McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.

, 2002
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Why Study Accounting ?
1. First of All – you need financial information to make significant
decision
For example
when you decide between Buying a Car or get one on Lease, Making
Monthly Budgets of Income & Expenditure, Investing your Savings or
Financing your Child’s Education.
2. Accounting information helps you to evaluate your Employer’s Short
and Long Term Potential.
3. It helps you in your Job Responsibilities of :
Sales- where U need information about availability of product and costs.
Production- Where information required about cost of materials, Labor &
Over Heads.
Quality Control – Where U need information about Variances between
expected and Actual production.
Human Resources- Where you need information regarding Cost of
Employees.
It gives you a competitive advantage over others who don’t know anything
about it.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 ACCOUNT
An account is a record of something. When you keep track of your
finances, you keep them safely recorded somewhere. You note your
income so you can report. You can keep account of your time. You
can schedule yourself to make most efficient use of your time. The
point is, the purpose of an account is to manage your resources.
Your life has plenty to do with accounting.

ACCOUNTING
Traditionally accounting has been defined as :

“………. the art of recording, classifying and summarizing in a significant

manner and in terms of money, transactions and events which are, in
part at least, of a financial character and interpreting the results
therefore.”

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 ACCOUNTING
It means that Accounting is an information system that identifies ( the
relevant financial transactions),
transactions records, analyses, classifies (into five
pillars of Accounting ), summarizes ( in the form of Financial
Statements,
Statements interprets and then communicates the results ( in the
form of an information ) of Financial transactions to the users of
Financial Statements.
Accounting is often called the “ Language of business ” because it
provides the means of recording and communicating business
activities and the results of those activities. Accounting is based
upon a double entry recording system called DOUBLE ENTRY
ACCOUNTING SYSTEM.
SYSTEM

BOOK KEEPING
It is the clerical side of accounting – the recording of routine
transactions and day-to-day record keeping. It is the preservation of
a systematic, quantitative record of an activity.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 WHO USES ACCOUNTING INFORMATION ?
1. Management including Directors, Managers and Executives.
2. Shareholders / Members.
3. Employees.
4. Government Agencies.
5. Lenders / Financial Institutions.
6. Creditors.
7. Investors.
8. Suppliers & Customers
9. Competitors.
10. Stock Exchanges
11. Corporate Law Authority or Securities & Exchange Commission (SEC)
12. The Press.
13. Central Board of Revenue (CBR) Etc.
14. Students for various Analysis.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 DOUBLE ENTRY ACCOUNTING SYSTEM
The double-entry accounting system is based on recording debit and
credit parts of transaction so that the total dollar amounts of debits
and credits equal each other. Each transaction affects at least two
general ledger accounts. A system of recording transactions in a
way that maintains the equality of the accounting equation.
Also discuss – Arms Length Transactions.
Transactions

SEPARATE ENTITY CONCEPT

The idea that the activities of an entity are to be separated from those of
the individual owners. The company’s money and property belong
to the company although they finance its activities and own the
company. So a company has a corporate personality which
separates it from its members / owners/ shareholders.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 ACCOUNTING:
Information for Decision Making

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
accounting
process

Accounting
“links” decision
makers with Accounting
Economic
economic
activities information
activities  and
with the results of
their decisions.

Actions
(decisions) Decision
makers
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Types
Types of
of Accounting
Accounting Information
Information

Financial Tax

Managerial

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Information
Information System
System

Information
Information Decisions
Decisions
Users
Users Supported
Supported

Investors
Investors 
Performance
Performance

Creditors
Creditors Financial
FinancialInformation
Information evaluations
evaluations

Managers
Managers Provided
Provided 
Stock
Stock

Owners  Investments
Owners Profitability
Profitability Investments

Customers
Customers 
Tax
Taxstrategies
strategies

Employees  
Labor
Laborrelations
Employees Financial
FinancialPosition
Position relations

Regulators
Regulators 
Resource
Resource
-SEC 
Cash allocations
-SEC CashFlows
Flows allocations
-IRS
-IRS 
Lending
Lending
-EPA
-EPA decisions
decisions

Borrowings
Borrowings
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Basic
Basic Functions
Functions of
of an
an Accounting
Accounting
System
System
 Interpret
and record
business
transactions.

Payment

Car

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Basic
Basic Functions
Functions of
of an
an Accounting
Accounting
System
System
 Interpret  Classify
and record similar
business transactions
transactions. into useful  Summarize
reports. and
communicate
information to
decision
makers.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial
Financial Reporting
Reporting and
and
Financial
Financial Statements
Statements
Income
Statement

Balance
Sheet

Statement
of Cash
Flows

Other
Other Information:
Information:
••Industry
Industry
••Competitors
Competitors
••Economy-wide
Economy-wide
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Characteristics
Characteristics of
of Externally
Externally
Reported
Reported Information
Information
AAMeans
Meanstoto
an
anEnd
End
Usefulness
Usefulness Broader
Broader than
than
Enhanced
Enhancedviavia Financial
Financial
Explanation
Explanation Statements
Statements

Based
Basedonon Historical
Historicalin
in
General
General Purpose
Purpose Nature
Nature
Assumption
Assumption

Results
Resultsfrom
fromInexact
Inexactand
and
Approximate
ApproximateMeasures
Measures
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Users
Users of
of Internal
Internal Accounting
Accounting
Information
Information

 Board of Directors
 Chief Executive Officer
 Chief Financial Officer
 Vice Presidents
 Business Unit Managers
 Plant Managers
 Store Managers
 Line Supervisors

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Characteristics
Characteristics of
of Internal
Internal
Accounting
Accounting Information
Information
Timeliness
Timeliness
Identify
Identify
AAMeans
Meanstoto Decision-
Decision-
an
anEnd
End Making
Making
Authority
Authority

Measures
Measuresof of Oriented
Oriented
Efficiency
Efficiencyand
and Toward
Toward
Effectiveness
Effectiveness Future
Future

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Integrity
Integrity of
of Accounting
Accounting Information
Information
Institutional Features
Generally Accepted Accounting Principles
(GAAP)
Financial Accounting Standards Board
Securities and Exchange Commission
Internal Control Structure
Audits

