ACCTG472:

Introduction

This course is a continuation of Intermediate Accounting I and provides students with an in depth look at generally accepted accounting principles and procedures so that they properly account for and present information in financial statements prepared for external users. Topics covered in this course include: revenue recognition, current liabilities and contingencies, long-term liabilities, investments, leases, pensions, income taxes, shareholders’ equity, taxes, earnings per share and the statement of cash flows.

For this week’s lesson we will be reviewing the various component parts of the Accounting Cycle and the Accounting Information System. The information is this lesson was covered in detail in ACCTG 211 and ACCTG 471.

We will start off by gaining an understanding of basic accounting terminology, including an explanation of the double-entry rules of accounting. Next we will identify and discuss the steps that make up the accounting cycle. We will then cover how to record transactions in the general journal, how to post entries to the respective ledger accounts, and review the preparation of a trial balance.

Further, our lesson for this week will identify and explain the reasons for preparing adjusting entries, discuss how to prepare the various financial statements from the “adjusted” trial balance, and discuss the rationale for preparing period end closing entries.

Learning Objectives

At the end of this lesson, you will be able to do the following:

• review basic accounting terminology;
• explain the double-entry rules of accounting;
• define, interpret, and learn the basic steps in the accounting cycle;
• review and practice how to record transactions in journals, post to general ledger accounts, and prepare a trial balance;
• explain and understand the purpose and procedures for preparing adjusting journal entries;
• prepare, interpret, and analyze how to prepare financial statements from the adjusted trial balance; and
• review and understand how to prepare period-end closing entries.

Lesson Readings & Activities

By the end of this lesson, make sure you have completed the readings and activities found in the Lesson 1 Course Schedule.

Double-Entry Accounting System

The double-entry system is a universally used system in accounting to ensure that debits equal credits. For every transaction that occurs, a company must record the two-sided effect of each, identifying the appropriate general ledger accounts affected. The double-entry system also serves a check-and-balance to ensure the accuracy of the records transaction amounts. If a company records every transaction with the equal number of debits and credits as it should, then the sum of the debit entries to all of accounts must, by rule, equal the sum of all of the credit entries.

As shown on the illustrative example, there are certain specific rules that must be followed that are the foundation for the double-entry system.

• Increases in all asset and expense accounts are recorded on the left (or debit) side, and decreases in those same accounts on the right (or credit) side.
• On the other hand, increases in all liability and revenue accounts are recorded on the right (or credit) side, and decreases on the left (or debit) side.

Transactions affecting stockholders' equity will also be recorded in a similar manner.

• Increases to equity accounts, such as Common Stock and Retained earnings, are recorded on the credit side, while increases to Dividends are recorded on the debit side.

The Accounting Equation

The basic accounting is represented by:

All transactions must either directly or indirectly flow through this equation. The foundation for the double-entry system of accounting is that for every debit there must be a credit, and for every credit there must be a debit. However, it should be noted that it is possible for a transaction to only affect either the left-hand side of the equation or only the right-hand side.

The above equation can be expanded to show the accounts that flow through stockholders' equity.

Journalization Process

A company records in "accounts" all transactions that impact asset, liability, and stockholders' equity accounts. The company's general ledger contains all of the asset, liability, and stockholders' equity accounts that have a balance. Companies typically do not record transactions directly into the ledger. Instead, transactions are formally recorded in the general journal. This process is often referred to as journalizing.

Posting

Posting is the process of transferring journal entries to the individual ledger accounts. A typical ledger follows a standard format that includes

• dates
• transaction numbers and
• debit/credit amounts transferred from the general journal.

When we talk about posting, we're talking about the process of simply taking the journal entries that we just prepared and placing them into the individual ledger accounts. Each account, whether it's an asset, liability, or owner's equity account, will be kept track of in T accounts. As a reminder debits are on the left and credits are on the right. The first thing we'll list is the transaction number from the general journal in parentheses, and then the amount that was debited or credited.

If we look at the cash ledger account in our example, the first journal entry involves this account. So we will put a one in parentheses, then the debit amount of $100,000. After all the transactions are posted, then we will tabulate the amounts to get the balances of each account, which will be used for the next step in the process.

