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Accounting cycle

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Standard set of accounting procedures to record transactions and prepare financial statements.

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Accounting information system

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A system that collects and processes transaction data and then disseminates the financial information to interested parties. Accounting information systems vary widely from one business to another, depending on the nature of the business and its transactions, the size of the company, the volume of data to be handled, and the informational demands.

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Account

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A systematic arrangement that shows the effect of transactions and other events on a specific element (asset, liability, and soon). Companies keep a separate account for each asset, liability, revenue, and expense, and for capital (stockholders' equity).

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Accrued expenses

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Expenses incurred but not yet paid or recorded at the statement date. Examples are interest, rent, taxes, and salaries. An accrued expense on the books of one company is often an accrued revenue to another company.

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Accrued revenues

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Revenues earned but not yet received in cash or recorded at the statement date. Accrued revenues result from the passing of time (e.g., interest revenue and rent revenue) or from unbilled or uncollected services that a company performed (e.g., commissions and fees).

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Adjusted trial balance

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A trial balance prepared from a company's ledger accounts after journalizing and posting all adjusting entries. It shows the effects of all financial events that occurred during the accounting period.

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Adjusting entry

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Adjustments made at the end of the accounting period to ensure that a company has recorded revenues in the period in which it earns them and recognized expenses in the period in which it incurs them—in other words, that it has followed the revenue recognition and expense recognition principles. Companies often prepare adjustments after the balance sheet date but date the entries as of the balance sheet date.

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Balance sheet

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Financial statement that shows the financial condition of a company at the end of a period by reporting its assets, liabilities, and owners' equity.

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Book value

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The difference between a depreciable asset's cost and its related accumulated depreciation. Book value of an asset generally differs from its market value because depreciation is a means of cost allocation, not of valuation.

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Closing entries

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Journal entries made at the end of a company's annual accounting period to transfer the balances of temporary accounts to a permanent owners' equity account (retained earnings or a capital account, depending on the company's form of organization).

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Closing process

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Accounting process at the end of the accounting period that reduces the balance of nominal (temporary) accounts to zero in order to prepare the accounts for the next period's transactions. In the closing process, the company transfers revenue and expense account balances to Income Summary, which matches expenses and revenues.

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Contra asset account

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An account that offsets an asset account on the balance sheet. An example is the accumulated depreciation account, which companies use in order to disclose both the original cost of an asset and the total expired cost to date.

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Credit

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The right side of an account. Commonly abbreviated as Cr.

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Debit

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The left side of an account. Commonly abbreviated as Dr.

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Depreciation

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The process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner.

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Double-entry accounting

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The universally used accounting system in which a company records the dual (two-sided) effect of each transaction in appropriate accounts. If a company records every transaction with equal debits and credits, then the sum of all the debits to the accounts must equal the sum of all the credits.

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General journal

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A complete record of a company's transactions or other financial events, listed chronologically and expressed in terms of debits and credits made to accounts.

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General ledger

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A list of all of a company's asset, liability, stockholders' equity, revenue, and expense accounts.

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Income statement

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Financial statement that measures the results of operations during a particular period and presents those results in terms of net income or net loss.

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Journalizing

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The process of entering transaction data in the journal.

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Nominal accounts

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Revenue, expense, and dividend accounts; except for dividends, these accounts appear on the income statement. Companies close nominal accounts, also called temporary accounts, at the end of the accounting period.

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Post-closing trial balance

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The trial balance after closing entries are made; consists only of asset, liability, and owners' equity accounts (the real accounts).

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Posting

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The process of transferring the essential facts and figures from the book of original entry (the journal) to the ledger accounts, using debits and credits made to accounts.

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Prepaid expenses

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Assets paid for and recorded before a company uses them. Prepaid expenses expire either with the passage of time (e.g., rent and insurance) or through use and consumption (e.g., supplies). Companies typically recognize prepaid expenses by making adjusting entries to record the expenses that apply to the current accounting period and to show the unexpired costs in the asset accounts.

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Real accounts

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Asset, liability, and equity accounts; these accounts appear on the balance sheet. Companies do not close real accounts, also called permanent accounts.

