Summary Accounting 19-20

ACCOUNTING SUMMARY
Chapter 1: Accounting in Action............................................................................................................7

LO 1: Identify the activities and users associated with accounting....................................................7
Accounting Activities and Users.....................................................................................................7
Who Uses Accounting Data...........................................................................................................7
LO 2: Explain the building blocks of accounting: ethics, principles, and assumptions.......................8
Generally Accepted Accounting Principles....................................................................................8
Measurement Principles................................................................................................................8
Assumptions..................................................................................................................................8
Forms of Business Ownership........................................................................................................9
LO 3: State the accounting equation and define its components......................................................9
The Accounting Equation...............................................................................................................9
LO 4: Analyze the effects of business transactions on the accounting equation.............................10
Analyzing Business Transactions..................................................................................................10
Summary of Transactions............................................................................................................10
LO 5: Describe the four financial statements and how they are prepared......................................11
The Four Financial Statements....................................................................................................11
Income Statement...................................................................................................................11
Owner’s Equity Statement.......................................................................................................11
Statement of Financial Position...............................................................................................11
(Statement of Cash Flow).........................................................................................................11
Differences GAAP/IFRS....................................................................................................................12
Similarities...................................................................................................................................12
Differences...................................................................................................................................12
Looking to The Future..................................................................................................................12
Chapter 2: The Recording Process.......................................................................................................13
LO 1: Describe how accounts, debits, and credits are used to record business transactions..........13
Accounts, Debits, and Credits......................................................................................................13
The Account.............................................................................................................................13
Debits and Credits....................................................................................................................13
Debit and Credit Procedure.....................................................................................................13
Summary of Debit / Credit Rules.............................................................................................14
LO 2: Indicate how a journal is used in the recording process.........................................................15
The Journal..................................................................................................................................15
LO 3: Explain how a ledger and posting help in the recording process............................................16
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The Ledger and Posting...............................................................................................................16
The Recording Process Illustrated................................................................................................17
LO 4: Prepare a trial balance............................................................................................................17
Limitations of a Trial Balance.......................................................................................................17
Similarities...................................................................................................................................18
Differences...................................................................................................................................18
Looking to the Future..................................................................................................................18
Chapter 3: Adjusting the Accounts......................................................................................................19
LO 1: Explain the accrual basis of accounting and the reasons for adjusting entries.......................19
Accrual-Basis and Adjusting Entries.............................................................................................19
Fiscal and Calendar Years............................................................................................................19
Accrual- versus Cash-Basis Accounting........................................................................................19
Recognizing Revenues and Expenses...........................................................................................20
Revenue Recognition Principle................................................................................................20
Expense Recognition Principle.................................................................................................20
The Need for Adjusting Entries....................................................................................................21
LO 2: Prepare adjusting entries for deferrals...................................................................................22
Prepaid Expenses.........................................................................................................................22
Example Supplies.....................................................................................................................22
Example Insurance...................................................................................................................23
Depreciation............................................................................................................................23
Example Depreciation..............................................................................................................23
Unearned Revenues....................................................................................................................24
Example Unearned Revenues..................................................................................................24
LO 3: Prepare adjusting entries for accruals....................................................................................25
Adjusting Entries for Accruals......................................................................................................25
Accrued Revenues.......................................................................................................................25
Example of Accrued Revenues.................................................................................................25
Accrued Expenses........................................................................................................................26
Example of Interest Expense....................................................................................................26
Example of Salaries and Wages Expense.................................................................................26
LO 4: Describe the nature and purpose of an adjusted trial balance...............................................27
Adjusted Trial Balance.................................................................................................................27
Preparing Financial Statements...................................................................................................28
Appendix 3B: Financial Reporting Concepts....................................................................................29
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Qualities of Useful Information...................................................................................................29
Two fundamental qualities......................................................................................................29
Enhancing Qualities.................................................................................................................29
Assumptions in Financial Reporting.............................................................................................29
Measurement Principles..............................................................................................................30
Cost Constraint............................................................................................................................30
Principles of Financial Reporting..................................................................................................30
Summary.........................................................................................................................................31
Similarities...................................................................................................................................32
Differences...................................................................................................................................32
Chapter 4: Completing the Accounting Cycle......................................................................................33
LO 1: Prepare a worksheet. (NOT)...................................................................................................33
LO 2: Prepare closing entries and a post-closing trial balance.........................................................33
Closing the Books.........................................................................................................................33
Preparing Closing Entries.............................................................................................................34
Example of Closing Entries & Post-Closing Trial Balance.........................................................34
Example of Post-Closing Trial Balance.....................................................................................34
LO 3: Explain the steps in the accounting cycle and how to prepare correcting entries..................35
The accounting Cycle...................................................................................................................35
Correcting Entries – An Avoidable Step.......................................................................................35
Example of Correcting Entries..................................................................................................35
LO 4: Identify the sections of a classified statement of financial position.......................................36
Classified Statement of Financial Position...................................................................................36
Intangible Assets......................................................................................................................36
Property, Plant, and Equipment..............................................................................................36
Long-Term Investments...........................................................................................................36
Current Assets.........................................................................................................................36
Owner’s Equity........................................................................................................................36
Non-Current Liabilities.............................................................................................................36
Current Liabilities.....................................................................................................................36
Similarities...................................................................................................................................37
Differences...................................................................................................................................37
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Chapter 5: Accounting for Merchandise Operations...........................................................................38
LO 1: Describe merchandising operations and inventory systems..................................................38
Merchandising Operations and Inventory Systems.....................................................................38
Income Measurement.............................................................................................................38
Operating Cycles..........................................................................................................................38
Service Company.....................................................................................................................38
Merchandising Company.........................................................................................................38
Flow of Costs...............................................................................................................................39
Perpetual System.....................................................................................................................39
Periodic System.......................................................................................................................39
Advantages of the Perpetual System.......................................................................................39
LO 2: Record purchases under a perpetual inventory system.........................................................40
Recording Purchases Perpetual System.......................................................................................40
Freight Costs................................................................................................................................40
Example Freight Costs..............................................................................................................40
Purchase Returns and Allowances...............................................................................................41
Purchase Discounts......................................................................................................................41
Summary of Purchasing Transactions..........................................................................................41
LO 3: Record sales under a perpetual inventory system..................................................................42
Recording Sales Perpetual System...............................................................................................42
Sales Returns and Allowances.....................................................................................................42
Sales Discounts............................................................................................................................42
LO 4: Apply the steps in the accounting cycle to a merchandising company...................................43
The Accounting Cycle for a Merchandising Company.................................................................43
Adjusting Entries......................................................................................................................43
Closing Entries.........................................................................................................................43
Recording Merchandise Transactions..........................................................................................44
Recording Sales of Merchandise..................................................................................................44
Closing Entries.............................................................................................................................44
Appendix 5B: Periodic Inventory System.....................................................................................44
Determining Cost of Goods Sold Under a Periodic System......................................................44
LO 5: Prepare financial statements for a merchandising company..................................................45
Income and Comprehensive Income Statements........................................................................45
Nonoperating Activities...............................................................................................................45
Other Revenues and Gains......................................................................................................45
Other Expenses and Losses......................................................................................................45
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Comprehensive Income Statement.............................................................................................46
Classified Statement of Financial Position...................................................................................46
Similarities...................................................................................................................................47
Differences...................................................................................................................................47
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Chapter 1: Accounting in Action
LO 1: IDENTIFY THE ACTIVITIES AND USERS ASSOCIATED WITH ACCOUNTING.
Accounting Activities and Users
Accounting consists of three activities
1. Identification – Select economic events (transactions)
2. Recording - Record, classify, and summarize
3. Communication
• Prepare accounting reports
• Analyze and interpret for users
Who Uses Accounting Data

