LESSON 2: REVIEW OF THE ACCOUNTING PROCESS

DEBIT CREDIT

1. Uncollectible Accounts Allowance for Uncollectible Accounts

2. Prepaid Rent Rent Expense

3. Office Supplies on Hand Supplies Expense

4. Salary Expense Salaries Payable

5. Insurance Expense Prepaid Insurance

6. Interest Receivable Interest Income

7. Interest Expense Interest Payable

8. Rent Income Unearned Rent Income

9. Depreciation Expense Accumulated Depreciation

10. Inventory, End Income Summary

THE ACCOUNTING CYCLE

 Recording Phase
1. Preparing or receiving the appropriate documents (documentation)
2. Journalizing the transactions
3. Posting the recorded transaction to the accounts in the ledger
 Summarizing Phase
1. Preparing the trial balance
2. Compiling the data for adjustments
3. Preparing the worksheet (optional)
4. Preparing the financial statements
5. Adjusting and closing the books
6. Preparing a post post-closing trial balance
7. Preparing reversing entries for certain adjusting entries (optional)
ADJUSTING ENTRIES

These are entries made prior to the preparation of financial statements to update certain
accounts so that they reflect correct balances as of the designated time. The importance of
making the adjusting entry for the income and expenses will be reported in the period they are
earned and incurred, respectively.

ACCOUNTS THAT NEED ADJUSTING ENTRY

1. Accrued revenues
2. Accrued expense
3. Unearned revenue
4. Prepaid expenses
5. Depreciation and other allocation
6. Allowance for uncollectible accounts
7. Inventory recorded using the periodic inventory system

ACCRUED REVENUES

Accrued revenues are income earned, but not yet received or collected.

 Adjusting entry for accrued revenue:

Receivable xx

Income xx

ACCRUED EXPENSE

Accrued expense is an expense incurred, but not yet paid.

 Adjusting entry for accrued expense:

 Expense xx

Payable xx

UNEARNED REVENUE

This is income already collected but, not yet rendered. Unearned revenue is also called
deferred income. There are two methods of recording unearned revenue:

 Liability Method

 Income Method

 Liability Method
The collection is initially credited to a liability account, where at the end of the
accounting period, the unearned portion of the income is transferred to an income
account.
 Recording the initial payment of expense (Journal Entry)
Cash xx
Unearned Revenue xx

 Adjusting entry for the liability method

Unearned Income xx

Income xx

 Income Method
The collection is initially credited to an income account, where at the end of the
accounting period, the unearned portion of the income is transferred to a liability account.

 Recording the initial payment of expense (Journal Entry)

Cash xx

Income xx
  Adjusting entry for the income method

Income xx

Unearned Income xx

PREPAID EXPENSE

This is an expense-paid or acquired in advance. It is initially recorded as an asset, but the

value is expensed over time. There are two methods of recording prepaid expenses or
prepayments:

 Asset Method

 Expense Method

 Asset Method
The payment or purchase is initially debited to an asset account, where at the end
of the accounting period, the expired or used portion is transferred to an expense account.
 Recording the initial payment of expense (Journal Entry)
Prepaid Expense xx
Cash xx
 Adjusting entry for the asset method
Expense xx
Prepaid Expense xx
 Expense Method
The payment or purchase is initially debited to an expense account, where at the
end of the accounting period, the unexpired or used portion is transferred to an asset
account.

 Recording the initial payment of expense (Journal Entry)

Expense xx
Cash xx
  Adjusting entry for the expense method
Prepaid Expense xx
Cash xx

DEPRECIATION OF PROPERTY, PLANT, & EQUIPMENT & OTHER ALLOCATION

Depreciation is the systematic allocation of the depreciable amount of an item of

property, plant, and equipment over its useful life. In addition, a depreciable amount is the cost
of an asset, or other amounts substituted for cost, less its residual value.

 Adjusting entry for depreciation:

Depreciation Expense xx

Accumulated Depreciation xx

 Single-line method:

Cost−Residual Value
Depreciation expense/year =
Extimated Useful Life

ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS

This account represents the customer’s account where it may no longer be collected or
that any possibly become bad debts.

 Adjusting entry for uncollectible account:

Uncollectible Account Expense xx

Allowance for Uncollectible Account xx

 To get the uncollectible account expense:

 Required allowance balance Pxx

Allowance balance before adjustment xx

(+ debit balance or (-) credit balance)

Uncollectible account expense for the period Pxx

INVENTORY (RECORDED USING THE PERIODIC INVENTORY SYSTEM)

Adjustment for inventory is necessary if the periodic inventory system is used. The
company does not record the physical movement of goods but purchases of goods are recorded
in the nominal account “purchases”. There are two methods in recording the adjustments:

 First Method

 Second Method

 First Method
Two entries are prepared which are transferring the beginning inventory balance
to the income summary account and establishing an ending inventory balance.
 To transfer beginning inventory balance to income summary
Income Summary xx
Inventory (Merchandise Inventory) xx
 To record ending inventory balance
Inventory (Merchandising Inventory) xx
Income Summary xx]

 Expense Method

In this method, a separate cost of goods sold account is set up.

 To record the adjusting entry:

 Inventory (or Merchandising Inventory), end xx

Purchase returns and allowances xx

Purchase discounts xx

Cost of goods sold xx

Inventory (or Merchandising Inventory), beg. xx

Purchases xx

Freight-in xx

CLOSING ENTRIES

The closing entry process enables you to determine net income or retained earnings for
the current accounting period. The purpose of the closing entry is to reset the temporary account
balances to zero on the general ledger. Temporary accounts are used to record accounting
activity during a specific period. It resets the account balance to zero, so you can properly track
income and categorize business expenses for the next accounting period and all periods that
follow.

Example of closing entries

REVERSING ENTRIES

 The reversing entry typically occurs at the beginning of an accounting period.

 These entries are made to reverse certain adjusting entries of the previous period.

 This is optional but, doing it simplifies the recording process of the next accounting
period. However, not all adjusting entries may be reversed.

 Adjusting entry that may be reversed:

1. Accrued income
2. Accrued expense
3. Unearned revenue using the income method
4. Prepaid expenses using the expense method

Notes:

 Adjusting journal entries involving "receivables" and "payables" are normally reversible.

 Adjusting journal entries involving "depreciation" and "bad debts" are not reversible.

 Reversing entries are the EXACT OPPOSITES of the adjusting journal entries.