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Reversing entries

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Journal entries, made at the beginning of the next accounting period, that are the exact opposite of the adjusting entries made in the previous period. Making reversing entries is an optional step in the accounting cycle.

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Special journals

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Records of transactions possessing a common characteristic, such as cash receipts, sales, purchases, cash payments. Using such journals reduces bookkeeping time.

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Statement of cash flows

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Financial statement that reports the cash provided and used by operating, investing, and financing activities during the period.

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Statement of retained earnings

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Financial statement that reconciles the balance of the retained earnings account from the beginning to the end of the period.

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Subsidiary ledger

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A list that contains the details related to a given general ledger account.

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T-account

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Basic account form, shaped like the letter T, that shows the effect of transactions on particular asset, liability, stockholders' equity, revenue, and expense accounts.

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Trial balance

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The list of all open accounts, in the sequence in which they appear in the ledger, and their balances. Companies may prepare a trial balance at any time, though they usually do so at the end of an accounting period. The trial balance proves the mathematical equality of debits and credits after posting and also uncovers errors in journalizing and posting.

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Unearned revenues

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Revenues received in cash and recorded as liabilities before a company earns them. Examples are rent, magazine subscriptions, and customer deposits for future service. Unearned revenues are the opposite of prepaid expenses.

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Understanding the following eleven terms helps in understanding what key Accounting concepts?

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(1) Event. (2) Transaction. (3) Account. (4) Real and nominal accounts. (5) Ledger. (6) Journal. (7) Posting. (8) Trial balance. (9) Adjusting entries. (10) Financial statements. (11) Closing entries

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Explain Double-entry Rules.

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The left side of any account is the debit side; the right side is the credit side. All asset and expense accounts are increased on the left or debit side and decreased on the right or credit side. Conversely, all liability and revenue accounts are increased on the right or credit side and decreased on the left or debit side. Stockholders' equity accounts, Common Stock and Retained Earnings, are increased on the credit side. Dividends is increased on the debit side.

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Identify Steps in the Accounting Cycle. The basic steps in the accounting cycle are?

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The basic steps in the accounting cycle are (1) identifying and measuring transactions and other events; (2) journalizing; (3) posting; (4) preparing an unadjusted trial balance; (5) making adjusting entries; (6) preparing an adjusted trial balance; (7) preparing financial statements; and (8) closing.

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Record Transactions in Journals, Post to Ledger Accounts, and Prepare a Trial Balance.

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The simplest journal form chronologically lists transactions and events expressed in terms of debits and credits to particular accounts. The items entered in a general journal must be transferred (posted) to the general ledger. Companies should prepare an unadjusted trial balance at the end of a given period after they have recorded the entries in the journal and posted them to the ledger.

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Explain the Reasons for Preparing Adjusting Entries.

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Adjustments achieve a proper recognition of revenues and expenses, so as to determine net income for the current period and to achieve: an accurate statement of end-of-the-period balances in assets, liabilities, and owners' equity accounts.

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Prepare Financial Statements From the Adjusted Trial Balance.

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Companies can prepare financial statements directly from the adjusted trial balance. The income statement is prepared from the revenue and expense accounts. The statement of retained earnings is prepared from the retained earnings account, dividends, and net income (or net loss). The balance sheet is prepared from the asset, liability, and equity accounts.

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Prepare Closing Entries.

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In the closing process, the company transfers all of the revenue and expense account balances (income statement items) to a clearing account called Income Summary, which is used only at the end of the fiscal year. Revenues and expenses are matched in the Income Summary account. The net result of this matching represents the net income or net loss for the period. That amount is then transferred to an owners' equity account (Retained Earnings for a corporation and capital accounts for proprietorships and partnerships).

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Event.

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A happening of consequence. An event generally is the source or cause of changes in assets, liabilities, and equity. Events may be external or internal.

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Transaction.

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An external event involving a transfer or exchange between two or more entities.

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Account.

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A systematic arrangement that shows the effect of transactions and other events on a specific element (asset, liability, and so on). Companies keep a separate account for each asset, liability, revenue, and expense, and for capital (owners' equity). Because the format of an account often resembles the letter T, it is sometimes referred to as a T-account. (See Illustration 3.3, .)