Internal Users
• Finance - Is cash sufficient to pay dividends to SAP shareholders?
• Marketing – What price should Nokia charge for a cell phone to maximize the company's net
income?
• Human Resources – Can Toyota afford to give its employees pay raises this year?
• Management - Which PepsiCo product line is the most profitable? Should any product lines
be eliminated?
External Users
• Investors
 Is Lenovo earning satisfactory income?
 How does Disney compare in size and profitability with Time Warner?
• Creditors – Will Singapore Airlines be able to pay its debts as they come due?
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LO 2: EXPLAIN THE BUILDING BLOCKS OF ACCOUNTING: ETHICS, PRINCIPLES, AND
ASSUMPTIONS.
Generally Accepted Accounting Principles
Standards that are generally accepted and universally practiced. These standards indicate how to
report economic events.
Standard-setting bodies:
• Financial Accounting Standards Board (FASB)
• International Accounting Standards Board (IASB)
Measurement Principles
Historical Cost Principle (or cost principle)
• Record assets at their cost.
Fair Value Principle
• Assets and liabilities should be reported at fair value (the price received to sell an asset or
settle a liability)
Selection of which principle to follow generally relates to trade-offs between relevance and faithful
representation.
Assumptions
Monetary Unit Assumption
• Include in accounting records only transaction data that can be expressed in terms of money
Economic Entity Assumption
• Activities of entity be kept separate and distinct from activities of its owner and all other
entities
 Proprietorship
Forms of Business
 Partnership
 Corporation Ownership
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Forms of Business Ownership
Proprietorship Partnership Corporation
• Owned by one person • Owned by two or more • Ownership divided into

• Owner is often persons shares
manager/operator • Often retail and service- • Separate legal entity
• Owner receives any profits, type businesses organized under state
suffers any losses, and is • Generally unlimited corporation law
personally liable for all personal liability • Limited liability
debts • Partnership agreement
LO 3: STATE THE ACCOUNTING EQUATION AND DEFINE ITS COMPONENTS.

