ILLUSTRATION 3-1 DOUBLE-ENTRY ACCOUNTING SYSTEM ASSETS Increase Decrease + DOUBLE-ENTRY ACCOUNTING REAL (PERMANENT) ACCOUNTS = LIABILITIES + Rules of Thumb + If the "normal balance" for an account is a debit, then the account is increased by a debit and decreased by a credit. If the "normal balance" for an account is a debit, credit, then the account is increased by a debit credit and decreased by a credit. Contra have normal balances that are the opposite of their "parent" accounts. + CAPITAL/OWNERS' EQUITY + RETAINED EARNINGS + NOMINAL ACCOUNTS REVENUES (and GAINS) + EXPENSES (and LOSSES) +
ILLUSTRATION 3-2 TRANSACTIONS AFFECTING THE EQUITY ACCOUNTS Ownership Structure Proprietorships and Partnerships Corporations Transactions Affecting Owners' Equity Impact on Owners' Equity Nominal (Temporary) Real (Permanent) Nominal (Temporary) Real (Permanent) Investment by Owner(s) Increase Capital Common Stock and related accounts Revenues Earned Increase Revenue Revenue Expenses Incurred Decrease Expense Capital Expense Retained Earnings Withdrawal by Owner(s) Decrease Drawing Dividends Source: Kieso and Weygandt, Intermediate Accounting, 9th Edition 11
ILLUSTRATION 3-3 THE ACCOUNTING CYCLE Identification and Measurement of Transactions and Other Events Reversing entries (optional) Post-closing trial-balance (optional) Journalization General journal Cash receipts journal Cash disbursements journal Purchases journal Sales journal Other special journals Posting General ledger (usually monthly) Subsidiary ledgers (usually daily) Closing (nominal accounts) Trial balance preparation Statement preparation Income statement Retained earnings Balance sheet Cash flows Work Sheet (optional) Adjustments Accruals Prepayments Estimated items Adjusted trial balance When the steps have been completed, the sequence starts over again in the next account period. Source: Kieso and Weygandt, Intermediate Accounting, 9th Edition 12
ILLUSTRATION 3-4 TYPES OF ADJUSTING ENTRIES Asset Expense Original Entry Prepaid Insurance xx Cash xx Adjusting Entry Insurance Expense xx Prepaid Insurance xx PREPAYMENTS BEFORE Liability Revenue Cash xx Unearned Rent Revenue xx Unearned Rent Revenue xx Rent Revenue xx Cash is Paid or Received An Expense or Revenue is Recognized Expense/Liability Adjusting Entry Salaries Expense xx Salaries Payable xx Subsequent Entry Salaries Payable xx Cash xx AFTER ACCRUALS Asset/Revenue Interest Receivable xx Interest Revenue xx Cash xx Interest Receivable xx 13
ILLUSTRATION 3-5 ADJUSTING AND CLOSING THE INVENTORY ACCOUNTS Adjusting the Permanent Inventory Account Beginning Inventory Adjust for beginning inventory by crediting Inventory and debiting Ending Inventory Adjust for ending inventory by debiting Inventory and crediting Closing the Temporary Close these accounts by debiting the account and crediting with Normal Debit Balances: Purchases Transportation-in Close these accounts by debiting the account and crediting with Normal Credit Balances: Purchase Discounts Purchase Allowances Returned Purchases (or Purchase Returns) Beginning Inventory and Temporary with Normal Debit Balances: 1. An overstatement of these items results in an overstatement of and an understatement of net income. 2. An understatement of these items results in an understatement of and an overstatement of net income. Ending Inventory and Temporary with Normal Credit Balances: 1. An overstatement of these items results in an understatement of and an overstatement of net income. 2. An understatement of these items results in an overstatement of and an understatement of net income. 14
ILLUSTRATION 3-6 REVERSING ENTRIES JOURNAL ENTRIES Accounting System Where Reversing Entries ARE Used REVERSING ENTRIES Accounting System Where Reversing Entries are NOT Used (1a) During 1999 (1a) Sales Salaries Expense. 409,600 (1a) Sales Salaries Expense 409,600 Salaries Payable 409,600 Salaries Payable.. 409,600 (1b) During 1999 (1b) Salaries Payable.. 409,600 (1b) Salaries Payable. 409,600 Cash 409,600 Cash.. 409,600 (2) 12/31/99 Adjusting (2) Sales Salaries Expense. 6,400 (2) Sales Salaries Expense 6,400 Salaries Payable 6,400 Salaries Payable.. 6,400 (3) 12/31/99 Closing (3) Income Summary 416,000 (3) Income Summary... 416,000 Sales Salaries Expense 416,000 Sales Salaries Expense.. 416,000 (4) 1/1/00 Reversing (4) Salaries Payable.. 6,400 (4) No entry. Sales Salaries Expense 6,400 (5) 1/1/00 Payroll (5) Sales Salaries Expense. 8,000 (5) Sales Salaries Expense 1,600 Cash. 8,000 Salaries Payable. 6,400 Cash 8,000 LEDGER ACCOUNT Sales Salaries Sales Salaries POSTINGS Expense Salaries Payable Expense Salaries Payable (1a) During 1999 409,600 409,600 409,600 409,600 (1b) During 1999 409,600 409,600 (2) 12/31/99 Adjusting 6,400 6,400 6,400 6,400 (3) 12/31/99 Closing 416,000 416,600 (4) 1/1/00 Reversing 6,400 (5) 1/1/00 Payroll 8,000 1,600 6,400 FINANCIAL STATEMENTS Sales Salaries Expense for the year 1999 $416,000 $416,000 Balance of Salaries Payable at close of business on 12/31/99 $6,400 $6,400 Sales Salaries Expense for the day 1/1/00 $1,600 $1,600 Balance of Salaries Payable at close of business on 1/1/00 $ 0 $ 0 15
ILLUSTRATION 3-7 CONVERSION FROM CASH BASIS TO ACCRUAL BASIS CASH BASIS ACCRUAL BASIS Receipts from ± increase/decrease in = Net Sales sales accounts receivable Receipts from ± decrease/increase in = Revenue unearned revenues related unearned revenue Payment for goods ± increase/decrease in = Net Purchases accounts payable Net Purchases ± decrease/increase in = Cost of Goods inventory Sold Payments for accrual ± increase/decrease in = Operating related expenses related payable Expense Payments for prepaid ± increase/decrease in = Operating related expenses related prepaid expense Expense 16
ILLUSTRATION 3-8 SPECIAL JOURNALS Journal Sales Transaction Recorded All merchandise sales on account Purchases All merchandise purchases on account Cash Receipts All cash receipts (including sales) Cash Payments All cash payments (including purchases) 17