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Integrity
Integrity of
of Accounting
Accounting Information
Information
Professional Organizations
American Institute of Certified Public
Accountants
Institute of Management Accountants
Institute of Internal Auditors
American Accounting Association

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Integrity
Integrity of
of Accounting
Accounting Information
Information
Competence, Judgment and Ethical Behavior
Certified Public Accountants (CPAs)
Certificate in Management Accounting (CMA)
Certificate in Internal Auditing (CIA)
Code of Professional Conduct

CP
A
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Any
Any Question
Question

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 THE ACCOUNTING
CYCLE:
Capturing Economic Events

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The Accounting Cycle

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Prepare after closing Journalize and Prepare Prepare adjusted

trial balance. post closing financial trial balance.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
entries. statements.
 Financial Accounting

ACCOUNTING CYCLE
The sequence of Accounting procedures applied every period in recording
transactions and preparing Financial Statements. These procedures begin
with journalizing transactions including adjusting and closing accounts and
conclude with preparation of an after-closing trial balance.

1. Recording of Business Transactions.

2. Posting of Transactions in Ledger Accounts.
3. Prepare Trial Balance.
4. Make Year End Adjustments.
5. Make Adjusted Trial Balance.
6. Make Closing Entries.
7. Prepare After-Closing Trial Balance.
8. Prepare Financial Statements.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting

CONSERVATISM
The traditional accounting practice of resolving uncertainty by choosing
the solution which leads to the lower ( more conservative ) amount of
income being recognized in the current accounting period. This
concept is designed to avoid over statement of financial strength or
earnings.

MATCHING PRINCIPLE
The generally accepted accounting principle that determines when
expenses should be recorded in the accounting records. The revenue
earned during an accounting period is matched (offset) with the
expenses incurred in generating this revenue.

REALIZATION PRINCIPLE
The generally accepted accounting principle that determines when
Revenue should be recorded in the accounting records. Revenue is
realized when services are rendered to customers or when goods are
sold or delivered to customers.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 FUNDAMENTAL ACCOUNTING ASSUMPTIONS

The following are recognized as fundamental accounting assumptions :

1. Going Concern.
2. Consistency.
3. Accrual.
 
Where fundamental accounting assumptions are followed in financial
statements, disclosure of such assumptions is not required. If the
fundamental accounting assumption is not followed, the fact should
be disclosed together with the reasons.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 FUNDAMENTAL ACCOUNTING ASSUMPTIONS

Going Concern
The enterprise is viewed as a going concern. It means that it is assumed
that the business will exist for a long time and transactions are
recorded from this point of view.
 
It is assumed that the enterprise has neither the intention nor the
necessity of liquidation or of curtailing materially the scale of its
operations.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 FUNDAMENTAL ACCOUNTING ASSUMPTIONS
Consistency
It is assumed that accounting policies are consistent from one period to
another. The accounting practices should remain the same from one
year to another – for instance
 
It would be improper to value stocks-in-trade according to one method
one year and according to another method next year. If the change
becomes necessary, the change and its effects should be stated
clearly.

Accrual
Revenue and costs are accrued, that is, recognized as they are earned or
incurred ( and not as money is received or paid ) and recorded in the
financial statements of the periods to which they relate.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 ACCOUNTING POLICIES / CONVENTIONS
The selection and application of the appropriate accounting policies and
the preparation of financial statements should be govern by the three
main accounting conventions :
 
1. Prudence
2. Substance Over Form
3. Materiality

Prudence
Means carefulness, care, caution, cautiousness, discretion and good
sense.
Uncertainties inevitably surround many transactions. This should be
recognized by exercising prudence / rational judgment in preparing
financial statements. Prudence does not justify the creation of
secret / hidden reserves.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 ACCOUNTING POLICIES / CONVENTIONS

Materiality
The relative importance of an amount or item. An item which is not
significant enough to influence the decisions of users of financial
statements is considered to be not material.
  
Financial statements should disclose all items, which are material enough
to affect evaluations or decisions.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 ACCOUNTING POLICIES / CONVENTIONS
Substance Over Form
In dictionary substance means matter, material, stuff or body. Similarly,
Form means shape, appearance, outward appearance, figure, outline
or structure.
 
It means that the financial transactions ( for which the entries are made
in the books of accounts ) should be accounted for and presented
(means that these are analyzed and recorded in the GL - general
ledger ) in accordance with their substance and financial reality and
not merely with their legal form.
 
In other words the transactions should be recorded considering their
impact (or the materiality of impact) on the financial position of the
company and not on the basis of their existence in the form of legal
or statutory grounds.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 ACCOUNTING POLICIES / CONVENTIONS

Substance Over Form

Example

Suppose, if A sells some equipment to B on the basis that A will use that
equipment for a period of three years after the sale of that
equipment to B then the ownership to the equipment has been
transferred to B at the time of Sale. The equipment after the sale
belongs to Mr. B but Mr. A is still entitled to use that equipment for
a period of three years as per the clauses of the Sale Deed.

Similarly, In the case of Leasing, the ownership of the property remains

with the Lessor but Lessee is entitled to use that Asset for a
predefined period.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 CLASSIFICATION
FIVE PILLARS OF
ACCOUNTING
1. A S S E T S.
2. L I A B I L I T I E S.
3. E Q U I T I E S.
4. E X P E N S E S.
5. R E V E N U E S.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 ASSETS
TYPES OF ASSETS
1. INTANGIBLE ASSETS.
2. TANGIBLE ASSETS.

