PREVIEW OF CHAPTER 3

Financial Reporting Mechanics

3
Financial Reporting Mechanics
Financial Reporting Mechanics
Basic Terminology
 Event  Journal
LEARNING OBJECTIVES  Transaction  Posting
After studying this chapter, you should be able to:
 Account  Trial Balance
1. Understand basic accounting 6. Prepare financial statements from the
terminology. adjusted trial balance.
 Real Account  Adjusting Entries
2. Explain double-entry rules. 7. Prepare closing entries.

3. Identify steps in the accounting cycle. 8. Prepare financial statements for a  Nominal Account  Financial Statements
merchandising company.
4. Record transactions in journals, post to ledger
accounts, and prepare a trial balance.  Ledger  Closing Entries
5. Explain the reasons for preparing adjusting
entries.

3
Financial Reporting Mechanics
Financial Reporting Mechanics
Debits and Credits
 An account shows the effect of transactions on a given
LEARNING OBJECTIVES asset, liability, equity, revenue, or expense account.

After studying this chapter, you should be able to:  Double-entry accounting system (two-sided effect).
1. Understand basic accounting terminology. 6. Prepare financial statements from the
adjusted trial balance.  Recording done by debiting at least one account and
2. Explain double-entry rules.
7. Prepare closing entries. crediting another.
3. Identify steps in the accounting cycle.
8. Prepare financial statements for a
4. Record transactions in journals, post to ledger
merchandising company.  DEBITS must equal CREDITS.
accounts, and prepare a trial balance.
5. Explain the reasons for preparing adjusting
entries.
 Debits and Credits Debits and Credits

 An arrangement that shows the If the sum of Debit entries are greater than the sum of
Account
effect of transactions on an Credit entries, the account will have a debit balance.
account.
 Debit = “Left” Account Name
Debit / Dr. Credit / Cr.
 Credit = “Right”
Transaction #1 10,000 3,000 Transaction #2
An Account can be Account Name
Transaction #3 8,000
illustrated in a T- Debit / Dr. Credit / Cr.
Account form.
Balance 15,000

Debits and Credits Debits and Credits Summary

Liabilities

Normal
Debit / Dr. Credit / Cr.
Normal
If the sum of Credit entries are greater than the sum of Balance Balance
Debit entries, the account will have a credit balance. Debit Credit Normal Balance

Chapter

Account Name
3-24

Assets Equity
Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Transaction #1 10,000 3,000 Transaction #2

Normal Balance Normal Balance
8,000 Transaction #3
Chapter Chapter
3-23 3-25
Revenue
Expense
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.
Balance 1,000

Normal Balance
Normal Balance

Chapter
3-26
Chapter
3-27

Debits and Credits Summary The Accounting Equation

Statement of Financial Position
Relationship among the assets, liabilities and equity of a
Income Statement
business: ILLUSTRATION
Expanded Equation and
Asset = Liability + Equity Revenue - Expense Debit/Credit Rules and Effects

Debit

Credit The equation must be in balance after every transaction. For

every Debit there must be a Credit.
 ILLUSTRATION
Financial Statements and Ownership Structure Financial Statements and
Ownership Structure

Ownership structure dictates the types of accounts that are Investments by shareholders
part of the equity section. Net income retained in the business

Proprietorship or Financial
Corporation
Partnership
Statements
 Capital account  Share capital
and Ownership
 Drawing account  Share premium
Structure
 Dividends
 Retained Earnings

3
Financial Statements and Ownership Structure
Financial Reporting Mechanics

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Understand basic accounting terminology. 6. Prepare financial statements from the

adjusted trial balance.
2. Explain double-entry rules.
7. Prepare closing entries.
3. Identify steps in the accounting cycle.
8. Prepare financial statements for a
4. Record transactions in journals, post to ledger
merchandising company.
accounts, and prepare a trial balance.
ILLUSTRATION
Effects of Transactions 5. Explain the reasons for preparing adjusting
on Equity Accounts entries.

3
THE ACCOUNTING CYCLE
Financial Reporting Mechanics
ILLUSTRATION
Transactions

Reversing entries Journalization

LEARNING OBJECTIVES
Post-closing trail balance Posting After studying this chapter, you should be able to:

1. Understand basic accounting terminology. 6. Prepare financial statements from the

adjusted trial balance.
2. Explain double-entry rules.
Closing Trial balance
7. Prepare closing entries.
3. Identify steps in the accounting cycle.
8. Prepare financial statements for a
4. Record transactions in journals, post to
Work merchandising company.
Statement preparation Sheet
Adjustments ledger accounts, and prepare a trial
balance.
5. Explain the reasons for preparing adjusting
Adjusted trial balance
entries.
Journalizing Posting
Posting – The process of transferring amounts from the journal
General Journal – a chronological list of transactions and other
to the ledger accounts.
events, expressed in terms of debits and credits to accounts. ILLUSTRATION

Journal Entries are recorded in the journal.