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Real and Nominal Accounts.

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Real (permanent) accounts are asset, liability, and equity accounts; they appear on the balance sheet. Nominal (temporary) accounts are revenue, expense, and dividend accounts; except for dividends, they appear on the income statement. Companies periodically close nominal accounts; they do not close real accounts.

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Ledger.

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The book (or computer printouts) containing the accounts. A general ledger is a collection of all the asset, liability, owners' equity, revenue, and expense accounts. A subsidiary ledger contains the details related to a given general ledger account.

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Journal.

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The "book of original entry" where the company initially records transactions and selected other events. Various amounts are transferred from the book of original entry, the journal, to the ledger. Entering transaction data in the journal is known as journalizing.

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Posting.

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The process of transferring the essential facts and figures from the book of original entry to the ledger accounts.

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Trial Balance.

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The list of all open accounts in the ledger and their balances. The trial balance taken immediately after all adjustments have been posted is called an adjusted trial balance. A trial balance taken immediately after closing entries have been posted is called a post-closing (or after-closing) trial balance. Companies may prepare a trial balance at any time.

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Adjusting Entries.

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Entries made at the end of an accounting period to bring all accounts up to date on an accrual basis, so that the company can prepare correct financial statements.

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Financial Statements.

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Statements that reflect the collection, tabulation, and final summarization of the accounting data. Four statements are involved: (1) The balance sheet shows the financial condition of the enterprise at the end of a period. (2) The income statement measures the results of operations during the period. (3) The statement of cash flows reports the cash provided and used by operating, investing, and financing activities during the period. (4) The statement of retained earnings reconciles the balance of the retained earnings account from the beginning to the end of the period.

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Closing Entries.

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The formal process by which the enterprise reduces all nominal accounts to zero and determines and transfers the net income or net loss to an owners' equity account. Also known as "closing the ledger," "closing the books," or merely "closing."

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Most companies use accrual-basis accounting:

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They recognize revenue when it is earned and expenses in the period incurred, without regard to the time of receipt or payment of cash.

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Some small enterprises and the average individual taxpayer, however, use a strict or modified cash-basis approach. Under the strict cash basis

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companies record revenue only when they receive cash, and they record expenses only when they disperse cash. Determining income on the cash basis rests upon collecting revenue and paying expenses. The cash basis ignores two principles: the revenue recognition principle and the expense recognition principle. Consequently, cash-basis financial statements are not in conformity with GAAP.

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The modified cash basis

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is a mixture of the cash basis and the accrual basis. It is based on the strict cash basis but with modifications that have substantial support, such as capitalizing and depreciating plant assets or recording inventory. This method is often followed by professional services firms (doctors, lawyers, accountants, and consultants) and by retail, real estate, and agricultural operations.

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Service Revenue Computation:To convert the amount of cash received from patients to service revenue on an accrual basis?

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we must consider changes in accounts receivable and unearned service revenue during the year. Accounts receivable at the beginning of the year represents revenues earned last year that are collected this year. Ending accounts receivable indicates revenues earned this year that are not yet collected. Therefore, to compute revenue on an accrual basis, we subtract beginning accounts receivable and add ending accounts receivable, as the formula in Illustration 3A-6 shows.

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Service Revenue Computation: Similarly, beginning unearned service revenue represents?

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cash received last year for revenues earned this year. Ending unearned service revenue results from collections this year that will be recognized as revenue next year. Therefore, to compute revenue on an accrual basis, we add beginning unearned service revenue and subtract ending unearned service revenue, as the formula in Illustration 3A-7 shows.

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Convert cash collected from customers to service revenue on an accrual basis, we would make the computations shown in

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Illustration 3A-8.

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Operating Expense Computation: To convert cash paid for operating expenses during the year to operating expenses on an accrual basis?

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we must consider changes in prepaid expenses and accrued liabilities. First, we need to recognize as this year's expenses the amount of beginning prepaid expenses. (The cash payment for these occurred last year.) Therefore, to arrive at operating expense on an accrual basis, we add the beginning prepaid expenses balance to cash paid for operating expenses.

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Operating Expense Computation: Conversely, ending prepaid expenses result from cash payments made this year for expenses to be reported next year?