A ) INTANGIBLE ASSETS
1. Goodwill.
2. Copyrights.
3. Patents.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 B) TANGIBLE ASSETS
1. Current Assets.
2. Non – Current Assets / Fixed Assets .
A
CURRENT ASSETS
1. Cash / Bank.
S
2. Accounts Receivables / Sundry Debtors. S
3. Notes Receivables / Bills Receivables.
4. Prepaid Expenses / Prepayments. E
5. Inventories / Stocks / Stores Spares & Loose Tools.
6. Office Supplies. T
7.
8.
Stock – in – Trade.
Short Term Loans & Advances.
S
9. Short Term Investments.
10. Short Term Deposits.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 B) TANGIBLE ASSETS
1. Current Assets.
2. Non – Current Assets / Fixed Assets . A
S
NON CURRENT ASSETS
1. FIXED ASSETS.
S
2. Long Term Deposits. E
3. Long Term Loans & Advances.
4. Long Term Investments.
T
S

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 TANGIBLE ASSETS
FIXED ASSETS ( Property, Plant & Equipment )
According to IAS-16, a class of Property, Plant and Equipment is a
A
grouping of assets of a similar nature and use in an enterprise’s
operations. The following are examples of separate classes (mainly S
due to their Capitalization policy ) :
1. Land ( Agricultural and Non-Agricultural both ).
S
2.
3.
Land and Buildings.
Machinery.
E
4.
5.
Ships.
Aircrafts.
T
6. Motor vehicles. S
7. Furniture and Fixtures.
8. Office Equipment.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 LIABILITIES
TYPES OF LIABILITIES
1. CURRENT LIABILITIES.
2. NON- CURRENT LIABILITES.
A ) CURRENT LIABILITIES
1. Bank Overdraft / Running Finance.
2. Accounts Payable / Sundry Creditors.
3. Notes Payable / Bills Payable.
4. Salaries Payable.
5. Income Tax Payable.
6. Dividend Payable.
7. Interest Payable.
8. Short Term Portion of the Long Term Loan & Redeemable
Capital.
9. Short Term Portion of Liabilities against assets subject to Finance
Lease.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 LIABILITIES
B ) NON - CURRENT LIABILITIES

1. Long Term Loans.

2. Long Term Deposits.
3. Long Term Liabilities against Assets subject to Finance Lease.
4. Deferred Liabilities ( Gratuity / PF / Taxation ).

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 EQUITIES
1. Issued Subscribed and Paid-up Capital.
2. Share Premium.
3. Capital Reserves.
4. General Reserves.
5. Retained Earnings / Un-Appropriated Profit.
6. Redeemable Capital.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Role
Role of
of Accounting
Accounting Records
Records
Establishes
Establishesaccountability
accountabilityfor
for
assets
assetsand
andtransactions.
transactions.
Keeps
Keepstrack
trackof
of routine
routine
business
businessactivities.
activities.
Obtains
Obtainsdetailed
detailedinformation
information
about
about aaparticular
particular transaction.
transaction.
Evaluates
Evaluatesefficiency
efficiencyand
and
performance
performancewithin
withincompany.
company.

Maintains
Maintainsevidence
evidence of
of
company’s
company’sbusiness
businessactivities.
activities.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The
The Ledger
Ledger
Accounts
Accounts are
are
Cash individual
individual records
records
showing
showing increases
increases
Accounts
and
and decreases.
decreases.
Payable
The
The entire
entire group
group of
of
Capital accounts
accounts is is kept
kept
Stock together
together in in an
an
accounting
accounting record
record
called
called aa ledger.
ledger.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The
The Use
Use of
of Accounts
Accounts

Increases are
Title of
recorded on one Account
side of the T- Left Right
account, and or or
Debit Credit
decreases are Side Side
recorded on the
other side.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 RULES OF DEBIT & CREDIT
Debit and Credit are not clearly defined in any of the Accounting book.
Most of the renowned books encompass the following definition :
 
Debit is a phenomenon that deals with the five pillars of Accounting and
describes the treatment of these pillars under the following rules :

1. Increase in Assets;
2. Decrease in Liabilities; BALANCE SHEET
3. Decrease in Equities;
4. Increase in Expenses;
INCOME STATEMENT
5. Decrease in Income / Revenues.

Credit denotes the above in the reverse manner .

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Let’s
Let’s see
see how
how
debits
debits and
and credits
credits
are
are recorded
recorded inin the
the
Cash
Cash account
account for
for
JJ’s
JJ’s Lawn
Lawn Care
Care
Service.
Service.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Debit
Debit and
and Credit
Credit Entries
Entries
Cash
Cash
Receipts
5/1
5/1 8,000
8,000 5/2
5/2 2,500
2,500 Payments
are on 5/25
5/25 75
75 5/8
5/8 2,000
2,000 are on the
the debit 5/29 750
side.
5/29 750 5/28
5/28 150
150 credit
side.
5/31
5/31 50
50
5/31
5/31 4,125
4,125 The
Thebalance
balance is
isthe
the
Bal.
Bal. difference
differencebetween
between
the
thedebit
debitand
andcredit
credit
entries
entriesin
inthe
the
account.
account.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Debit
Debit and
and Credit
Credit Rules
Rules
Debits
Debits and
and credits
credits affect
affect accounts
accounts as
as
follows:
follows:

A = L + OE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Double
Double Entry
Entry AccountingThe
AccountingThe
Equality
Equality of
of Debits
Debits and
and Credits
Credits

A = L + OE
=
Debit Credit
balances balances

In
In the
the double-entry
double-entry accounting
accounting system,
system,
every
every transaction
transaction is
is recorded
recorded by
by equal
equal
dollar
dollar amounts
amounts of
of debits
debits and
and credits.
credits.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Let’s record
selected
transactions for
JJ’s Lawn Care
Service in the
accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 May
May 1:
1: Jill
Jill Jones
Jones and
and her
her family
family invested
invested $8,000
$8,000
in
in JJ’s
JJ’s Lawn
Lawn CareCare Service
Service and
and received
received 800
800 shares
shares
of
of stock.
stock.

Will Capital Stock

Will Cash increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 1:
1: Jill
Jill Jones
Jones and
and her
her family
family invested
invested $8,000
$8,000
in
in JJ’s
JJ’s Lawn
Lawn CareCare Service
Service and
and received
received 800
800 shares
shares
of
of stock.
stock.

Capital Stock
Cash increases
increases $8,000
$8,000 with a debit.
with a credit.

Cash Capital Stock

5/1 8,000 5/1 8,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 2:2: JJ’s
JJ’s purchased
purchased aa riding
riding lawn
lawn mower
mower
for
for $2,500
$2,500 cash.
cash.

Will Tools &

Will Cash increase
Equipment increase
or decrease?
or decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 2:2: JJ’s
JJ’s purchased
purchased aa riding
riding lawn
lawn mower
mower
for
for $2,500
$2,500 cash.
cash.