Cash 101

debit transaction number	DR	CR	credit transaction number
(1)	$100,000	$ 2,400	(2)
(7)	2,000	10,000	(3)
(9)	5,000	20,000	(5)
(10)	10,000	2,000	(8)
-	-	500	(11)
-	$82,100	-	-

Accounts Receivable 102

debit transaction number	DR	CR	credit transaction number
(6)	$10,000	$2,000	(7)
-	$8,000	-	-

Supplies 103

debit transaction number	DR	CR	credit transaction number
(4)	$4,000	-	-
-	$4,000	-	-

Prepaid Insurance 105

debit transaction number	DR	CR	credit transaction number
(2)	$2,400	-	-
-	$2,400	-	-

Truck 111

debit transaction number	DR	CR	credit transaction number
(5)	$20,000	-	-
-	$20,000	-	-

Equipment 112

debit transaction number	DR	CR	credit transaction number
(3)	$50,000	-	-
-	$50,000	-	-

Accounts Payable 201

debit transaction number	DR	CR	credit transaction number
(8)	$2,000	$4,000	(4)
-	-	$2,000	-

Notes Payable 202

debit transaction number	DR	CR	credit transaction number
-	-	$40,000	(3)
-	-	$40,000	-

Unearned Revenue 204

debit transaction number	DR	CR	credit transaction number
-	-	$10,000	(10)
-	-	$10,000	-

Common Stock 301

debit transaction number	DR	CR	credit transaction number
-	-	$100,000	(1)
-	-	$100,000	-

Revenue 331

debit transaction number	DR	CR	credit transaction number
-	-	$10,000	(6)
-	-	5,000	(9)
-	-	$15,000	-

Utilities Expense 345

debit transaction number	DR	CR	credit transaction number
(11)	$500	-	-
-	$500	-	-

Unadjusted Trial Balance Preparation

The unadjusted trial balance lists all of the general ledger accounts and the respective balances of each of the accounts, and is typically prepared at the end of each accounting period, typically monthly. The balances of each account in the general ledger are typically used as a source in preparing the trial balance.

The trial balance lists accounts in the order in which they appear in the ledger. All asset accounts are normally listed first, followed by liability, equity, dividends, revenue, and expense accounts. The primary purpose of the trial balance is to ensure the mathematical equality of debits and credits after posting has been completed. A trial balance can also help detect errors in journalizing and posting. Also, it assists in the preparation of financial statements. The trial balance does not, however, prove that a company has recorded all transactions or that the general ledger is correct.

Unadjusted Trial Balance

Unadjusted Trial Balance
Account	Debit	Credit
Cash	$82,100	-
Accounts Receivable	8,000	-
Supplies	4,000	-
Prepaid Insurance	2,400	-
Truck	20,000	-
Equipment	50,000	-
Account Payable	-	$2,000
Notes Payable	-	40,000
Unearned Revenue	-	10,000
Common Stock	-	100,000
Revenue	-	15,000
Utilities Expense	500
-	$167,000	$167,000

Adjustments

In order to ensure that a company has recorded revenues and expenses in the correct accounting period, various adjusting journal entries are required to be made at the end of the accounting period. Adjusting entries are typically recorded after the preliminary (or first) trial balance is prepared. Adjusting entries fall into two broad categories: deferrals and accruals.

Adjusting Journal Entry

Adjusting Journal Entry
Adjusting Transaction #	Date	Account	Ref.	Debit	Credit
-	Dec.	-	-	-	-
1	31	Supplies Expense	343	$800	-
-	-	Supplies	103	-	$800
		(to record supplies used)
2	31	Insurance Expense	342	400	-
-	-	Prepaid Insurance	105	-	400
		(to record insurance expired)
3	31	Unearned Revenue	204	4,000	-
-	-	Revenue	331	-	4,000
		(to record revenue earned)
4	31	Interest Expense	346	167	-
-	-	Interest Payable	205	-	167
		(to record interest accrued)
5	31	Accounts Receivable	102	1,000	-
-	-	Revenue	331	-	1,000
		(to record revenue earned)
6	31	Depreciation Expense, Equipment	347	9,600
		Accumulated Depreciation, Equipment	110		9,600
		(to record depreciation expense, equipment)
7	31	Depreciation Expense, Truck	348	5,000
		Accumulated Depreciation, Truck	111		5,000
		(to record depreciation, Truck)

 

Adjusted Trial Balance

After all adjusting entries have been journalized and posted to the appropriate ledger accounts, a company prepares another trial balance from the general ledger accounts referred to as the adjusted trial balance.

