putting his personal money or equipment etc. into the business, that is considered as an Owner s investment Drawings account is used when the owner is taking out money from the business for his/her personal use.] Assets=Liabilities + Owner s Capital Drawings +Profit OR Loss Financial Statements: Prepare Income Statement and calculate for profit or loss. Prepare Statement of Owner s equity. Beginning Owner s Capital + investments + profit drawings loss = Ending Owner s Capital [Note: In the same period of time, the company can have either profit or loss. The two cannot happen at the same time.] Prepare Balance Sheet Remember that total assets have to equal total liabilities + total owner s equity We use the ending amount of owner s capital calculated from the Statement of Owner s Equity in the Balance Sheet. Cash Flow Statement may be prepared separately, but the ending balance of cash has to be the same as the cash amount in the Balance Sheet. March.30, 2012 Page 1

2 Account Classifications Assets: Cash, Accounts Receivable, Notes Receivable, Interest Receivable, Supplies, Equipment, Prepaid Insurance, Land, Building, Machinery, Furniture and fixtures Liabilities: Accounts Payable, Notes Payable, Interest Payable, Unearned Revenue Owner s Equity: Owner s name, capital [Note: Owner s capital includes profit OR loss, owner s investments and drawings. Profit OR loss= revenues expenses] Tips for Journalizing Transactions 1. When the owner invests his/her personal asset such as cash into the business, it is a credit for owner s name, capital account. 2. When the owner withdraws money from the company for his/her personal use, it is a debit for owner s name, drawings account. 3. Billed, on account or on credit means no cash transaction was made yet so either you didn t pay other people or other people didn t pay you so you ll have to use a receivable account or payable account. 4. Accounts Payable will increase when the amount you owe other people increases. Therefore, you ll have a credit for Accounts Payable. Accounts Payable will decrease when you pay back money therefore you ll incur a debit for Accounts Payable. 5. Accounts Receivable will increase when the amount other people owe you increases. Therefore, you ll have a debit for Accounts Receivable. Accounts Receivable will decrease as you collect money from those people. Thus, you ll have a credit for Accounts Receivable. 6. When question states Paid $ that means cash has been paid and therefore will result in a credit for Cash. 7. When question states Received $ that means cash was received and thus results in a debit for Cash. March.30, 2012 Page 2

3 8. Rent paid for the current month is a Rent Expense but rent paid for more than the current period is a Prepaid Rent. For example, rent payment for the entire year is a Prepaid Rent and it s an asset account because it brings us benefits for the future. [Note: the benefit is that we don t have to pay monthly rent for the entire year since we already paid for it right now.] We record Rent Expense after each month as we use it up. 9. If the question did not ask us to use Cash Basis, assume Accrual Basis of Accounting is being used. 10. Under Accrual Basis of Accounting, Revenue is recorded whenever services are performed. Thus, if question states Performed services or Provided services we need to record as revenue. Thus, it will be a credit in Sales Revenue, Revenue or Fees Earned. T accounts (Pattern Memorization Tip) Debit is always on the left side and Credit is always on the right. Recall the formula: Assets = Liabilities + Owner s Equity Notice how Assets is by itself on the left side of the equation and Liabilities and Owner s Equity are together on the right side of the equation. Furthermore, Owner s Equity can be divided up into four categories with a positive sign before Owner s Capital and Revenues and a negative sign before Drawings and Expenses. If we move Drawings and Expenses to the left side of the equation, we would have the following formula: Assets + Drawings + Expenses = Liabilities + Owner s Capital + Revenues [Note: the formula above is only used to help you to memorize the T account patterns faster. It should not be used in any other case.] Look at the equation above. The accounts on the left side have the same T account pattern and the accounts on the right side have the same T account pattern. March.30, 2012 Page 3

4 (The following space is left blank for you to make your own coloured T- accounts. ) Adjusting Entries Adjusting Entries are made at each year end to make sure expenses and revenues are recorded in the correct period. 4 types of adjusting entries -Prepaid Expense: expenses paid and were recorded as a Prepaid Expense asset account. Now some parts need to be converted into expense. Usually, it s a Debit of Expense and credit of Prepaid. For example, debit Insurance Expense and credit Prepaid Insurance - Accrued Expense: expenses incurred but not yet recorded. Usually, it s a debit of Expense and a credit of Payable. For example, debit Interest Expense and credit Interest Payable. -Unearned Revenues: Cash was received before services were provided by us. Thus, it was recorded as a liability in Unearned Revenues account. Once we have provided the service we convert it into revenue. Usually, it s a debit of Unearned Revenue and a credit of Service Revenue. -Accrued Revenues: We have already provided the service however cash is not yet received or we haven t recorded the transaction yet. Usually, it s a debit of Accounts Receivable and a credit of Service Revenue. March.30, 2012 Page 4