Tools & Equipment

Cash decreases
increases $2,500
$2,500 with a credit.
with a debit.

Cash Tools & Equipment

5/1 8,000 5/2 2,500 5/2 2,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 8:8: JJ’s
JJ’s purchased
purchased aa $15,000
$15,000 truck.
truck. JJ’s
JJ’s
paid
paid $2,000
$2,000 down
down inin cash
cash and
and issued
issued aa note
note
payable
payable for
for the
the remaining
remaining $13,000.
$13,000.

Will Cash and

Notes Payable
Will Truck increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 May
May 8:
8: JJ’s
JJ’s purchased
purchased aa $15,000
$15,000 truck.
truck. JJ’s
JJ’s
paid
paid $2,000
$2,000 down
down inin cash
cash and
and issued
issued aa note
note
payable
payable for
for the
the remaining
remaining $13,000.
$13,000.

Cash decreases
$2,000 with a credit.
Truck increases
Notes Payable
$15,000 with a debit.
increases $13,000
with a credit.
Cash
5/1 8,000 5/2 2,500
Truck
5/8 2,000
5/8 15,000
Notes Payable
5/8 13,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  May
May 11:
11: JJ’s
JJ’s purchased
purchased some
some repair
repair parts
parts
for
for $300
$300 on
on account.
account.

Will Tools & Will Accounts

Equipment increase Payable increase or
or decrease? decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 11:
11: JJ’s
JJ’s purchased
purchased some
some repair
repair parts
parts for
for
$300
$300 on
on account.
account.

Tools & Equipment Accounts Payable

increases $300 with increases $300 with
a debit. a credit.

Tools & Equipment Accounts Payable

5/2 2,500 5/11 300
5/11 300

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 18:
18: JJ’s
JJ’s sold
sold half
half of
of the
the repair
repair parts
parts to
to
ABC
ABC Lawns
Lawns for
for $150,
$150, aa price
price equal
equal to
to JJ’s
JJ’s cost.
cost.
ABC
ABC Lawns
Lawns agrees
agrees to
to pay
pay JJ’s
JJ’s within
within 3030 days.
days.

Will Tools & Will Accounts

Equipment increase Receivable increase
or decrease? or decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 18:
18: JJ’s
JJ’s sold
sold half
half of
of the
the repair
repair parts
parts to
to
ABC
ABC Lawns
Lawns for
for $150,
$150, aa price
price equal
equal toto JJ’s
JJ’s cost.
cost.
ABC
ABC Lawns
Lawns agrees
agrees to
to pay
pay JJ’s
JJ’s within
within 30
30 days.
days.

Tools & Equipment Accounts Receivable

decreases $150 with increases $150 with
a credit. a debit.

Tools & Equipment Accounts Receivable

5/2 2,500 5/18 150 5/18 150
5/11 300

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Journal
Journal

In
In an
an actual
actual accounting
accounting system,
system, transactions
transactions
are
are initially
initially recorded
recorded in
in the
the journal.
journal.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2003
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts
Posting
involves
copying
information
from the
journal to the
ledger
accounts.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2003
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest cash Ledger
in the business.
Cash
Date Debit Credit Balance
2003
May 1 8,000 8,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2003
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest cash Ledger
in the business.
Capital Stock
Date Debit Credit Balance
2003
May 1 8,000 8,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2003
May 2 Tools & Equipment 2,500
Cash 2,500
Purchased lawn mower.

Let’s
Let’s see
see what
what the
the cash
cash account
account looks
looks like
like after
after
posting
posting the
the cash
cash portion
portion of
of this
this transaction
transaction for
for
JJ’s
JJ’s Lawn
Lawn Care
Care Service.
Service.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Ledger
Ledger Accounts
Accounts After
After Posting
Posting
General Ledger
Cash
Date Debit Credit Balance
2003
May 1 8,000 8,000
2 2,500 5,500

This
This ledger
ledger format
format is
is referred
referred to
to as
as aa
running
running balance
balance (as
(as opposed
opposed to to simple
simple
TT accounts).
accounts).
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 What
What is
is Net
Net Income?
Income?
Net
Net income
income is
is not
not an asset it’s
an asset it’s an
an increase
increase in
in
owners’
owners’ equity
equity from
from profits
profits of
of the
the business.
business.

A = L + OE
Increase Decrease Increase

Either (or both) of these . . . but this is

effects occur as net income what “net income”
is earned . . . really means.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Retained
Retained Earnings
Earnings

A = L + OE
Capital Retained
Stock Earnings

The balance in the Retained Earnings account represents

the total net income of the corporation over the entire
lifetime of the business, less all amounts which have
been distributed to the stockholders as dividends.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Revenue
Revenue and
and Expenses
Expenses
The price for
goods sold
and services Increases
rendered during a owner’s equity.
given accounting
period.

The costs of
goods and Decreases
services used up owner’s equity.
in the process of
earning revenue.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The
The Realization
Realization Principle:
Principle: When
When
To
To Record
Record Revenue
Revenue

Realization Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Matching
Matching Principle:
Principle: When
When To
To
Record
Record Expenses
Expenses

Matching Principle
Expenses should be
recorded in the
period in which they
are used up.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Debits
Debits and
and Credits
Credits for
for Revenue
Revenue and
and
Expense
Expense
Expenses EQUITIES Revenues
decrease Debit Credit increase
owner’s for for owner’s
equity. Decrease Increase equity.

EXPENSES REVENUES
Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Investments
Investments by
by and
and Payments
Payments to
to
Owners
Owners
Payments to Owners’
EQUITIES
owners investments
decrease Debit Credit increase
for for
owners’ Decrease Increase owners’
equity. equity.

DIVIDENDS CAPITAL STOCK

Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Let’s
Let’s analyze
analyze the
the
revenue,
revenue, and
and
expense
expense
transactions
transactions forfor
JJ’s
JJ’s Lawn
Lawn Care
Care
Service
Service for
for the
the
month
month ofof May.
May.
We
We will
will also
also
analyze
analyze aa dividend
dividend
transaction.
transaction.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  May
May 29:
29: JJ’s
JJ’s provided
provided lawn
lawn care
care services
services for
for
aa client
client and
and received
received $750
$750 in
in cash.
cash.