September 1: Shareholders invested Tk.15,000 cash in the

corporation in exchange for ordinary shares.
ILLUSTRATION

ILLUSTRATION 3-8

ILLUSTRATION
Posting a Journal
Posting
Entry

Posting – Transferring amounts from journal to ledger.

An Expanded Example
The purpose of transaction analysis is
(1) to identify the type of account involved, and
(2) to determine whether a debit or a credit is required.

Keep in mind that every journal entry affects one or more of the
following items: assets, liabilities, equity, revenues, or expense.

Posting Posting
1. October 1: Shareholders invest Tk.100,000 cash in an 2. October 1: Pioneer purchases office equipment costing
advertising venture to be known as Pioneer Advertising Tk.50,000 by signing a 3-month, 12%, Tk.50,000 note
Agency Inc. payable.

Oct. 1 Cash 100,000 Oct. 1 Equipment 50,000

Share Capital—Ordinary 100,000 Notes payable 50,000

Cash Share Capital—Ordinary Equipment Notes Payable

Debit Credit Debit Credit Debit Credit Debit Credit
100,000 100,000 50,000 50,000
Posting Posting
3. October 2: Pioneer receives a Tk.12,000 cash advance 4. October 3: Pioneer pays Tk.9,000 office rent, in cash, for
from KC, a client, for advertising services that are expected October.
to be completed by December 31.
Oct. 3 Rent Expense 9,000
Oct. 2 Cash 12,000
Cash 9,000
Unearned Service Revenue 12,000

Cash Unearned Service Revenue Cash Rent Expense

Debit Credit Debit Credit Debit Credit Debit Credit
100,000 12,000 100,000 9,000 9,000
12,000 12,000

Posting Posting
5. October 4: Pioneer pays Tk.6,000 for a one-year insurance 6. October 5: Pioneer purchases, for Tk.25,000 on account,
policy that will expire next year on September 30. an estimated 3-month supply of advertising materials from
Aero Supply.
Oct. 4 Prepaid Insurance 6,000
Oct. 5 Supplies 25,000
Cash 6,000
Accounts Payable 25,000

Cash Prepaid Insurance Supplies Accounts Payable

Debit Credit Debit Credit Debit Credit Debit Credit
100,000 9,000 6,000 25,000 25,000
12,000 6,000

Posting Posting
7. October 9: Pioneer signs a contract with a local newspaper 8. October 20: Pioneer’s board of directors declares and pays
for advertising inserts (flyers) to be distributed starting the a Tk.5,000 cash dividend to shareholders.
last Sunday in November. Pioneer will start work on the
content of the flyers in November. Payment of Tk.7,000 is Oct. 20 Dividends 5,000
due following delivery of the Sunday papers containing the Cash 5,000
flyers.

A business transaction has not occurred. There is only an Cash Dividends

agreement between Pioneer Advertising and the newspaper for Debit Credit Debit Credit
the services to be provided in November. Therefore, no journal
100,000 9,000 5,000
entry is necessary in October.
12,000 6,000
5,000
 Posting Posting
10. October 31: Pioneer receives Tk.28,000 in cash and bills
9. October 26: Employees are paid every four weeks. The
Copa Company Tk.72,000 for advertising services of
total payroll is Tk.2,000 per day. The pay period ended on
Tk.100,000 provided in October.
Friday, October 26, with salaries of Tk40,000 being paid.
Oct. 31 Cash 28,000
Oct. 26 Salaries and Wages Expense 40,000 Accounts Receivable 72,000
Cash 40,000 Service Revenue 100,000

Cash Accounts Receivable Service Revenue

Cash Salaries and Wages Expense
Debit Credit Debit Credit Debit Credit
Debit Credit Debit Credit
100,000 9,000 72,000 100,000
100,000 9,000 40,000
12,000 6,000
12,000 6,000
28,000 5,000
5,000
40,000
40,000
80,000

Trial Balance

A Trial Balance
 List of each account and its balance in the order in
which they appear in the ledger.

 Debit balances listed in the left column and credit

balance in the right column.