5 Additional Practice Question The following Balance Sheet is given. Note that ABC Corporation s year end is on June 30 th and it prepares financial statements on a yearly basis. ABC Corporation Balance Sheet Year Ended June 30, 2010 Assets Cash $22,533.2 Accounts Receivable 5,000 Interest Receivable 175 Note Receivable 10,000 Prepaid Insurance 6000 Supplies 6,700 Equipment 9,902 Less: Accumulated depreciation equipment Building 100,000 Less: Accumulated depreciation-building 10,000 90,000 Land 18,500 Total assets 167,820 Liabilities Liabilities and Owner s Equity Accounts Payable $8714 Interest Payable 160 Note Payable 15,000 March.30, 2012 Page 5

6 Unearned Service Revenue 9890 Total liabilities Owner s equity Y.Yang, Capital 134,056 Total Liabilities and owner s equity 167,820 Additional Information: 1. March 15/2010, lent $10,000 to BestWishes Organization and signed a 4 month note with a 6% interest. Interest and principal due on maturity. 2. June 30/2010, purchased one year insurance for $ Jan.1/2010, borrowed $8000 from AceExams Corporation and signed an 8 month note with 4% interest. Interest and principal due at maturity. 4. June 30/2010, borrowed $7000 from MagicPower Limited and signed a 1 year note with 2% interest. Interest and principal due on maturity. 5. June 29/2010, received $9890 from Pure Blue organization for services to be provided in the following month. 6. By the end of the fiscal year, ABC Corporation has $500 supplies left on hand. 7. Equipment and building both have 10 years of useful life with no residual value. The company is using straight line method. Transactions: 1. July 15, collected principal and interest due from BestWishes. 2. Jul. 18 provided service for $105,588 cash 3. July 20, provided services for Pure Blue organization. 4. July 30, purchased new equipment from GoldenRing Co. for $4000, paid $1000 cash and signed a $3000, 3.5% note payable due in 2 months. Interest and principal due on maturity. 5. Sept. 1, paid back AceExams interest and principal 6. Sept. 30, paid back GoldenRing Co. amount owing. 7. Oct. 2, purchased $700 of supplies on account. 8. Oct. 31 purchased 1 year $6780 insurance for equipment purchased from GoldenRing Co. 9. Nov. 1 paid for supplies purchased on Oct.2 March.30, 2012 Page 6

7 10. Dec.31 provided services of $8256 on account 11. Jan. 25 collected amount from Dec.31 transaction Instructions: 1. Journalize the transactions above 2. Record all adjusting entries necessary 3. Prepare T-accounts 4. Prepare Adjusted Trial Balance 5. Prepare Income Statement 6. Prepare Statement of Owner s Equity 7. Prepare Balance Sheet Solutions Jul. 15 Cash 10,200 Interest Receivable 175 Interest Revenue 25 Note Receivable 10,000 Jul.18 Cash Service Revenue Jul.20 Unearned Service Revenue 9890 Service Revenue 9890 Jul.30 Equipment 4000 Cash 1000 Note Payable 3000 March.30, 2012 Page 7

8 Sept.1 Note Payable 8000 Interest Payable 160 Interest Expense Cash Sept.30 Note Payable 3000 Interest Expense 17.5 Cash Oct. 2 Supplies 700 Accounts Payable 700 Oct.31 Prepaid Insurance 6780 Cash 6780 Nov. 1 Accounts Payable 700 Cash 700 Dec.31 Accounts Receivable 8256 Service Revenue 8256 Jan.25 Cash 8256 Accounts Receivable 8256 March.30, 2012 Page 8

9 Jun.30/2011 Insurance Expense Prepaid Insurance [ x(8/12)] Jun. 30/2011 Note Payable 7000 Interest Expense 140 Cash 7140 Jun.30/2011 Supplies Expense 6900 Supplies 6900 Jun.30/2011 Depreciation Expense equipment Accumulated Depreciation-equipment June.30/2011 Depreciation Expense Building 10,000 Accumulated Depreciation building 10,000 March.30, 2012 Page 9