Adjusted Trial Balance

Adjusted Trial Balance
Account	Debit	Credit
Cash	$82,100	-
Accounts Receivable	9,000	-
Supplies	3,200	-
Prepaid Insurance	2,000	-
Truck, net	15,000	-
Equipment, net	40,400	-
Account Payable	-	$2,000
Interest Payable	-	167
Notes Payable	-	40,000
Unearned Revenue	-	6,000
Common Stock	-	100,000
Revenue	-	20,000
Depreciation Expense (Equipment)	9,600
Depreciation Expense (Truck)	5,000
Utilities Expense	500	-
Supplies Expense	800	-
Insurance Expense	400	-
Interest Expense	167
-	$168,167	$168,167

Statement Preparation

Financial statements are normally prepared directly from the account balance information contained in the adjusted trial balance. The statements include the following:

• Income Statement
• Statement of Retained Earnings
• Balance Sheet

Income Statement

Income Statement

Mar Electrical Service
Income Statement
For the period ended December 31, 20XX

Revenues	-	-
Revenue	-	$20,000
Expenses	-	-
Utilities Expense	$500	-
Supplies Expense	800	-
Insurance Expense	400	-
Interest Expense	167	-
Depreciation Expense, Equipment	9,600
Depreciation Expense, Truck	5,000
Total Expenses	-	16,467
Net Income	-	$3,533

 

Statement of Retained Earnings 

Statement of Retained Earnings

Mar Electrical Service
Statement of Retained Earnings
For the period ended December 31, 20XX

Retained Earnings 12/1/20XX	-	$0
Add:  Net Income	-	+$3,533
Less: Dividends	-	0
=Retained Earnings 12/31/20XX	-	$3,533

 

Balance Sheet

Balance Sheet

Mar Electrical Service
Balance Sheet 
As of December 31, 20XX

Assets	-	Liabilities	-
Cash	$82,100	Accounts Payable	$2,000
Accounts Receivable	9,000	Notes Payable	40,000
Supplies	3,200	Interest Payable	167
Prepaid Insurance	2,000	Unearned Revenue	6,000
Total Current Assets	$96,300	Total Liabilities	$48,167
Truck	15,000	Owners' Equity	-
Equipment	40,400	Common Stock	100,000
Total PP&E	$55,400	Retained Earnings	3,533
Total Assets	$151,700	Total Owners' Equity	$103,533
-	-	Total Liabilities & Owners' Equity	$151,700

Closing Process

The closing process zeros out the balances in all temporary accounts (revenue, expense, and dividend accounts), in order to prepare the recording and posting of transactions for the new accounting period. For example, Amazon.com would need to close the revenue and expenses on the income statement each year so that when a new year starts, the new revenue and the new expenses for the new year can start to be accumulated. Balances in these temporary accounts are transferred to a clearing account titled income summary. The sole purpose of this income summary account is to facilitate the closing process of the temporary accounts.

Only revenue and expense accounts are "closed out" to income summary while dividends are closed directly to retained earnings. The income summary account, as the name suggests, shows us our net income or loss and will be exactly the same as the net income/loss on the income statement, which also does not include dividends. The balance in the income summary account is also closed out directly to retained earnings.

Let's look at how to prepare closing entries.

Closing Entries

Closing Entries
Transaction Number	Date	Account	Ref.	Debit	Credit
1	20XX	Revenue	331	$20,000	-
-	Dec.31	Income Summary	350	-	$20,000

The first step in the closing process is to close all revenues. Revenues increase owner's equity, so they would have a credit balance. To get rid of them or taken down to zero then, we would debit them. So we would debit revenues and credit income summary. In our example, we only have one revenue account. So we will debit revenue $20,000 and credit income summary for $20,000 as well.

Closing Entries

Closing Entries
Transaction Number	Date	Account	Ref.	Debit	Credit
2	20XX	Income Summary	350	$16,467	-
-	Dec.31	Utilities Expense	345	-	$500
-	-	Supplies Expense	343	-	800
-	-	Insurance Expense	342	-	400
-	-	Interest Expense	346	-	166.67
		Depreciation Expense, Equipment	347		9,600
		Depreciation Expense, Truck	348		5,000

The second step in the process is to close all expenses. Expenses decrease owner's equity, so they would have a typical debit balance. So to get rid of them or take them to zero, we would credit them. So we will debit income summary, leave that blank for now, and credit all the expenses. Once we get a total of all the expenses, that's what we will debit to income summary.