 Used to prove the mathematical equality of debit and

credit balances.

 Uncovers errors in journalizing and posting.

3
Adjusting Entries
Financial Reporting Mechanics
Makes it possible to:
 Report on the statement of financial position the
appropriate assets, liabilities, and equity at the statement
LEARNING OBJECTIVES
date.
After studying this chapter, you should be able to:

1. Understand basic accounting terminology. 6. Prepare financial statements from the

 Report on the income statement the proper revenues
2. Explain double-entry rules.
adjusted trial balance. and expenses for the period.
7. Prepare closing entries.
3. Identify steps in the accounting cycle. ► Revenues are recorded in the period in which services
8. Prepare financial statements for a
4. Record transactions in journals, post to ledger
merchandising company. are performed.
accounts, and prepare a trial balance.

5. Explain the reasons for preparing ► Expenses are recognized in the period in which they are
adjusting entries. incurred.
Adjusting Entries Adjusting Entries for Deferrals

Types of Adjusting Entries Deferrals are expenses or revenues that are recognized at a
Illustration
date later than the point when cash was originally exchanged.
Deferrals Accruals
Two types of deferrals
1. Prepaid Expenses. Expenses 3. Accrued Revenues.  Prepaid expenses
paid in cash before they are Revenues for services
used or consumed. performed but not yet  Unearned revenues
received in cash or recorded.
If a company does not make an adjustment for these deferrals,
2. Unearned Revenues. 4. Accrued Expenses.
Cash received before Expenses incurred but not  the asset and liability are overstated, and
services are performed. yet paid in cash or recorded.
 the related expense and revenue are understated.

Adjusting Entries for Prepaid Expenses

Prepaid Expenses. Assets paid for and recorded before a

company uses them.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

 Insurance  Rent
 Supplies  Buildings and equipment
 Advertising

ILLUSTRATION Adjusting Entries for Deferrals

Adjusting Entries for Prepaid Expenses Adjusting Entries for Prepaid Expenses

Supplies. Pioneer purchased advertising supplies costing Supplies. An inventory count at the close of business on
Tk.25,000 on October 5. Prepare the journal entry to record October 31 reveals that Tk.10,000 of supplies are still on hand.
the purchase of the supplies.
Oct. 31 Supplies Expense 15,000
Oct. 5 Supplies 25,000 Supplies 15,000
Cash 25,000
Supplies Supplies Expense
Supplies Cash
Debit Credit Debit Credit
Debit Credit Debit Credit
25,000 15,000 15,000
25,000 25,000

10,000
Adjusting Entries for Adjusting Entries for Prepaid Expenses
Prepaid Expenses
Statement
Statement Presentation:
Presentation:
Supplies expense
Supplies identifies that shows a balance of
portion of the asset’s Tk.15,000, which
cost that will provide equals the cost of
future economic benefit. supplies used in
October

ILLUSTRATION
ILLUSTRATION

Adjusting Entries for Prepaid Expenses Adjusting Entries for Prepaid Expenses

Insurance. On Oct. 4th, Pioneer paid Tk.6,000 for a one-year fire Insurance. An analysis of the policy reveals that Tk.500 (Tk.6,000
insurance policy, beginning October 1. Show the entry to ÷ 12) of insurance expires each month. Thus, Pioneer makes the
record the purchase of the insurance. following adjusting entry.

Oct. 4 Prepaid Insurance 6,000 Oct. 31 Insurance Expense 500

Cash 6,000 Prepaid Insurance 500

Prepaid Insurance Cash Prepaid Insurance Insurance Expense

Debit Credit Debit Credit Debit Credit Debit Credit
6,000 6,000 6,000 500 500

5,500

Adjusting Entries for Adjusting Entries for Prepaid Expenses

Prepaid Expenses
Statement
Statement Presentation:
Presentation:
Insurance
Prepaid Insurance expense identifies
represents the that portion of the
unexpired cost for asset’s cost that
the remaining 11 expired in
months of October.
coverage.