10 T-accounts March.30, 2012 Page 10

11 ABC Corporation Adjusted Trial Balance June 30, 2011 Debit Credit Cash $ Accounts Receivable 5000 Prepaid Insurance 2260 Supplies 500 Equipment Accumulated Depreciation-equipment $ Building 100,000 Accumulated Depreciation-building 20,000 Land Accounts Payable 8714 Y.Yang, Capital Service Revenue Interest Revenue 25 Depreciation Expense-Equipment Depreciation Expense-Building 10,000 Interest Expense Supplies Expense 6900 Insurance Expense Totals $ $ March.30, 2012 Page 11

12 ABC Corporation Income Statement Year Ended June 30, 2011 Revenues Service Revenue $ Interest Revenue 25 Total revenues Expenses Interest expense Insurance expense Supplies expense 6900 Depreciation expense-equipment Depreciation expense- building Total expenses Profit $ ABC Corporation Statement of Owner s Equity Year Ended June 30, 2011 Y. Yang, capital, June 30, 2010 $ Add: Profit Y. Yang, capital, June 30, 2011 $ March.30, 2012 Page 12

13 ABC Corporation Balance Sheet June 30, 2011 Assets Cash $ Accounts Receivable 5000 Prepaid Insurance 2260 Supplies 500 Equipment $13902 Less: Accumulated Depreciation-equipment Building Less: Accumulated Depreciation-building Land Total assets $ Liabilities and Owner s Equity Liabilities Accounts Payable $8714 Owner s Equity Y. Yang, capital Total liabilities and owner s equity $ March.30, 2012 Page 13

14 Chapter 4 Completion of the Accounting Cycle Temporary Accounts and Permanent Accounts Temporary accounts include owner s drawings account and Income Statement accounts such as revenues and expenses. Balance Sheet accounts are permanent accounts. By the end of the accounting period, all the temporary accounts will be closed into the permanent account Owner s Capital. Closing Entry Steps 1. Close revenue accounts into Income Summary. When Revenue has its normal balance of credit we close it by debiting Revenue and crediting Income Summary. 2. Close expense accounts into Income Summary. When Expense has its normal balance of debit we close it by crediting Expense and debiting Income Summary. 3. Close Income Summary into Owner s Capital. -If the company has profit then its Income Summary would have a credit balance. In this case to close Income Summary we need to debit Income Summary and Credit Owner s Capital. -If the company has a loss then its Income Summary would have a debit balance. Thus, to close Income Summary we need credit Income Summary and debit Owner s Capital. 4. Close Drawings into Owner s Capital. When Drawings has its normal balance of debit we close it by crediting Drawings and debiting Owner s Capital. [Tip: Closing the account means turning the ending balance of the account into 0. Therefore, if the account has a debit balance we would credit it by the same number. For example, Service Revenue has an ending balance of $15000 credit. To close it, we debit Service Revenue by $15000 and credit Income Summary by $15000.] March.30, 2012 Page 14

15 The Difference between Trial Balance, Adjusted Trial Balance and Post- Closing Trial Balance - Trial Balance is prepared at the end of the period before adjusting entries are done. - Adjusted Trial Balance is prepared after the adjusting entries are done. - Post-Closing Trial Balance is prepared after the adjusting entries and closing entries are done. It only includes permanent accounts and their balances. Correcting Entries We need to record correcting entries only when error occurs in our previous transactions. Two Methods in correcting an error: Correct the error by first reversing the incorrect entry that was previously recorded then put in the correct entry. Directly correct the error without reversing the incorrect entry. Example 1: annual depreciation on equipment of $6000 was debited to Depreciation Expense and credited to Equipment. Method 1: Using the first method, we need to reverse the error first. Reversing the error means the account that was recorded as a debit before needs to be credited. Also, the previously recorded credit should be debited. Equipment 6000 Depreciation Expense 6000 After that, we need to put in the correct entry (what should have been recorded in the first place). Depreciation Expense 6000 Accumulated Depreciation - Equipment 6000 March.30, 2012 Page 15

16 Method 2: In this method, we correct the error without reversing the incorrect entry. Thus, we need to combine the entries from method 1 into one entry. Equipment 6000 Accumulated Depreciation Equipment 6000 [Note: In Method 1, we have debited and credited Depreciation Expense by the same amount. Therefore, it cancels each other.] Example 2: The accrual of wages of $865 was debited to Wages and credited to Cash. Method 1: Method 2: Cash 865 Wages 865 Wages Expense 865 Wages Payable 865 Cash 865 Wages Expense 865 Wages 865 Wages Payable 865 Example 3: Purchased $906 of Supplies was recorded as a debit to supplies of $609 and credit to cash of $609. Method 1: Cash 609 Supplies 609 Supplies 906 Cash 906 March.30, 2012 Page 16