The Accounting Equation
Assets = Liabilities + Owner's Equity
Basic Accounting Equation

• Provides underlying framework for recording and summarizing economic events
• Assets are claimed by either creditors or owners
• If a business is liquidated, claims of creditors must be paid before ownership claims
Assets
• Resources a business owns
• Provide future services or benefits
• Cash, Supplies, Equipment, etc.
Liabilities
• Claims against assets (debts and obligations)
• Creditors (party to whom money is owed)
• Accounts Payable, Notes Payable, Salaries and Wages Payable, etc.
Owner’s Equity
• Ownership claim on total assets
• Referred to as residual equity
• Investment by owners and revenues (+)
• Drawings and expenses (-)
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Equation Assets = Liabilities + Owner's Equity
Expanded Owner's Owner's

Assets = Liabilities + - + Revenues - Expenses
Equation Capital Drawings
Increase in Owner’s Equity

• Investment by Owner. Assets the owner puts into the business
• Revenues. Increases in assets or decreases in liabilities resulting from sale of goods or
performance of services in normal course of business
•
Decrease in Owner’s Equity
• Drawings. A withdraw of cash or other assets for personal use
• Expenses. Cost of assets consumed, or services used in the process of earning revenue
LO 4: ANALYZE THE EFFECTS OF BUSINESS TRANSACTIONS ON THE ACCOUNTING

EQUATION.
Analyzing Business Transactions
Transactions are a business’s economic events recorded by accountants.
• May be external or internal
• Not all activities represent transactions
• Have a dual effect on the accounting equation
Summary of Transactions
1. Each transaction analyzed in terms of effect on:
a. Three components of basic accounting equation
• Assets
• Liabilities
• Owner’s equity
b. Specific types of items, such as Cash
2. Two sides of equation must always be equal
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LO 5: DESCRIBE THE FOUR FINANCIAL STATEMENTS AND HOW THEY ARE PREPARED.
The Four Financial Statements
Companies prepare four financial statements:
Income Statement Owner's Equity Statement of Statement

Statement Financial Position of Cash Flows
Income Statement
• Reports revenues and expenses for a specific
period of time
• Lists revenues first, followed by expenses
• Shows net income (or net loss)
• Does not include investment and withdrawal
transactions between owner and business in
measuring net income
Owner’s Equity Statement

• Reports changes in owner’s equity for a specific
period of time
• Time period is the same as that covered by the
income statement
Statement of Financial Position

• Reports assets, liabilities, and owner's equity at
a specific date
• Lists assets at top, followed by liabilities and
owner’s equity
• Total assets must equal total owner’s equity and
liabilities
• Snapshot of company’s financial condition at a
specific moment in time (usually month-end or
year-end)
(Statement of Cash Flow)

• Information on cash receipts and payments for a specific period of time
• Answers the following:
 Where did cash come from?
 What was cash used for?
 What was change in cash balance?
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DIFFERENCES GAAP/IFRS
Similarities
• GAAP based on a similar conceptual framework as IFRS.
• Three common forms of organization (proprietorship, partnership and corporations)
• Transaction analysis is the same
• Financial frauds
Differences
• Sarbanes-Oxley Act (SOX) mandates internal controls for large public companies listed on U.S.
exchanges. Debate: non-US companies also need to comply with extra layer or regulation?
• US regulators have recently eliminated the need for foreign companies that trade shares in US
markets to reconcile their accounting with GAAP
• IFRS less detailed in its accounting and disclosure requirements than GAAP. (Principle based
IFRS vs Rules based GAAP)
Looking to The Future

Both the IASB and the FASB are hard at work developing standards that will lead to the elimination
of major differences in the way certain transactions are accounted for and reported.
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Chapter 2: The Recording Process
LO 1: DESCRIBE HOW ACCOUNTS, DEBITS, AND CREDITS ARE USED TO RECORD BUSINESS
TRANSACTIONS.
Accounts, Debits, and Credits
The Account
• Record of increases and decreases in a specific asset, liability, owner’s equity, revenue, or
expense item.
• Debit = “Left”
• Credit = “Right”
An account can be
illustrated in a T-account
form.
Questions?
• What parts of the accounting equation will be affected by this transaction? Asset, Liability,
Owner’s Equity, …
• For what amount?
• Will the account be increased or decreased in this transaction?
• Type of account + increase/decrease  debit or credit
Debits and Credits

If the sum of Debit entries are greater than the sum of Credit entries, the account will have a debit
balance.
If the sum of Credit entries are greater than the sum of Debit entries, the account will have a credit
balance.
Debit and Credit Procedure

Double-entry system
• Each transaction must affect two or more accounts to keep basic accounting equation in
balance
• Recording done by debiting at least one account and crediting at least one other account
• DEBITS must equal CREDITS
Assets - Debits should exceed credits

Liabilities - Credits should exceed debits
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Normal balance is on the increase side
Owner’s investments and revenues increase owner’s equity (credit)

Owner’s drawings and expenses decrease owner’s equity (debit)
Earning revenues is to benefit owner(s)

Effect of debits and credits on revenue accounts is the same as effect on Owner’s Capital
Expenses have opposite effect
Summary of Debit / Credit Rules
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LO 2: INDICATE HOW A JOURNAL IS USED IN THE RECORDING PROCESS.
The Journal
The Recording Process