ILLUSTRATION
ILLUSTRATION
 Adjusting Entries for Prepaid Expenses Adjusting Entries for
Prepaid Expenses
Depreciation. Pioneer estimates depreciation on its office
equipment to be Tk.400 per month. Pioneer recognizes Statement
depreciation for October by the following adjusting entry. Presentation:
Oct. 31 Depreciation Expense 400 Accumulated
Accumulated Depreciation 400 Depreciation—is a
contra asset
account.
Depreciation Expense Accumulated Depreciation
Debit Credit Debit Credit
400 400

ILLUSTRATION

Adjusting Entries for Prepaid Expenses Adjusting Entries for Unearned Revenues

Receipt of cash before the services are performed is recorded

Statement
as a liability called unearned revenues.
Presentation:
Depreciation Cash Receipt BEFORE Revenue Recorded
expense identifies
that portion of the Unearned revenues often occur in regard to:
asset’s cost that
expired in  Rent  Magazine subscriptions
October.  Airline tickets  Customer deposits
 Tuition

ILLUSTRATION

Adjusting Entries for Unearned Revenues Adjusting Entries for Unearned Revenues

Unearned Revenue. Pioneer received ₺12,000 on October 2 Unearned Revenues. An evaluation of the service Pioneer
from KC for advertising services expected to be completed by performed for Knox during October, the company determines
December 31. Show the journal entry to record the receipt on that it should recognize 4,000 of revenue in October.
Oct. 2nd.
Oct. 31 Unearned Service Revenue 4,000
Oct. 2 Cash 12,000 Service Revenue 4,000
Unearned Service Revenue 12,000
Service Revenue Unearned Service Revenue
Cash Unearned Service Revenue
Debit Credit Debit Credit
Debit Credit Debit Credit
100,000 4,000 12,000
12,000 12,000
4,000
8,000
Adjusting Entries for Adjusting Entries for Unearned Revenues
Unearned Revenues
Statement
Statement
Presentation:
Presentation:
Service revenue
Unearned service
shows total revenue
revenue represents the
recognized in
remaining advertising
October.
services expected to be
performed in the future.

ILLUSTRATION
ILLUSTRATION

Adjusting Entries for Accruals

Accruals are made to record

 revenues for services performed and

 expenses incurred in the current accounting period.

Without an accrual adjustment, the

 revenue account (and the related asset account) or the

 expense account (and the related liability account) are

understated.

ILLUSTRATION Adjusting Entries for Accruals

Adjusting Entries for Accrued Revenues Adjusting Entries for Accrued Revenues

Revenues recorded for services performed for which cash has Accrued Revenues. In October Pioneer performed services
yet to be received at statement date are accrued revenues. worth Tk.2,000 that were not billed to clients on or before
October 31. Pioneer makes the following adjusting entry.
Adjusting entry results in:
Oct. 31 Accounts Receivable 2,000
Revenue Recorded BEFORE Cash Receipt Service Revenue 2,000

Accrued revenues often occur in regard to: Accounts Receivable Service Revenue
Debit Credit Debit Credit
 Rent
72,000 100,000
 Interest
2,000 4,000
 Services performed 2,000
74,000 106,000
 ILLUSTRATION

Adjusting Entries for Adjusting Entries for Accrued Expenses

Accrued Revenues
Expenses incurred but not yet paid in cash or recorded.

ILLUSTRATION
Adjusting entry results in:

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

 Rent  Taxes
 Interest  Salaries

Statement Presentation

Adjusting Entries for Accrued Expenses Adjusting Entries for Accrued Expenses

Accrued Interest. Pioneer signed a three-month, 12%, note Accrued Interest. Pioneer signed a three-month, 12%, note
payable in the amount of Tk.50,000 on October 1. The note payable in the amount of Tk.50,000 on October 1. Prepare the
requires interest at an annual rate of 12 percent. Three factors adjusting entry on Oct. 31 to record the accrual of interest.
determine the amount of the interest accumulation:
Oct. 31 Interest Expense 500
ILLUSTRATION
Formula for Computing Interest Payable 500
1 2 3 Interest

Interest Expense Interest Payable

Debit Credit Debit Credit
500 500

ILLUSTRATION

Adjusting Entries for Adjusting Entries for Accrued Expenses

Accrued Expenses

ILLUSTRATION

Accrued Salaries. At October 31, the salaries and wages for these
days represent an accrued expense and a related liability to
Pioneer. The employees receive total salaries of Tk.10,000 for a
five-day work week, or Tk.2,000 per day.

Statement Presentation
 ILLUSTRATION

Adjusting Entries for Accrued Expenses Adjusting Entries for

Accrued Expenses
Accrued Salaries. Employees receive total salaries of Tk.10,000
for a five-day work week, or Tk.2,000 per day. Prepare the
adjusting entry on Oct. 31 to record accrual for salaries. ILLUSTRATION

Oct. 31 Salaries and Wages Expense 6,000

Salaries and Wages Payable 6,000

Salaries and Wages Expense Salaries and Wages Payable

Debit Credit Debit Credit
40,000 6,000
6,000

46,000
Statement Presentation

Adjusting Entries for Accrued Expenses Adjusting Entries for Accrued Expenses

Accrued Salaries. On November 23, Pioneer will again pay total Bad Debts. Assume Pioneer reasonably estimates a bad debt
salaries of Tk.40,000. Prepare the entry to record the payment of expense for the month of Tk.1,600. It makes the adjusting entry
salaries on November 23. for bad debts as follows.