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ending prepaid expenses result from cash payments made this year for expenses to be reported next year (Under the accrual basis, Dr. Windsor would have deferred recognizing these payments as expenses until a future period.) To convert these cash payments to operating expenses on an accrual basis, we deduct ending prepaid expenses from cash paid for expenses, as the formula in Illustration 3A-9 shows.

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Operating Expense Computation: Similarly, beginning accrued liabilities result from expenses recognized last year that require cash payments this year.

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Ending accrued liabilities relate to expenses recognized this year that have not been paid. To arrive at expenses on an accrual basis, we deduct beginning accrued liabilities and add ending accrued liabilities to cash paid for expenses, as the formula in Illustration 3A-10 shows.

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Operating Expense Computation: to convert cash paid for operating expenses to operating expenses on an accrual basis, we would make the computations shown in Illustration 3A-11.

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...

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Operating Expense Computation: adjust collections and disbursements on a cash basis to revenue and expense on an accrual basis, to arrive at

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accrual net income. In any conversion from the cash basis to the accrual basis, depreciation or amortization is an additional expense in arriving at net income on an accrual basis.

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Theoretical Weaknesses of the Cash Basis

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The cash basis reports exactly when cash is received and when cash is disbursed. Today's economy is considerably more lubricated by credit than by cash. The accrual basis, not the cash basis, recognizes all aspects of the credit phenomenon. Investors, creditors, and other decision-makers seek timely information about an enterprise's future cash flows. Accrual-basis accounting provides this information by reporting the cash inflows and outflows associated with earnings activities as soon as these companies can estimate these cash flows with an acceptable degree of certainty. Receivables and payables are forecasters of future cash inflows and outflows. In other words, accrual-basis accounting aids in predicting future cash flows by reporting transactions and other events with cash consequences at the time the transactions and events occur, rather than when the cash is received and paid.

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Theoretical Weaknesses of the Cash Basis

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Today's economy is considerably more lubricated by credit than by cash. The accrual basis, not the cash basis, recognizes all aspects of the credit phenomenon. Investors, creditors, and other decision makers seek timely information about an enterprise's future cash flows.

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The FASB uses the phrase "transactions and other events and circumstances that affect a business enterprise" to....

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describe the sources or causes of changes in an entity's assets, liabilities, and equity. Events are of two types: (1) External events involve interaction between an entity and its environment, such as a transaction with another entity, a change in the price of a good or service that an entity buys or sells, a flood or earthquake, or an improvement in technology by a competitor. (2) Internal events occur within an entity, such as using buildings and machinery in operations, or transferring or consuming raw materials in production processes.

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Transactions are types of ....

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types of external events. They may be an exchange between two entities where each receives and sacrifices value, such as purchases and sales of goods or services. Or, transactions may be transfers in one direction only. For example, an entity may incur a liability without directly receiving value in exchange, such as charitable contributions. Other examples include investments by owners, distributions to owners, payment of taxes, gifts, casualty losses, and thefts.

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Most companies use accrual-basis accounting

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Most companies use accrual-basis accounting recognize revenue when it is earned and expenses in the period incurred, Under the strict cash-basis, companies without regard to the time of receipt or payment of cash.

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Under the strict cash-basis, companies

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strict cash-basis, companies record revenue only when they receive cash, and record expenses only when they disperse cash.

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An enterprise records as many events as possible ....

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An enterprise records as many events as possible that affect its financial position. As discussed earlier in the case of human resources, it omits some events because of tradition and others because of complicated measurement problems. Recently, however, the accounting profession shows more receptiveness to accepting the challenge of measuring and reporting events previously viewed as too complex and immeasurable.

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The procedures for preparing a trial balance?

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The procedures for preparing a trial balance consist of: 1. Listing the account titles and their balances. 2. Totaling the debit and credit columns. 3. Proving the equality of the two columns.

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The trial balance proves?

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The trial balance proves the mathematical equality of debits and credits after posting. Under the double-entry system, this equality occurs when the sum of the debit account balances equals the sum of the credit account balances. A trial balance also uncovers errors in journalizing and posting. In addition, it is useful in the preparation of financial statements.