• Analyze transaction
• Enter transaction in journal
• Transfer journal information to ledger accounts
The Journal
• Book of original entry
• Transactions recorded in chronological order
• Contributions to the recording process:
• Discloses the complete effects of a transaction
• Provides a chronological record of transactions
• Helps to prevent or locate errors because the debit and credit amounts can be easily
compared
 Journalizing - Entering transaction data in the journal.
+
Ex. Date Account name A/L/CA/E/R/CR/OE/IS/CE or Debit Credit
-
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LO 3: EXPLAIN HOW A LEDGER AND POSTING HELP IN THE RECORDING PROCESS.
The Ledger and Posting
The Ledger
• Entire group of accounts
maintained by a company
• Provides the balance in each
account
• Keeps track of changes in
account balances
 General ledger contains all asset, liability, and owner’s equity accounts
ILLUSTRATION 2.17
Posting a journal entry
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The Recording Process Illustrated
Follow these steps:
1. Determine what type of account is involved.
2. Determine what items increased or decreased and by how much.
3. Translate the increases and decreases into debits and credits.
ILLUSTRATION 2.19
LO 4: PREPARE A TRIAL BALANCE.

Limitations of a Trial Balance
Trial balance may balance even when:
1. A transaction is not journalized.
2. A correct journal
entry is not posted.
3. A journal entry is
posted twice.
4. Incorrect accounts
are used in
journalizing or
posting.
5. Offsetting errors
are made in
recording the
amount of a
transaction.
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Locating Errors
Errors in a trial balance generally result from
• mathematical mistakes,
• incorrect postings,
• or simply transcribing data incorrectly.
Currency Signs
• Do not appear in journals or ledgers
• Typically used only in trial balance and financial statements
• Shown only for first item in column and for the total of that column
Underlining
• Single line is placed under column of figures to be added or subtracted
• Totals are double-underlined
Similarities
• Transaction analysis is the same under IFRS and GAAP.
• Both the IASB and the FASB go beyond the basic definitions provided in this textbook for the
key elements of financial statements, that is assets, liabilities, equity, revenues, and
expenses. The more substantive definitions, using the FASB definitional structure, are
provided in the Chapter 1 A Look at U.S. GAAP section.
• As shown in the textbook, currency signs are typically used only in the trial balance and the
financial statements. The same practice is followed under GAAP, using the U.S. dollar.
• A trial balance under GAAP follows the same format as shown in the textbook.
Differences
• IFRS relies less on historical cost and more on fair value than U.S. companies.
• The statement of financial position is often called the balance sheet in the United States.
Looking to the Future

The basic recording process shown in this textbook is followed by companies across the globe. It is
unlikely to change in the future. The definitional structure of assets, liabilities, equity, revenues, and
expenses may change over time as the IASB and FASB evaluate their overall conceptual framework
for establishing accounting standards.
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Chapter 3: Adjusting the Accounts
LO 1: EXPLAIN THE ACCRUAL BASIS OF ACCOUNTING AND THE REASONS FOR ADJUSTING
ENTRIES.
Accrual-Basis and Adjusting Entries
Accountants divide the economic life of a business into artificial time periods (Time Period
Assumption).
Generally a ALTERNATIVE TERMINOLOGY

• month, The time period assumption
• quarter, or is also called the
• year. periodicity assumption.
Fiscal and Calendar Years

• Monthly and quarterly time periods are called interim periods
• Most large companies must prepare both quarterly and annual financial statements
• Fiscal Year = Accounting time period that is one year in length
• Calendar Year = January 1 to December 31
Accrual- versus Cash-Basis Accounting
Accrual-Basis Accounting Cash-Basis Accounting
Transactions recorded in the periods in which

the events occur.
Companies recognize revenues when they Revenues recognized when cash is received.
perform services (rather than when they
receive cash).
Expenses are recognized when incurred (rather Expenses recognized when cash is paid.
than when paid).
In accordance with generally accepted Cash-basis accounting is not in accordance with

accounting principles (GAAP). generally accepted accounting principles
(GAAP).
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Source: EY: survey results accounting system trends
Recognizing Revenues and Expenses

Revenue Recognition Principle
Recognize revenue in the accounting period in which the performance
obligation is satisfied.
Expense Recognition Principle

Companies recognize expenses in the period in which they make eﬀorts (consume
assets or incur liabilities) to generate revenue.
“Let the expenses

follow the revenues.”
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The Need for Adjusting Entries
Adjusting Entries
• Ensure that the revenue recognition and expense recognition principles are followed.
• Necessary because the trial balance may not contain up-to-date and complete data.
• Required every time a company prepares financial statements.
• Will include one income statement account and one statement of financial position account.
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LO 2: PREPARE ADJUSTING ENTRIES FOR DEFERRALS.
Deferrals are expenses or revenues that are recognized at a date later than the point when cash was
originally exchanged. There are two types:
• Prepaid expenses
• Unearned revenues
Prepaid Expenses
Payments of expenses that are recorded as an asset to show the service or benefit the company will
receive in the future.
Prepayments often occur in regard to: Insurance, supplies, advertising, rent, equipment, buildings, …
 Expire either with the passage of time or through use

 Adjusting entry:
o Increase (debit) to an
expense account and
o Decrease (credit) to an
asset account
Example Supplies
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Example Insurance
Depreciation
 Buildings, equipment, and motor vehicles (assets that provide service for many years) are
recorded as assets, rather than an expense, on the date acquired
 Depreciation is the process of allocating the cost of an asset to expense over its useful life
 Depreciation does not attempt to report the actual change in the value of the asset
 Allocation concept, not a valuation concept
 Accumulated Depreciation is called a contra asset account.

