WEEK 2. A Review of the Accounting Cycle

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1 WEEK 2 A Review of the Accounting Cycle

2 Learning Objectives Identify and explain the basic steps in the accounting process (accounting cycle). Analyze transactions and make and post journal entries. Distinguish between accrual and cash basis accounting. Discuss the importance and expanding role of computers to the accounting process.

3 Overview of the Accounting Process Step 1 Business documents analyzed Steps in the Reporting Steps the Phase Reporting Phase Step 2 Transactions recorded in journals Step 3 Transactions posted to ledgers Step 4 Trial balance Step 5 Adjustments Recording Phase Work sheet (optional) Step 6 Financial statements Step 7 Closing entries Step 8 Post-closing trial balance (optional)

4 Double Entry Accounting The accepted system for recording accounting data. Each transaction/ business event is recorded to maintain the equality of: The basic accounting equation Assets = Liabilities Owners Equity +

5 Journalizing Transactions Transactions are events that have an economic impact on a business. Business documents are records that are evidence of transactions. A journal is an accounting record in which business transactions are entered in chronological order.

6 Journal Entry Process Every journal entry involves a 3-step process: 1. Identify the accounts involved with an event or transaction. 2. Determine whether each account increased or decreased. 3. Determine the amount by which each account was affected.

7 Debits and Credits A debit is an entry on the left side of an account. A credit is an entry on the right side. General Journal Entry Format Date Debit Entry... xx Credit Entry... Explanation xx

8 Debit & Credit Effects Assets = Liabilities + DR CR DR CR Owners Equity DR CR - + Capital Stock Retained Earnings DR CR DR DR CR DR Expenses Revenues CR Dividends CR + - DR CR

9 Types of Journals The general journal is used to record all transactions. A special journal is used to record a particular type of frequently recurring transaction. Sales, Purchases, Cash payments, Cash Receipts

10 General Journal Date Description Post Ref. Debits Credits 2005 June 15 Cash Wages Payable (Payment of wages for June.) 25 Accounts Receivable Sales Revenue (Revenue earned on account.).

11 Example: Journal Entry On January 2, sold merchandise costing OMR60 to a customer on account for OMR75. Make the journal entry.

12 Example: Journal Entry Jan. 2 Accounts Receivable Sales Revenue (Sold merchandise on account.) 2 Cost of Goods Sold Inventory (To record cost and reduce inventory.)

13 Posting to the Ledger Accounts Posting is the process of transferring amounts from the journal to the general ledger. A ledger is a collection of accounts in which data from transactions recorded in the journals are posted, classified, and summarized. A chart of accounts lists all accounts used by the company.

14 Posting to the Ledger Accounts The Accounts Receivable account in the general ledger after revenue was earned on June 25 has been posted: Account Accounts Receivable Account No: 180 Date Item PR Debit Credit Balance 2005 June 1 Balance 10, Accounts Receivable J24 7,500 3,050

15 Reporting Phase A trial balance is prepared. Adjusting entries are recorded. Financial statements are prepared. Closing entries are made. A post-closing trial balance is prepared (optional).

16 Preparing a Trial Balance Determine the account balance for each T-Account. A trial balance is a list of all accounts and their balances. It provides a means to assure that debits equal credits.

17 XYZ Company Trial Balance December 31, 2005 Debits Credits Cash 21 Accounts Receivable 15 Inventory 12 Land 200 Accounts Payable 30 Capital Stock 150 Retained Earnings 24 Sales Revenue 919 Cost of Goods Sold 850 Advertising Expense 10 Misc. Expenses 15 Total 1,123 1,123

18 Preparing Adjusting Entries Adjusting entries are required at the end of each accounting period prior to preparing the financial statements. The purpose for adjusting entries are to: bring balance sheet accounts current. reflect proper amounts of revenues, costs, and expenses on the income statement

19 Most Common Adjusting Entries Unrecorded Revenues -Revenues that have been earned but not yet recorded. Unearned Revenues -Revenues that have been recorded but not yet earned. Unrecorded Expenses -Expenses that have been incurred but not yet recorded. Prepaid Expenses -Expenses that have been recorded but not yet incurred.

20 Three Step Process for Adjusting Entries Identify the original entries that were made, if any. Original entries are only made for unearned revenues and prepaid expenses. Determine what the correct balances should be at this point in time. Make the adjustments needed to bring the balances to the desired amounts.

21 Asset Depreciation Rosi, Inc. purchased buildings in 2000 at a cost of OMR 156,000, an expected life of 20 years, and no anticipated residual value. Each year, 5% of the cost is depreciated. At the end of 2005, the following adjusting entry is made: Adjusting Entry 12/31Depreciation Expense Buildings 7,800 Accumulated Depr. Buildings 7,800 To record depreciation on building at 5% per year.

22 Bad Debts An estimation of bad debts based on the ending receivables balance reveals that the allowance account needs to be increased by OMR1,100. Adjusting Entry 12/31 Bad Debts Expense 1,100 Allowance for Bad Debts 1,100 To adjust for estimated bad debts expense.

23 Bad Debts Later, on March 19 that a OMR150 receivable is deemed to be uncollectible. Using the allowance account, the uncollectible account is written off the books. 3/19 Allowance for Bad Debts 150 Accounts Receivable 150 To write off an uncollectible account. Note that this entry is not an adjusting entry. It is made when the account is determined to be uncollectible.

24 Accrued Expenses At the end of the fiscal period, Rosi, Inc. had accrued salaries and wages totaling OMR 2,150. Adjusting Entry 12/31 Salaries and Wages Expense 2,150 Salaries and Wages Payable 2,150 To record accrued salaries and wages.

25 Accrued Revenues Rosi, Inc. holds a note receivable from a customer on which interest total OMR 250 has accrued. Adjusting Entry 12/31 Interest Receivable 250 Interest Revenue 250 To record accrued interest on a note receivable.

26 Prepaid Expenses Rosi, Inc. s trial balance shows that the asset account Prepaid Insurance has a balance of OMR 8,000. By December 31, only OMR 3,800 applies to future periods. Adjusting Entry 12/31 Insurance Expense 4,200 Prepaid Insurance 4,200 To record expired insurance. 8,000 3,800

27 Deferred Revenues Rosi, Inc. receives a payment of OMR 2,550 from a customer prior to the services being rendered. By December 31, OMR 2,075 in services have been provided. 2,550 2,075 Adjusting Entry 12/31 Rent Revenue 475 Unearned Rent Revenue 475 To record unearned rent revenue.

28 Accrual Accounting Recognizes revenues as they are earned, not necessarily when cash is received. Recognizes expenses as they are incurred, not necessarily when cash is paid. Provides a better basis for financial reports

29 Cash Basis Accounting Cash-basis accounting is focused on cash receipts and cash disbursements. Typically used by service businesses, such as CPAs, dentists, and engineers.

30 Computers and Accounting Many steps of the accounting cycle are performed using computers. Typical computerized functions include, generating reports and computational analysis. But it will never replace a good accountant

31 Summary 1. Analyze transactions and business documents. 2. Journalize transactions. 3. Post journal entries to accounts. 4. Determine account balances and prepare a trial balance. 5. Journalize and post adjusting entries. 6. Differentiate accrual accounting and cash basis accounting 7. Understand computerised accounting.

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