Nov. 23 Salaries and Wages Payable 6,000 Oct. 31 Bad Debt Expense 1,600
Salaries and Wages Expense 34,000 Allowance for Doubtful Accounts 1,600
Cash 40,000
ILLUSTRATION
Adjustment for Bad Debt
Expense
Salaries and Wages Expense Salaries and Wages Payable
Debit Credit Debit Credit
34,000 6,000 6,000

ILLUSTRATION

Adjusting Entries for Adjusted

Accrued Expenses Trial
Balance
ILLUSTRATION
Shows the balance
of all accounts,
after adjusting
entries, at the end
of the accounting
period.

Proves the equality

of the total debit
and credit balances

Statement Presentation ILLUSTRATION

 3
Preparing Financial Statements
Financial Reporting Mechanics
Financial Statements are prepared directly from the
Adjusted Trial Balance.
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Understand basic accounting terminology. 6. Prepare financial statements from the

2. Explain double-entry rules. adjusted trial balance.
Retained Statement
3. Identify steps in the accounting cycle. 7. Prepare closing entries. Income
Earnings of Financial
4. Record transactions in journals, post to ledger 8. Prepare financial statements for a Statement
accounts, and prepare a trial balance. merchandising company. Statement Position
5. Explain the reasons for preparing adjusting
entries.

ILLUSTRATION Preparation of the Income

Statement and Retained Earnings Statement from
the Adjusted Trial Balance ILLUSTRATION
Preparation of the Statement of Financial Position from the Adjusted Trial Balance

3
Financial Reporting Mechanics
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Understand basic accounting terminology.
2. Explain double-entry rules.
3. Identify steps in the accounting cycle.
4. Record transactions in journals, post to ledger
accounts, and prepare a trial balance.
5. Explain the reasons for preparing adjusting
entries.
Closing Entries
Basic Process
 Reduce the balance of nominal (temporary) accounts to zero
in preparation for the next period’s transactions.
 Transfer all revenue and expense account balances (income
statement accounts) to Retained Earnings.
6. Prepare financial statements from the
adjusted trial balance.  Statement of financial position (asset, liability, and equity)
7. Prepare closing entries. accounts are not closed.
8. Prepare financial statements for a
merchandising company.  Dividends are closed directly to Retained Earnings.
 Income Summary account may be used however it has no
effect on the financial statements.
Closing Entries Illustration 3-38

ILLUSTRATION

Closing Journal Entries:

Retained Earnings 5,000

Dividends 5,000

Service Revenue 106,000

Salaries & Wages Expense 46,000
Supplies Expense 15,000
Rent Expense 9,000
Insurance Expense 500
Interest Expense 500
Depreciation Expense 400
Bad Debt Expense 1,600
Retained Earnings 33,000

ILLUSTRATION

3
Accounting Cycle Summarized
Financial Reporting Mechanics
1. Enter the transactions of the period in appropriate journals.
2. Post from the journals to the ledger (or ledgers).
3. Prepare an unadjusted trial balance (trial balance).
LEARNING OBJECTIVES
4. Prepare adjusting journal entries and post to the ledger(s).
After studying this chapter, you should be able to:
5. Prepare a trial balance after adjusting (adjusted trial balance).
1. Understand basic accounting terminology. 6. Prepare financial statements from the
6. Prepare the financial statements from the adjusted trial balance. adjusted trial balance.
2. Explain double-entry rules.
7. Prepare closing entries.
3. Identify steps in the accounting cycle.
7. Prepare closing journal entries and post to the ledger(s).
4. Record transactions in journals, post to ledger 8. Prepare financial statements for a
8. Prepare a trial balance after closing (post-closing trial balance). accounts, and prepare a trial balance. merchandising company.
5. Explain the reasons for preparing adjusting
9. Prepare reversing entries (optional) and post to the ledger(s). entries.

ILLUSTRATION

Financial Statements of a Merchandising Company

Merchandising ILLUSTRATION
Company
Financial
Statements of a
Merchandising
Company

ILLUSTRATION