 Offsets related asset account on the statement of financial position
 Book value is the difference between the cost of any depreciable asset and its accumulated
depreciation
Example
Depreciation
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Unearned Revenues
Receipt of cash that is recorded as a liability because the service has not been performed.
Unearned revenues often occur in regard to:

 Rent
 Airline tickets
 Magazine subscriptions
 Customer deposits
 Adjusting entry is made to record the revenue for services performed during the period and
to show the liability that remains
at the end of the period
 Results in a decrease (debit) to a
liability account and an increase
(credit) to a revenue account
Example Unearned Revenues
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LO 3: PREPARE ADJUSTING ENTRIES FOR ACCRUALS.
Adjusting Entries for Accruals
Accruals are made to record,
• Revenues for services performed but not yet recorded at the statement date
• Expenses incurred but not yet paid or recorded at the statement date
Accrued Revenues
Revenues for services performed but not yet received in cash or recorded.
Accrued revenues often occur in regard to:

 Rent
 Interest
 Services
 Adjusting entry records the receivable that exists and records the revenues for services
performed.
o Increases (debits) an asset account and
o Increases (credits) a revenue account
Example of
Accrued
Revenues
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Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Accrued expenses often occur in regard to rent, interest, taxes, salaries, …
 Adjusting entry records the obligation and recognizes the expense.

o Increase (debit) an expense
account and
o Increase (credit) a liability
account
Example of
Interest Expense
Example of
Salaries and
Wages Expense
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LO 4: DESCRIBE THE NATURE AND PURPOSE OF AN ADJUSTED TRIAL BALANCE.
Adjusted Trial Balance
• Prepared after adjusting entries are journalized and posted
• Proves equality of debit and credit balances
• Basis for the preparation of financial statements
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Preparing Financial Statements
Financial Statements are prepared directly from the Adjusted Trial Balance.
Owner’s Statement
Income
Equity of Financial
Statement
Statement Position
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APPENDIX 3B: FINANCIAL REPORTING CONCEPTS
Qualities of Useful Information
Two fundamental qualities
1. Relevance
• Make a difference in a business decision
• Provides information that has predictive value and confirmatory value
• Materiality is a company-specific aspect of relevance
 An item is material when its size makes it likely to influence the decision of an
investor or creditor
2. Faithful Representation
• Information accurately depicts what really happened.
• Information must be
 complete (nothing important has been omitted)
 neutral (is not biased toward one position or another)
 free from error
Enhancing Qualities
Assumptions in Financial Reporting
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Measurement Principles
Cost Constraint
Accounting standard-setters weigh the cost that companies
will incur to provide the information against the benefit that
financial statement users will gain from having the
information available.
Principles of Financial Reporting
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SUMMARY
Accounting for Prepaid Expenses
Reason for Account Before

Examples Adjusting Entry
Adjustment Adjustment
Insurance, supplies, Prepaid expense Assets overstated. Dr. Expenses

advertising, rent, originally recorded Expenses Cr. Assets
depreciation in asset accounts understated. or Contra
have been used. Assets
Accounting for Unearned Revenues

Rent, magazine Unearned revenues Liabilities overstated. Dr. Liabilities

subscriptions, recorded in liability Revenues
customer deposits for accounts are now understated. Cr. Revenues
future service recognized as revenue
for services
performed.
Accounting for Accrued Revenues

Interest, rent, services Services performed Assets understated. Dr. Assets

but not yet received in Revenues
cash or recorded. understated. Cr. Revenues
Accounting for Accrued Expenses

Interest, rent, salaries Expenses have been Expenses understated. Dr. Expenses
incurred but not yet
paid in cash or Liabilities understated. Cr. Liabilities
recorded.
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Similarities
 Like IFRS, companies applying GAAP also use accrual-basis accounting to ensure that they
record transactions that change a company’s financial statements in the period in which
events occur.
 Similar to IFRS, cash-basis accounting is not in accordance with GAAP.
 GAAP also divides the economic life of companies into artificial time periods. Under both
GAAP and IFRS, this is referred to as the time period assumption.
 The form and content of financial statements are very similar under GAAP and IFRS.
 Revenue recognition fraud is a major issue in U.S. financial reporting. The same situation exists
for most other countries as well.
Differences
 Under IFRS, revaluation (using fair value) of items such as land and buildings is permitted. IFRS
allows depreciation based on revaluation of assets, which is not permitted under GAAP.
 The terminology used for revenues and gains, and expenses and losses, differs somewhat
between IFRS and GAAP. For example, under IFRS, income includes both revenues, which arise
during the normal course of operating activities, and gains, which arise from activities outside
of the normal sales of goods and services. The term income is not used this way under GAAP.
Instead, under GAAP income refers to the net difference between revenues and expenses.
 Under IFRS, expenses include both those costs incurred in the normal course of operations as
well as losses that are not part of normal operations. This is in contrast to GAAP, which defines
each separately.