17 Method 2: Supplies 297 Cash 297 In method 2 we combine the two entries from method 1 together as shown in the following T accounts. Supplies Cash Therefore, we end up with a debit of 297 for Supplies and a credit of 297 for cash. March.30, 2012 Page 17

18 Chapter 5 Accounting for Merchandising Operations Difference between the two Inventory Systems Perpetual inventory system keeps track of what happens to merchandise inventory after every purchase or sale. By the end of the period the actual number of inventory on hand should be the same as the one recorded in the company s books. If it s not the same, adjusting entries need to be made. Example: Ending inventory on books showed a balance of $6100. After a physical count, only $6000 is left on hand. Therefore, $100 of merchandise inventory is missing. To adjust for this number, we record: Cost of Goods Sold 100 Merchandise Inventory 100 Periodic inventory system do NOT keep track of what happens to merchandise inventory account after every purchase or sale. Instead, by the end of the period, the company will take a physical count and adjust for cost of goods sold. Formula: Beginning Inventory + Cost of Goods Purchased Ending Inventory = Cost of Goods Sold Shipping Payments(For Perpetual System) FOB Shipping Point Buyer pays for freight cost. When buyer pays for the shipping, it is considered as part of their inventory cost. The entry is shown as followed: Merchandise Inventory Cash FOB Destination Seller pays for freight cost. When the seller pays for the shipping cost it is not considered as part of the inventory cost but an expense for them. Freight Out Cash March.30, 2012 Page 18

19 Journal Entries (Perpetual System) If you are the Buyer Purchase merchandise on account Merchandise Inventory Accounts Payable Returned merchandise on account Accounts Payable Merchandise Inventory Paid for merchandise purchased on account within the discount period Accounts Payable Merchandise Inventory Cash [Note: If the company paid back within the discount period, the amount of discount is considered as a reduction of the cost of the merchandise that was originally purchased. For example: You purchased a pair of pants that were originally $70 and you have taken a 10% discount ($7) on it. Therefore, in total you only paid $63 so the pants are worth $63 for you, not $70. This is why we subtract the discount amount from Merchandise Inventory.] Paid for merchandise purchased on account after the discount period Accounts Payable Cash March.30, 2012 Page 19

20 If you are the Seller Sold merchandise on account Accounts Receivable Sales Cost of Goods Sold Merchandise Inventory Buyer returned merchandise to us Sales Return and Allowances Accounts Receivable If the merchandise is in good condition and can be sold to other customers then we need to record the following transaction. If not then the following transaction may be ignored. Merchandise Inventory Cost of Goods Sold Buyer paid us within the discount period Cash Sales Discounts Accounts Receivable [Note: Sales Return and Allowances and Sales Discounts are contra revenue accounts. They work in the opposite direction with Sales. Net Sales = Sales Sales Return and Allowances Sales Discounts If Sales Return and Allowances or Sales Discounts increase, Net Sales would decrease.] March.30, 2012 Page 20

21 Journal Entries (Periodic System) If you are the Buyer Purchase merchandise on account Purchases Accounts Payable Paid for freight cost on purchases Freight In Cash Returned merchandise on account Accounts Payable Purchase Returns and Allowances Paid for merchandise purchased on account within the discount period Accounts Payable Purchase Discounts Cash Paid for merchandise purchased on account after the discount period Accounts Payable Cash March.30, 2012 Page 21

22 If you are the Seller Sold merchandise on account Accounts Receivable Sales Buyer returned merchandise to us Sales Return and Allowances Accounts Receivable Buyer paid us within the discount period Cash Sales Discounts Accounts Receivable Income Statements For Single-Step Income Statement format please refer to your textbook on page 263. For Multi- Step Income Statement format under Perpetual System please refer to your textbook on page 266. For Multi-Step Income Statement format under Periodic System please refer to your textbook on page 274. March.30, 2012 Page 22