Will Sales Revenue

Will Cash increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 May
May 29:
29: JJ’s
JJ’s provided
provided lawn
lawn care
care services
services for
for aa
client
client and
and received
received $750
$750 in
in cash.
cash.

Sales Revenue
Cash increases
increases $750 with
$750 with a debit.
a credit.

Cash Sales Revenue

5/1 8,000 5/2 2,500 5/29 750
5/29 750 5/8 2,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 31:
31: JJ’s
JJ’s purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
mower
mower and
and the
the truck
truck for
for $50
$50 cash.
cash.

Will Gasoline
Will Cash increase
Expense increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 31:
31: JJ’s
JJ’s purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
mower
mower and
and the
the truck
truck for
for $50
$50 cash.
cash.

Gasoline Expense
Cash decreases $50
increases $50 with a
with a credit.
debit.

Cash Gasoline Expense

5/1 8,000 5/2 2,500 5/31 50
5/29 750 5/8 2,000
5/31 50

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 31:
31: JJ’s
JJ’s Lawn
Lawn Care
Care paid
paid Jill
Jill Jones
Jones and
and
her
her family
family aa $200
$200 dividend.
dividend.

Will Dividends
Will Cash increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

  May
May 31:
31: JJ’s
JJ’s Lawn
Lawn Care
Care paid
paid Jill
Jill Jones
Jones and
and
her
her family
family aa $200
$200 dividend.
dividend.

Cash decreases Dividends increase

$200 with a credit. $200 with a debit.

Cash Dividends
5/1 8,000 5/2 2,500 5/31 200
5/29 750 5/8 2,000
5/31 50
5/31 200

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Now,
Now, let’s
let’s look
look at
at
the
the Trial
Trial Balance
Balance
for
for JJ’s
JJ’s Lawn
Lawn CareCare
Service
Service for
for the
the
month
month ofof May.
May.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 JJ's Lawn Care Service All balances
Unadjusted Trial Balance are taken from
May 31, 2003 the ledger
accounts on
Cash $ 3,925
Accounts receivable 75 May 31 after
Tools & equipment 2,650 considering all
Truck 15,000 of JJ’s
Notes payable $ 13,000 transactions
Accounts payable 150 for the month.
Capital stock 8,000
Dividends 200 Proves equality
Sales revenue 750 of debits and
Gasoline expense 50 credits.
Total $ 21,900 $ 21,900

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Another COMPREHENSIVE Q/S :
Preparation of Trial Balance
GIVEN :
The following are some of the transactions of HAQQANI Stores for the month of January 2004.
DATES TRANSACTIONS
JAN - 01 Haqqani invested Rs. 280,000 cash for his business.
JAN - 01 Purchased shop building for cash Rs. 100,000.
JAN - 02 Purchased shop furniture for cash Rs. 20,000.
JAN - 04 Purchased merchandise for cash Rs. 15,000.
JAN - 05 Paid Transportation Expense Rs. 150.
JAN - 07 Purchased merchandise on account from Jamali & Sons for Rs. 17,800 and paid transport Rs. 160.
JAN - 10 Sold merchandise for cash Rs. 14,350.
JAN - 13 Sold merchandise on account to Patel & Co. for Rs. 8,500.
JAN - 16 Purchased shop equipment for cash Rs. 8,000.
JAN - 19 Paid for merchandise purchased Rs. 13,600.
JAN - 22 Received on account of cash sales Rs. 4,500.
JAN - 26 Paid for Transportation Rs. 120.
JAN - 27 Received cash from Patel & Co. Rs. 5,000.
JAN - 28 Paid cash to Jamali & Sons Rs. 15,000.
JAN - 30 Paid Salaries to employees for the month Rs. 4,500.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting
SOLUTION TO THE QUESTION :
HAQQANI STORES
GENERAL JOURNAL
Post
DATE ACCOUNT TITLES & DESCRIPTION DEBIT CREDIT
Ref

2004 Cash 280,000

Jan 01 Haqqani's Capital 280,000
( To record Haqqani's Investment in the business )

Jan 01 Shop Building 100,000

Cash 100,000
( To record the purchase of Shop building for cash )

Jan 02 Shop Furniture 20,000

Cash 20,000
( To record the purchase of Shop Furniture for cash )

Jan 04 Purchases 15,000

Cash 15,000
( To record the purchase of merchandise for cash )

Jan 05 Transportation Expense 150

Cash 150
( To record the payment of Transportation )

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting

HAQQANI STORES
GENERAL JOURNAL
Post
DATE ACCOUNT TITLES & DESCRIPTION DEBIT CREDIT
Ref

Jan 07 Purchases 17,800

Accounts Payable - Jamali & Sons 17,800
( To record the purchase of merchandise on account )

Transportation Expense 160

Cash 160
( To record the payment of Transportation )

Jan 10 Cash 14,350

Sales 14,350
( To record the sale of merchandise for cash )

Jan 13 Accounts Receivables - Patel & Co.'s 8,500

Sales 8,500
( To record the sale of merchandise on account )

Jan 16 Shop Equipment 8,000

Cash 8,000
( To record the purchase of shop equipment for Cash )

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting
HAQQANI STORES
GENERAL JOURNAL
Post
DATE ACCOUNT TITLES & DESCRIPTION DEBIT CREDIT
Ref
Jan 19 Purchases 13,600
Cash 13,600
( To record the purchase of merchandise for Cash )

Jan 22 Cash 4,500

Sales 4,500
( To record Cash Sales )

Jan 26 Transportation Expense 120

Cash 120
( To record payment of Transportation )

Jan 27 Cash 5,000

Accounts Receivables - Patel & Co.'s 5,000
( To record receipt of Cash from Patel & Co. )

Jan 28 Accounts Payable - Jamali & Sons 15,000

Cash 15,000
( To record the payment of Cash to Jamali & Sons. )

Jan 30 Salaries Expense 4,500

Cash 4,500
( To record the payment of Salaries for the month )