The IASB and FASB completed a joint project on revenue recognition. The purpose of this project
was to develop comprehensive guidance on when to recognize revenue. It is hoped that this
approach will lead to more consistent accounting in this area.
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Chapter 4: Completing the Accounting Cycle
LO 1: PREPARE A WORKSHEET. (NOT)
LO 2: PREPARE CLOSING ENTRIES AND A POST-CLOSING TRIAL BALANCE.

Closing the Books
At the end of the accounting period, the company makes the accounts ready for the next period.
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Preparing Closing Entries
Closing entries formally recognize in the ledger the transfer of:
 Net income (or net loss) to owner’s capital
 Owner’s drawings to owner’s capital
Produce a zero balance in each temporary account.
Companies generally journalize and post-closing entries only at end of the annual accounting period.
Example of Closing Entries & Post-Closing Trial Balance
Example of Post-Closing Trial Balance
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LO 3: EXPLAIN THE STEPS IN THE ACCOUNTING CYCLE AND HOW TO PREPARE
CORRECTING ENTRIES.
The accounting Cycle
Correcting Entries – An Avoidable Step

• Unnecessary if accounting records are free of errors
• Made whenever an error is discovered
• Must be posted before closing entries
Instead of preparing a correcting entry, it is possible to reverse the incorrect entry and then
prepare the correct entry.
Example of Correcting Entries

Case 1: On May 10, Mercato Co. journalized and posted a NT$500 cash collection on account from a
customer as a debit to Cash NT$500 and a credit to Service Revenue NT$500. The company
discovered the error on May 20, when the customer paid the remaining balance in full.
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LO 4: IDENTIFY THE SECTIONS OF A CLASSIFIED STATEMENT OF FINANCIAL POSITION.
Classified Statement of Financial Position
 Presents a snapshot at a point in time
 To improve understanding, companies group similar assets and similar liabilities together
Intangible Assets
 Long-lived assets that do not have
psychical substance
Property, Plant, and Equipment
 Long useful lives
 Currently used in operations
 Depreciation - allocating the cost
of assets to a number of years
 Accumulated depreciation - total
amount of depreciation expensed
thus far in the asset’s life
 Sometimes called fixed assets or
plant assets
Long-Term Investments
 Investments in stocks and bonds of other companies
 Investments in non-current assets such as land or buildings that are not currently being used
in operating activities
 Long-term notes receivable
Current Assets
 Assets that a company expects to convert to cash or use up within one year or the operating
cycle, whichever is longer
 Operating cycle is the average time that it takes to
o purchase inventory,
o sell it on account, and
o collect cash from customers
Owner’s Equity
 Proprietorship - one capital account
 Partnership - capital account for each
partner
 Corporation - Common Stock and
Retained Earnings
Non-Current Liabilities
 Obligations a company expects to
pay after one year.
Current Liabilities
 Obligations company is to pay within
coming year or its operating cycle, whichever is longer
 Usually list notes payable first, followed by accounts payable. Other items follow in order of
magnitude
 Common examples are accounts payable, salaries and wages payable, notes payable,
interest payable, income taxes payable, current maturities of long-term obligations
 Liquidity - ability to pay obligations expected to be due within the next year
Page 36 of 48
Similarities
 The procedures of the closing process are applicable to all companies, whether they are
using IFRS or GAAP.
 IFRS generally requires a classified statement of financial position similar to the classified
balance sheet under GAAP.
 IFRS follows the same guidelines as GAAP for distinguishing between current and non-
current assets and liabilities.
Differences
 IFRS officially uses the term statement of financial position in its literature, while in the
United States it is often referred to as the balance sheet.
 IFRS requires that specific items be reported on the statement of financial position, whereas
no such general standard exists in GAAP.
 While IFRS companies often report non-current assets before current assets in their
statements of financial position, this is never seen under GAAP.
 Under IFRS, current assets are usually listed in the reverse order of liquidity. For example,
under GAAP cash is listed first, but under IFRS it is listed last.
 GAAP has many differences in terminology from what are shown in your textbook.
 Both GAAP and IFRS are increasing the use of fair value to report assets. However, at this
point IFRS has adopted it more broadly. As examples, under IFRS, companies can apply fair
value to property, plant, and equipment, and in some cases intangible assets.