23 Chapter 6 Inventory Costing Three Inventory Cost Determination Methods Specific Identification FIFO (First-In, First-Out) Average For Specific Identification, the cost of goods sold can be tracked towards a specific inventory. This method is usually used for inventory with significant costs and which can be easily identified. FIFO and Average are used for inventories with insignificant costs and are not easily identified. FIFO (First-In, First-Out) Just as it sounds, First-In First-Out means the goods we purchased first should the ones that are sold first. Average Cost Under this method, average cost needs to be calculated after each purchase. Ratios Inventory Turnover = Days Sales in Inventory = March.30, 2012 Page 23

24 Jan.1 Purchased 200 units at $6 each FIFO & Average Cost Example Jan.15 Purchased 150 units at $7.5 each Jan. 19 Sold 300 units for $15 each Feb. 1 Purchased 100 units for $5 each FIFO Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Jan x6= Jan x7.5= Jan = Feb x5= Average Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Jan x6= Jan x7.5= = = = Jan = Feb x5= = 150 = = [Note: FIFO and Average Cost are methods used to determine costs. Therefore, for the January 19 transaction we do not use $15 in our chart. However, we will need to use $15 when calculating for Sales and Accounts Receivable.] March.30, 2012 Page 24

25 Chapter 7 Internal Control and Cash Debit Card, Credit Card Transactions Cash Debit Card Expense or Credit Card Expense Sales Petty Cash Fund Establishing the Fund Petty Cash Cash Making Payments from the Fund No accounting entry is made at this time but the payment should be documented on a pre-numbered petty cash receipt. It needs to be signed by both the custodian (the person who is responsible for the fund) and the person who receives the cash. Replenishing the Fund No cash shortage or overage Example: There was originally $100 in petty cash fund. $50 was used on Fright In, $40 was used on postage. Now there is $10 left in the petty cash fund. Merchandise Inventory 50 Postage Expense 40 Cash 90 March.30, 2012 Page 25

26 With cash shortage Example: There was originally $100 in petty cash fund. $50 was used on Fright In, $40 was used on postage. Now there is $8 left in the petty cash fund. With Cash Overage Merchandise Inventory 50 Postage Expense 40 Cash Over and Short 2 Cash 92 Example: There was originally $100 in petty cash fund. $50 was used on Fright In, $40 was used on postage. Now there is $12 left in the petty cash fund. Merchandise Inventory 50 Postage Expense 40 Cash Over and Short 2 Cash 88 [Note: Replenishing the fund does not change the balance in the fund. In the three examples above, we have used up $90 of the fund and the balance in the fund should be $100. In the first case, there is $10 left in the fund thus we just need to reimburse the $90 used. There is no shortage or overage. In the second case, there is only $8 left in the fund so we need to reimburse $92. The additional $2 is given for the shortage of cash. Notice Cash Over and Short is debited. It is reported in the Income Statement as Miscellaneous Expense. In the third case, there is $12 left in the fund so we only need to reimburse $88. We do not need to give the $2 because we had an overage of cash. Notice here the Cash Over and Short is credited. Therefore, it is reported as Miscellaneous Revenue in the Income Statement.] March.30, 2012 Page 26

27 To increase petty fund s balance Example: There was originally $100 in petty cash fund. $50 was used on Fright In, $40 was used on postage. Now there is $12 left in the petty cash fund. Company decides to increase petty cash s balance to $150. Bank Reconciliation Petty Cash 50 Merchandise Inventory 50 Postage Expense 40 Cash Over and Short 2 Cash 138 The balances on the company s books might be different from the bank. Therefore, bank reconciliation is required to make the two balances agree with each other. The difference between the balances might be caused by time lags or errors created by either party. Reconciling items per bank (adjusting bank s balance) Deposits in transit (+) Deposits in transit are recorded by the company but not yet recorded by the bank. It should be added to the balance per bank. Outstanding cheques (-) Outstanding cheques are money paid by the company but not yet cleared(recorded) by the bank. It should be deducted from the balance per bank because it is the amount of money paid by the company but not yet deducted on the bank s balance. Bank errors Adjust for any errors that the bank had made from balance per bank. Reconciling items per book (adjusting company s balance) March.30, 2012 Page 27

28 Credit memo and other deposits (+) Credit memos on the bank may include money that customers paid online from their bank to the company. This amount may be recorded in the bank but not yet recorded by the company. Therefore, this amount should be added to the balance per books. Debit memo and other payments (-) Debit memos might include money that bank already deducted from the company s balance but not yet recorded by the company such as bank service charges of the company. This amount should be deducted from the balance per books. Company errors Adjust for any errors that the company had made from balance per book. March.30, 2012 Page 28

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