So in our example, we have six expenses, utilities expense of $500, supplies expense of $800, insurance expense of $400, interest expense of $166.67, depreciation expense (equipment) for $9,600 and depreciation expense (truck) of $5,000. So if we total them then, it comes to $16,467. And that's what we will debit to income summary.

Closing Entries

Closing Entries
Transaction Number	Date	Account	Ref.	Debit	Credit
3	20XX	Income Summary	350	$3,533	-
-	Dec.31	Retained Earnings	313	-	$3,533

The third step in the process is the only step that doesn't have a specific rule. We do know that the third step will always contain income summary and retained earnings. Which one is debited and which one is credited, however, can change. In this case, we debited income summary for the expenses of $16,467 and credited it for the revenues of $20,000. So we have a credit balance of $3,533.

To get rid of that then, we would debit income summary for that amount and credit retained earnings for that same amount. Had we lost money or had more expenses and revenues, this transaction would be reversed. We would debit retained earnings and credit income summary.

Post-Closing Trial Balance

Once the closing entries have been journalized and posted, a third trial balance may be prepared. It is called the post-closing trial balance. Since all of the temporary accounts now have zero balances as a result of the closing process, only permanent accounts (asset, liability, and equity account balances other than dividends) should appear on the post-closing trial balance. The post-closing trial balance is the last step in finalizing the accounting period prior to recording business transactions in the next accounting period (often the next month).

Post-Closing Trial Balance

Post-Closing Trial Balance
Account	Debit	Credit
Cash	$82,100	-
Accounts Receivable	9,000	-
Supplies	3,200	-
Prepaid Insurance	2,000	-
Truck	15,000	-
Equipment	40,400	-
Account Payable	-	$2,000
Interest Payable	-	167
Notes Payable	-	40,000
Unearned Revenue	-	6,000
Common Stock	-	100,000
Retained Earnings		3,533
-	$151,700	$151,700

It should be noted that the post-closing trial balance provides evidence that a company has properly recorded the journal entries and posted the closing entries. However, none of the trial balances (preliminary, adjusted or post-closing) are foolproof because they do not prove that the company has recorded all transactions or that the general ledger is correct. For example, the post-closing trial balance will still be in balance if a transaction has not been recorded and posted to the ledger, or if a transaction is recorded and posted twice in error.

Terminology Self-Check

This might be a good time to review some of the terms we used in this lesson.

 

Self-Check Activity

Enter the corresponding letter for the term in the box on the right into the box next to the definition on the left. Click the Submit button to see how you did.  You can click on the Try Again button to repeat this exercise.

• A . Accrued Expenses
• B . Accrued Revenues
• C . Closing Process
• D . Double-entry System
• E . Post-closing Trial Balance
• F . Posting
• G . Prepaid Expenses
• H . Trial Balance
• I . Unearned Revenues

1. The process of transferring journal entries to the individual ledger accounts
2. Lists all of the general ledger accounts, lists the respective balances of each of the accounts, and is typically prepared at the end of each accounting period
3. Expenses paid for in cash and recorded as assets before they are used or consumed
4. Expenses that have been incurred but not paid as yet in cash or recorded in the accounting records
5. Revenues that have been earned not yet received in either cash or recorded in the accounting records
6. Revenues received in cash and recorded as liabilities before they are earned
7. Zeros out the balances in all temporary accounts (revenue, expense and dividend accounts), in order to prepare the recording and posting of transactions for the new accounting period
8. The last step to finalize the accounting period prior to recording business transactions in the next accounting period (often the next month)
9. Universally used in accounting to ensure that debits equal credits

 

Solution

The process of transferring journal entries to the individual ledger accounts

Posting

Lists all of the general ledger accounts, lists the respective balances of each of the accounts, and is typically prepared at the end of each accounting period

Trial Balance

Expenses paid for in cash and recorded as assets before they are used or consumed

Prepaid Expenses

Expenses that have been incurred but not paid as yet in cash or recorded in the accounting records

Accrued Expenses

Revenues that have been earned but not yet received in either cash or recorded in the accounting records

Accrued Revenues

Revenues received in cash and recorded as liabilities before they are earned

Unearned Revenues

Zeros out the balances in all temporary accounts (revenue, expense, and dividend accounts) in order to prepare the recording and posting of transactions for the new accounting period

Closing Process

The last step to finalize the accounting period prior to recording business transactions in the next accounting period (often the next month)

Post-closing Trial Balance

Universally used in accounting to ensure that debits equal credits

Double-entry System