The IASB and the FASB are working on a project related to financial statement presentation. A key
feature of the proposed framework is that each of the statements will be organized in the same
format, to separate an entity’s financing activities from its operating and investing activities and,
further, to separate financing activities into transactions with owners and creditors. Thus, the same
classifications used in the statement of financial position would also be used in the income
statement and the statement of cash flows.
Page 37 of 48
Chapter 5: Accounting for Merchandise Operations
LO 1: DESCRIBE MERCHANDISING OPERATIONS AND INVENTORY SYSTEMS.
Merchandising Operations and Inventory Systems
The primary source of revenues is referred to as sales revenue or sales.
Income Measurement
Cost of goods sold is the total cost of merchandise sold during the period.
Operating Cycles
Service Company
Merchandising Company
Ordinarily is longer than that of a service company.
Page 38 of 48
Flow of Costs
Companies use a perpetual or a periodic inventory system.
Perpetual System
 Maintain detailed records of cost of each inventory purchase and sale(see Helpful Hint).
 Records continuously show inventory that should be on hand for every item
 Company determines cost of goods sold each time a sale occurs
Periodic System
 Do not keep detailed records of the goods on hand
 Cost of goods sold determined by count at the end of the accounting period.
 Calculation of Cost of Goods Sold:
Advantages of the Perpetual System

 Traditionally used for merchandise with high unit values
 Shows quantity and cost of inventory that should be on hand at any time
 Provides better control over inventories than a periodic system
Page 39 of 48
LO 2: RECORD PURCHASES UNDER A PERPETUAL INVENTORY SYSTEM.
Recording Purchases Perpetual System
 Made using cash or credit (on account)
 Normally record when goods are received from seller
 Purchase invoice should support each credit purchase
Freight Costs
Example Freight Costs
Page 40 of 48
Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not
meet specifications.
Purchase Discounts
Credit terms may permit buyer to claim a cash discount for prompt payment. Example: Credit terms
2/10, n/30.
Advantages:
 Purchaser saves money
 Seller shortens operating cycle by converting accounts receivable into cash earlier
Summary of Purchasing Transactions
Page 41 of 48
LO 3: RECORD SALES UNDER A PERPETUAL INVENTORY SYSTEM.
Recording Sales Perpetual System
 Made using cash or credit (on account)
 Sales revenue, like service revenue, is recorded when performance obligation is satisfied
 Performance obligation is satisfied when goods are transferred from seller to buyer
 Sales invoice should support each credit sale
Sales Returns and Allowances

 “Flip side” of purchase returns and allowances
 Contra-revenue account to Sales Revenue (debit)
 Sales not reduced (debited) because:
 Would obscure importance of sales returns and allowances as a percentage of sales
 Could distort comparisons
Sales Discounts
 Offered to customers to promote prompt payment of balance due
 Contra-revenue account (debit) to Sales Revenue
Page 42 of 48
LO 4: APPLY THE STEPS IN THE ACCOUNTING CYCLE TO A MERCHANDISING COMPANY.
The Accounting Cycle for a Merchandising Company
Adjusting Entries
 Generally same as a service company
 One additional adjustment to make records agree with actual inventory on hand
 Involves adjusting Inventory and Cost of Goods Sold
Closing Entries
Page 43 of 48
Recording Merchandise Transactions
 Record revenues when sales are made
 Do not record cost of merchandise sold on date of sale.
 Physical inventory count determines:
 Cost of merchandise on hand and
 Cost of merchandise sold during the period
 Record purchases in Purchases account
 Purchase returns and allowances, Purchase discounts, and Freight costs are recorded in
separate accounts
Recording Sales of Merchandise

 No entry is recorded for cost of goods sold at time of sale under a periodic system.
Closing Entries
 All accounts that affect the determination of net income are closed to Income Summary
 In journalizing, all debit column amounts are credited, and all credit columns amounts are
debited
 Beginning inventory balance is debited to Income Summary and credited to Inventory
 Ending inventory balance is debited to Inventory and credited to Income Summary
Appendix 5B: Periodic Inventory System