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting
HAQQANI STORES
GENERAL LEDGER
(Debit) CASH (Asset) (Credit)
2004 Rs. 2004 Rs.
Jan - 01 Opening Balance NIL Jan - 01 Shop Building a/c 100,000
Jan - 01 Haqqani's Capital a/c 280,000 Jan - 02 Shop Furniture a/c 20,000
Jan - 10 Sales a/c 14,350 Jan - 04 Purchases a/c 15,000
Jan - 22 Sales a/c 4,500 Jan - 05 Transportation Expense a/c 150
Jan - 27 Accounts Rec-Patel & Co. a/c 5,000 Jan - 07 Transportation Expense a/c 160
Jan - 16 Shop Equipment a/c 8,000
Jan - 19 Purchases a/c 13,600
Jan - 26 Transportation Expense a/c 120

T Jan - 28
Jan - 30
Jan - 31
Accounts Pay-Jamali & Co. a/c
Salaries Expense a/c
Closing Balance
15,000
4,500
127,320

Account 303,850 303,850

Form of
(Debit) CAPITAL (Credit)
Ledger 2004 Rs. 2004 Rs.
Jan - 01 Opening Balance
Jan - 01 Cash a/c 280,000
Jan -31 Closing Balance 280,000
280,000 280,000

(Debit) SHOP BUILDING (Asset) (Credit)

2004 Rs. 2004 Rs.
Jan - 01 Opening Balance NIL
Jan - 01 Cash a/c 100,000 Jan - 31 Closing Balance 100,000

100,000 100,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting
HAQQANI STORES
GENERAL LEDGER

(Debit) SHOP FURNITURE (Asset) (Credit)

2004 Rs. 2004 Rs.
Jan - 01 Opening Balance NIL
Jan - 02 Cash a/c 20,000 Jan -31 Closing Balance 20,000

20,000 20,000

(Debit) PURCHASE (Credit)

2004
Jan - 01
Jan - 04
Opening Balance
Cash a/c
Rs.
NIL
15,000
2004 Rs.
T
Jan - 07
Jan - 19
Accounts Pay - Jamil & Sons
Cash a/c
17,800
13,600 Jan - 31 Closing Balance 46,400
Account
46,400 46,400
Form of
Ledger
(Debit) TRANSPORTATION EXPENSE (Expense) (Credit)
2004 Rs. 2004 Rs.
Jan - 05 Cash a/c 150
Jan - 07 Cash a/c 160
Jan - 26 Cash a/c 120 Jan -31 Closing Balance 430
430 430

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting
HAQQANI STORES
GENERAL LEDGER

(Debit) ACCOUNTS PAYABLE (Credit)

2004 Rs. 2004 Rs.
Jan - 01 Opening Balance NIL
Jan - 28 Cash a/c 15,000 Jan - 07 Cash a/c 17,800
Jan -31 Closing Balance 2,800
17,800 17,800

(Debit) SALES ( Revenue ) (Credit)

2004 Rs. 2004 Rs.
Jan - 10 Cash a/c 14,350
Jan - 13 Accounts Rec - Patel & Co. 8,500
Jan - 31 Closing Balance 27,350 Jan - 22 Cash a/c 4,500
27,350 27,350

(Debit) ACCOUNTS RECEIVABLES (Asset) (Credit)

2004 Rs. 2004 Rs.
Jan - 01 Opening Balance NIL Jan - 27 Cash a/c 5,000
Jan - 13 Sales a/c 8,500
Jan - 31 Closing Balance 3,500
8,500 8,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting

HAQQANI STORES
GENERAL LEDGER

(Debit) SHOP EQUIPMENT (Asset) (Credit)

2004 Rs. 2004 Rs.
Jan - 01 Opening Balance NIL
Jan - 16 Cash a/c 8,000
Jan - 31 Closing Balance 8,000
8,000 8,000

(Debit) SALARIES EXPENSE ( Expense ) (Credit)

2004 Rs. 2004 Rs.
Jan - 30 Cash a/c 4,500
Jan - 31 Closing Balance 4,500
4,500 4,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting

HAQQANI STORES
TRIAL BALANCE
AS ON JANUARY 31, 2004.
Post
S.No. ACCOUNT TITLES DEBIT CREDIT
Ref
in Rupees in Rupees

1 Cash 127,320
2 Haqqani's Capital 280,000
3 Shop Building 100,000
4 Shop Furniture 20,000
5 Purchases 46,400
6 Transportation Expenses 430
7 Accounts Payables 2,800
8 Sales 27,350
9 Accounts Receivables 3,500
10 Shop Equipment 8,000
11 Salaries Expenses 4,500

TOTAL 310,150 310,150

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting
H AQ Q ANI STO RES
INCOME STATEMENT
For the period ended MAY 31, 1994.

Rupees Rupees

Sales Revenue 27,350

Less : Sales return and Allownaces -
Sales Discount -
NET SALES 27,350

Less : COST OF GOODS SOLD

Merchandise Inventory (Opening - 01-01-2004) -
Add : Purchases 46,400
Add : Carriage - In -
46,400
Less : Purchase Discount -
Purchase Returns -
Net Purchases 46,400
Merchandise available for Sale 46,400
Less : Merchandise Inventory (Closing - 31-01-2004) -
COST OF GOODS SOLD 46,400

GROSS PROFIT (19,050)

Less : OPERATING EXPENSES

Salaries Expense Rs. 4,500
Depreciation Expense -
Transportation Expense 430
Insurance Expense -
Bad Debt Expense -
TOTAL OPERATING EXPENSES 4,930

TOTAL NET LOSS Rs. (23,980)

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting

H AQ Q ANI STO RES

BALANCE SHEET
AS ON JANUARY 31, 2004.
ASSETS EQUITIES
Rupees Rupees
CURRENT ASSETS CURRENT LIABILITIES
Cash 127,320 Accounts Payable Rs. 2,800
Accounts Receivables 3,500 Notes payables -
Less : All for Bad Debts - 3,500 Salaries payable -
Merchandise Inventory - Closing - Sundry Creditors -
Prepaid Insurance -
Investments - PROPRIETORSHIP
Office Supplies -
NON-CURRENT ASSETS Riaz's Capital Rs. 256,020
Shop Building 100,000
Less : All for Depreciation - 100,000
Shop Furniture 20,000
Shop Equipment 8,000

TOTAL 258,820 258,820

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Financial Accounting

H AQ Q ANI STO RES

STATEMENT OF CHANGES IN CAPITAL
For the month ended JANUARY 31, 2004.