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A trial balance does not prove that a company _____ all transactions or that____ is ______.

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A trial balance does not prove that a company recorded all transactions or that the ledger is correct. Numerous errors may exist even though the trial balance columns agree. For example, the trial balance may balance even when a company (1) fails to journalize a transaction, (2) omits posting a correct journal entry, (3) posts a journal entry twice, (4) uses incorrect accounts in journalizing or posting, or (5) makes offsetting errors in recording the amount of a transaction. In other words, as long as a company posts equal debits and credits, even to the wrong account or in the wrong amount, the total debits will equal the total credits.

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Posting a Journal Entry: The numbers in the "Ref." column of the general journal refer to....

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Posting a Journal Entry The numbers in the "Ref." column of the general journal refer to the ledger accounts to which a company posts the respective items. For example, the "101" placed in the column to the right of "Cash" indicates that the company posted this $15,000 item to Account No. 101 in the ledger.

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Posting a Journal Entry: The posting of the general journal is completed when a company records?

answer

The posting of the general journal is completed when a company records all of the posting reference numbers opposite the account titles in the journal. Thus, the number in the posting reference column serves two purposes: (1) It indicates the ledger account number of the account involved. (2) It indicates the completion of posting for the particular item. Each company selects its own numbering system for its ledger accounts. Many begin numbering with asset accounts and then follow with liabilities, owners' equity, revenue, and expense accounts, in that order.

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Posting a Journal Entry: The ledger accounts show the accounts?

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The ledger accounts in Illustration 3.8 show the accounts after completion of the posting process. The reference J1 (General Journal, ) indicates the source of the data transferred to the ledger account.

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In some cases, a company uses special journals in addition to the general journal. Special journals?

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In some cases, a company uses special journals in addition to the general journal. Special journals summarize transactions possessing a common characteristic (e.g., cash receipts, sales, purchases, cash payments). As a result, using them reduces bookkeeping time.

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Each general journal entry consists of four parts?

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Each general journal entry consists of four parts: (1) the accounts and amounts to be debited (Dr.), (2) the accounts and amounts to be credited (Cr.), (3) a date, and (4) an explanation. A company enters debits first, followed by the credits (slightly indented). The explanation begins below the name of the last account to be credited and may take one or more lines. A company completes the "Ref." column at the time it posts the accounts.

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Companies do not record transactions and selected other events originally in the ledger. A transaction affect?

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Companies do not record transactions and selected other events originally in the ledger. A transaction affects two or more accounts, each of which is on a different page in the ledger. Therefore, in order to have a complete record of each transaction or other event in one place, a company uses a journal (also called "the book of original entry"). In its simplest form, a general journal chronologically lists transactions and other events, expressed in terms of debits and credits to accounts.

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In its simplest form, a general journal chronologically lists?

answer

In its simplest form, a general journal chronologically lists transactions and other events, expressed in terms of debits and credits to accounts.

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Image: Accounting Cycle

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3.6

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Image: Accrual Adjustment for Recievable and Revenue Accounts

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3.28

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Image: Adjusted Trial Balance worksheet

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3.33

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Image: Adjusting entry deferrals

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3.21

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Image: Adjustment entries for Accruals

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3.27

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Image: Adjustment for Bad Debt Expense

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3.32

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Image: Adjustment for Depriciation

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3.24

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Image: Adjustment for Insurance

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3.23

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Image: Adjustment for Interest

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3.30

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Image: Adjustment for Salaries and Wages Expense

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3.31

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Image: Adjustment for supplies

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3.22

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Image: Adjustment for Unearned Service Revenu

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3.26

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Image: Classies of adjusting Entries accrual / deferral

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3.20

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Image: Closing Entries Journalized

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3.36

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Image: Effects of Transcations on Owner Equity accounts

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3.5

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Image: Expanded Equation and DR.CR Rules and Effects

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3.3

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Image: Financial Statment and Ownership Structure

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3.4

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Image: Formula for computing Interst

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3.29

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Image: Prep of the IS and RE for the Adjusted TB

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3.34

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Image: Prep of the the BS from the Adjusted TB

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3.35

Accounting (Chapter 3)

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