Determining Cost of Goods Sold Under a Periodic System
 No running account of changes in inventory
 Ending inventory determined by physical count
 Cost of goods sold not determined until end of period.
Page 44 of 48
LO 5: PREPARE FINANCIAL STATEMENTS FOR A MERCHANDISING COMPANY.
Income and Comprehensive Income Statements
 Shows several steps in determining net income
 Two steps relate to principal operating activities
 Distinguishes between operating and non-operating activities
Nonoperating Activities
Various revenues and expenses and gains and losses that are unrelated to company’s main line of
operations.
Other Revenues and Gains
 Interest revenue from notes receivable and marketable securities.
 Dividend revenue from investments in common stock.
 Rent revenue from subleasing a portion of the store.
 Gain from the sale of property, plant, and equipment.
Other Expenses and Losses
 Interest expense on notes and loans payable.
 Casualty losses from recurring causes, such as vandalism and accidents.
 Loss from the sale or abandonment of property, plant, and equipment.
 Loss from strikes by employees and suppliers.
Page 45 of 48
Comprehensive Income Statement
Items excluded from net income but included in comprehensive income are either reported in
either:
 Combined statement of net income and comprehensive income
 Separate comprehensive income statement
Classified Statement of Financial Position
Page 46 of 48
Similarities
 Under both GAAP and IFRS, a company can choose to use either a perpetual or periodic
inventory systems.
 Inventories are defined by IFRS as held-for-sale in the ordinary course of business, in the
process of production for such sale, or in the form of materials or supplies to be consumed in
the production process or in the performing of services. The definition under GAAP is
essentially the same.
 Similar to GAAP, comprehensive income under IFRS includes unrealized gains and losses (such
as those on non-trading securities) that are not included in the calculation of net income.
Differences
 Under GAAP companies generally classify income statement items by function. Classification
by function leads to descriptions like administration, distribution (selling), and manufacturing.
Under IFRS, companies must classify expenses either by nature or by function. Classification by
nature leads to descriptions such as the following: salaries, depreciation expense, and utilities
expense. If a company uses the functional-expense method on the income statement,
disclosure by nature is required in the notes to the financial statements.
 Presentation of the income statement under GAAP follows either a single-step or multiple-
step format. IFRS does not mention a single-step or multiple-step approach.
 Under IFRS revaluation of land, buildings, and intangible assets is permitted. The initial gains
and losses resulting from this revaluation are reported as adjustments to equity, often
referred to as other comprehensive income. The effect of this difference is that the use of
IFRS results in more transactions affecting equity (other comprehensive income) but not net
income.

The IASB and FASB are working on a project that would rework the structure of financial statements.
Specifically, this project will address the issue of how to classify various items in the income
statement. A main goal is to provide information that better represents how businesses are run. In
addition, this approach draws attention away from just one number—net income. It will adopt major
groupings similar to those currently used by the statement of cash flows (operating, investing, and
financing), so that numbers can be more readily traced across statements. For example, the amount
of income that is generated by operations would be traceable to the assets and liabilities used to
generate the income. This approach would also provide detail, beyond that currently seen in most
statements (either GAAP or IFRS), by requiring that line items be presented both by function and by
nature. The new financial statement format was heavily influenced by suggestions from financial
statement analysts.
 Companies estimate total units of activity to calculate depreciation cost per unit
 Expense varies based on units of activity
 Depreciable cost is cost less residual value
 Often referred to as units-of-production method
Page 47 of 48
Page 48 of 48

Summary Accounting 19-20

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Summary Accounting 19-20

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ACCOUNTING SUMMARY

Chapter 1: Accounting in Action............................................................................................................7

Who Uses Accounting Data

• Owned by one person • Owned by two or more • Ownership divided into

LO 3: STATE THE ACCOUNTING EQUATION AND DEFINE ITS COMPONENTS.

Assets = Liabilities + Owner's Equity

Basic Accounting Equation

Expanded Owner's Owner's

Increase in Owner’s Equity

LO 4: ANALYZE THE EFFECTS OF BUSINESS TRANSACTIONS ON THE ACCOUNTING

Income Statement Owner's Equity Statement of Statement

Owner’s Equity Statement

Statement of Financial Position

(Statement of Cash Flow)

Looking to The Future

Debits and Credits

Debit and Credit Procedure

Assets - Debits should exceed credits

Owner’s investments and revenues increase owner’s equity (credit)

Earning revenues is to benefit owner(s)

Summary of Debit / Credit Rules

The Recording Process

 Journalizing - Entering transaction data in the journal.

LO 4: PREPARE A TRIAL BALANCE.

Looking to the Future

Generally a ALTERNATIVE TERMINOLOGY

Fiscal and Calendar Years

Accrual- versus Cash-Basis Accounting

Accrual-Basis Accounting Cash-Basis Accounting

Transactions recorded in the periods in which

In accordance with generally accepted Cash-basis accounting is not in accordance with

Recognizing Revenues and Expenses

Expense Recognition Principle

“Let the expenses

 Expire either with the passage of time or through use

 Accumulated Depreciation is called a contra asset account.

Unearned revenues often occur in regard to:

Example Unearned Revenues

Accrued revenues often occur in regard to:

Accrued expenses often occur in regard to rent, interest, taxes, salaries, …

 Adjusting entry records the obligation and recognizes the expense.

Assumptions in Financial Reporting

Principles of Financial Reporting

Accounting for Prepaid Expenses

Reason for Account Before

Insurance, supplies, Prepaid expense Assets overstated. Dr. Expenses

Accounting for Unearned Revenues

Reason for Account Before

Rent, magazine Unearned revenues Liabilities overstated. Dr. Liabilities

Accounting for Accrued Revenues

Reason for Account Before

Interest, rent, services Services performed Assets understated. Dr. Assets

Accounting for Accrued Expenses

Reason for Account Before

Looking to the Future

LO 2: PREPARE CLOSING ENTRIES AND A POST-CLOSING TRIAL BALANCE.

Example of Closing Entries & Post-Closing Trial Balance

Example of Post-Closing Trial Balance

Correcting Entries – An Avoidable Step

Example of Correcting Entries

Looking to the Future

Advantages of the Perpetual System

Example Freight Costs

Summary of Purchasing Transactions