HAQQANI's Capital Rs. 280,000

Add : Net Profit / Loss ( from INCOME STATEMENT ) (23,980)

256,020
Less : Riaz's Drawings -

HAQQANI's Capital - Closing - January 31, 2004.

Rs. 256,020

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 THE ACCOUNTING
CYCLE:
Accruals and Deferrals

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 At the end of the
period, we need to
make adjusting entries
to get the accounts up
to date for the financial
statements.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Adjusting
Adjusting Entries
Entries

Adjusting Every
entries are adjusting
needed whenever entry involves a
revenue or expenses change in either a
affect more than one revenue or expense
accounting and an asset
period. or liability.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Types
Types of
of Adjusting
Adjusting Entries
Entries

 Converting
Converting  Converting
Converting
assets
assets to
to liabilities
liabilities to
to
expenses
expenses revenue
revenue

 Accruing
Accruing  Accruing
Accruing
unpaid
unpaid uncollected
uncollected
expenses
expenses revenues
revenues

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Converting
Converting Assets
Assets to
to Expenses
Expenses
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Paid
Paidfuture
future Recognize
Recognizeportion
portion
expenses
expensesin in of
ofasset
assetconsumed
consumed
advance
advance
(creates
(createsanan as
asexpense,
expense,and and
asset).
asset).  Reduce
Reducebalance
balanceof of
McGraw-Hill/Irwin
asset
asset account.
account.
© The McGraw-Hill Companies, Inc., 2002
 Converting
Converting Assets
Assets to
to Expenses
Expenses

Examples Include:
Depreciation
Supplies
Expiring Insurance Policies

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Converting
Converting Assets
Assets to
to Expenses
Expenses

$2,400 Insurance Policy

Coverage for 12 Months

$200 Monthly Insurance Expense

Jan. 1 Dec. 31

On
On January
January 1,
1, Webb
Webb Co.
Co. purchased
purchased aa one-
one-
year
year insurance
insurance policy
policy for
for $2,400.
$2,400.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Converting
Converting Assets
Assets to
to Expenses
Expenses
Initially,
Initially, costs
costs that
that benefit
benefit more
more than
than one
one
accounting
accounting period
period are
are recorded
recorded as
as assets.
assets.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 1 Unexpired Insurance 2,400
Cash 2,400
Purchase a one-year insurance policy.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Converting
Converting Assets
Assets to
to Expenses
Expenses
The
The costs
costs are
are expensed
expensed asas they
they are
are used
used to
to
generate
generate revenue.
revenue.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Monthly Adjusting Entry for Insurance
Jan. 31 Insurance Expense 200
Unexpired Insurance 200
Insurance expense for January.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Converting
Converting Assets
Assets to
to Expenses
Expenses
Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Cost
Cost of
of assets
assets Cost
Cost of
of assets
assets
that
that benefit
benefit used
used this
this period
period to
to
future
future periods.
periods. generate
generate revenue.
revenue.

Unexpired Insurance Insurance Expense

1/1 2,400 1/31 200 1/31 200
Bal. 2,200

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Concept
Concept of
of Depreciation
Depreciation
Depreciable
Depreciable assets
assets are
are physical
physical objects
objects
that
that retain
retain their
their size
size and
and shape
shape but
but lose
lose
their
their economic
economic usefulness
usefulness over
over time.
time.

Depreciation
Depreciation isis the
the systematic
systematic allocation
allocation
of
of the
the cost
cost of
of aa depreciable
depreciable asset
asset to
to
expense.
expense.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The
The Concept
Concept of
of Depreciation
Depreciation
The
The portion
portion of
of an
an asset’s
asset’s utility
utility that
that is
is used
used
up
up must
must be
be expensed
expensed inin the
the period
period used.
used.

Fixed
Fixed The asset’s Accumulated
usefulness is Accumulated
Asset
Asset Depreciation
partially Depreciation
(debit)
(debit) (credit)
consumed (credit)
On date during the
period. At end of
when initial
payment is period . . .
made . . . Depreciation
Depreciation
Cash
Cash Expense
Expense
(credit)
(credit) (debit)
(debit)
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
On May 2, 2003, JJ’s Lawn Care Service
purchased a lawn mower with a useful
life of 50 months for $2,500 cash.
Using the straight-line method, calculate
the monthly depreciation expense.
Depreciation
Cost of the asset
expense (per =
Estimated useful life
period)

$50 = $2,500
50 © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
JJ’s
JJ’s Lawn
Lawn Care
Care Service
Service would
would make
make the
the
following
following adjusting
adjusting entry.
entry.

GENERAL JOURNAL
P
Date Account Titles and Explanation RDebit Credit
May 31 Depreciation Expense: Tools & Eq. 50
Accumulated Depreciation: Tools & Eq. 50
To record one month's depreciation.

Contra-asset
Contra-asset
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Depreciation
Depreciation Is
Is Only
Only an
an Estimate
Estimate
JJ’s
JJ’s $15,000
$15,000 truck
truck is
is depreciated
depreciated over
over 60
60
months
months as as follows:
follows:

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
May 31 Depreciation Expense: Truck 250
Accumulated Depreciation: Truck 250
To record one month's depreciation.

$15,00060
$15,00060 months
months == $250
$250 per
per
© The
month
month
McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Accumulated
Accumulated depreciation
depreciation would
would
appear
appear on
on the
the balance
balance sheet
sheet as
as
follows:
follows:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction Adjusting
AdjustingEntry
Entry
Collected
Collected 
Recognize
Recognizeportion
portion
from
from earned
earnedas asrevenue,
revenue,
customers
customers in in and
and
advance
advance 
Reduce
Reducebalance
balanceofof
(creates
(createsaa liability
liability account.
account.
liability).
liability).
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue

Examples Include:
Airline Ticket Sales
Sports Teams’ Sales of
Season Tickets

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue

$6,000 Rental Contract

Coverage for 12 Months

$500 Monthly Rental Revenue

Jan. 1 Dec. 31

On
On January
January 1,
1, Webb
Webb Co.
Co. received
received $6,000
$6,000 in
in
advance
advance for
for aa one-year
one-year rental
rental contract.
contract.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue
Initially,
Initially, revenues
revenues that
that benefit
benefit more
more than
than one
one
accounting
accounting period
period are
are recorded
recorded as
as liabilities.
liabilities.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 1 Cash 6,000
Unearned Rental Revenue 6,000
Collected $6,000 in advance for rent.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue
Over
Over time,
time, the
the revenue
revenue is
is recognized
recognized as
as itit is
is
earned.
earned.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Monthly Adjusting Entry for Rent Revenue
Jan. 31 Unearned Rental Revenue 500
Rental Revenue 500
Rental revenue for January.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Converting
Converting Liabilities
Liabilities to
to Revenue
Revenue

Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Liability
Liability for
for Revenue
Revenue earned
earned
future
future periods.
periods. this
this period.
period.

Unearned Rental Revenue Rental Revenue

1/31 500 1/1 6,000 1/31 500
Bal. 5,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

Recognize
Recognizeexpense
expense Liability
Liabilitywill
will
incurred,
incurred,and
and be
bepaid.
paid.

Record
Recordliability
liabilityfor
for
future
futurepayment.
payment.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
Hey, when
do we get
paid?
Examples Include:
Interest
Wages and Salaries
Property Taxes

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses

$3,000 Wages
Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2

On
On May
May 31,
31, Webb
Webb Co.
Co. owes
owes wages
wages of
of $3,000.
$3,000.
Pay
Pay day
day is
is Friday,
Friday, June
June 2.
2.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
Initially,
Initially, an
an expense
expense and
and aa liability
liability are
are
recorded.
recorded.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
May 31 Wages Expense 3,000
Wages Payable 3,000
To accrue wages owed to employees.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
Balance
Balance Sheet
Sheet Income
Income Statement
Statement
Liability
Liability toto be
be Cost
Cost incurred
incurred this
this
paid
paid in
in aa future
future period
period toto generate
generate
period.
period. revenue.
revenue.

Wages Payable Wages Expense

5/31 3,000 5/31 3,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
$5,000 Weekly Wages

$3,000 Wages $2,000 Wages

Expense Expense

Monday, Wednesday, Friday,

May 29 May 31 June 2

Let’s
Let’s look
look at
at the
the entry
entry for
for June
June 2.
2.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Accruing
Accruing Unpaid
Unpaid Expenses
Expenses
The
The liability
liability is
is extinguished
extinguished when
when the
the debt
debt is
is
paid.
paid.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
June 2 Wages Expense (for June) 2,000
Wages Payable (accrued in May) 3,000
Cash 5,000
Weekly payroll for May 29-June 2.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

Recognize
Recognizerevenue
revenue Receivable
Receivable
earned
earned but
butnot
notyet
yet will
will be
be
recorded,
recorded,and
and collected.
collected.

Record
Recordreceivable.
receivable.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue

Examples Include:
Interest Earned
Work Completed But Not
Yet Billed to Customer

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
$170 Interest
Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15
On
On Jan.
Jan. 31,
31, the
the bank
bank owes
owes Webb
Webb Co.
Co.
interest of $170. Interest is paid on the 15
interest of $170. Interest is paid on the 15th th

day
day ofof each
each month.
month.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
Initially,
Initially, the
the revenue
revenue isis recognized
recognized and
and aa
receivable
receivable is
is created.
created.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jan. 31 Interest Receivable 170
Interest Revenue 170
To recognize interest revenue.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
Balance
Balance Sheet
Sheet
Income
Income Statement
Statement
Receivable
Receivable toto
be
be collected
collected in
in aa Revenue
Revenue earned
earned
future
future period.
period. this
this period.
period.

Interest Receivable Interest Revenue

1/31 170 1/31 170

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
$320 Monthly Interest

$170 Interest $150 Interest

Revenue Revenue

Saturday, Monday, Tuesday,

Jan. 15 Jan. 31 Feb. 15

Let’s
Let’s look
look at
at the
the entry
entry for
for February
February 15.
15.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Accruing
Accruing Uncollected
Uncollected Revenue
Revenue
The
The receivable
receivable is
is collected
collected in
in aa future
future period.
period.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Feb. 15 Cash 320
Interest Revenue (for February) 150
Interest Receivable (accrued Jan. 31) 170
To record interest received.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Accruing
Accruing Income
Income Taxes
Taxes Expense:
Expense: The
The
Final
Final Adjusting
Adjusting Entry
Entry
As
As aa corporation
corporation earns
earns taxable
taxable income,
income, itit
incurs
incurs income
income taxes
taxes expense,
expense, and
and also
also aa
liability
liability to
to governmental
governmental tax
tax authorities.
authorities.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Dec. 31 Income Taxes Expense 780
Income Taxes Payable 780
Estimated income taxes applicable to
taxable income earned in December.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Adjusting
Adjusting Entries
Entries and
and Accounting
Accounting
Principles
Principles
Costs
Costs are
are matched
matched with
with revenue
revenue
in
in two
two ways:
ways:

 Direct
Direct association
association of
of costs
costs
with
with specific
specific revenue
revenue
transactions.
transactions.


 Systematic
Systematic allocation
allocation ofof costs
costs
over
over the
the “useful
“useful life”
life” of
of the
the
expenditure.
expenditure.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The
The Concept
Concept of
of Materiality
Materiality
An
An item
item is
is “material”
“material” ifif knowledge
knowledge ofof the
the
item
item might
might reasonably
reasonably influence
influence the
the
decisions
decisions of of users
users of
of financial
financial statements.
statements.

Many companies
immediately charge
the cost of Lightbulbs
immaterial items to
expense.
Supplies
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Effects of the Adjusting Entries

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Recall
Recall from
from the
the accounting
accounting cycle
cycle
discussed
discussed in in Chapter
Chapter 3,
3, that
that after
after
the
the adjusting
adjusting entries
entries are
are made,
made, anan
Prepare adjusted
adjusted
adjusted trial
trial balance
balance is
is prepared.
prepared. trial balance.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 End
End of
of Chapter
Chapter

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002