Chapter 1
INTRODUCTION
The purpose of accounting is to provide a means of recording, reporting, summarizing, and interpreting economic data. In order to do this, an accounting system must be designed. A system design serves the needs of users of accounting information. Once a system has been designed, reports can be issued and decisions based upon these reports are made for various departments. Since accounting is used by everyone in one form or another, a good understanding of accounting principles is beneficial to all.
ACCOUNTING FIELDS
The accounting profession is generally divided into two categories: 1) private accounting and 2) public accounting. Private accountants are employed by a business, while public accountants practice as individuals or as members of an accounting firm. Public accountants are subject to strict government regulations and requirements which are determined by each individual state where a license is granted. Private accountants on the other hand require no licenses. They perform tasks which have been determined by their employer. Accounting fields exist that specialize in very specific areas of a business. Examples are auditing, budgetary, tax, social, cost, managerial, financial and international.
BASIC ACCOUNTING PRINCIPLES & CONCEPTS
Bookkeeping is concerned with the recording of business data, while accounting is concerned with the design, interpretation of data, and the preparation of financial reports. Three forms of business entities exist: 1) sole proprietorship, 2) partnership, and 3) corporations. Corporations have the unique status of being a separate legal entity in which ownership is divided into shares of stock. A shareholder's liability is limited to his/her contribution to capital. Whenever a business transaction is recorded, it must be recorded to accounting records at cost. All business transactions must be recorded. All properties owned by businesses are assets. All debts are liabilities. The rights of owners is equity.
THE ACCOUNTING EQUATION & TRANSACTIONS
Assets, liabilities and owner's equity are the basic elements of the accounting equation. The excess of assets over liabilities is owner's equity. Thus, assets are equal to liabilities plus owner's equity at all times. Any business transaction has to affect at least one of these elements.
ACCOUNTING STATEMENTS
There are two basic accounting statements used by most businesses. The balance sheet presents the assets, liabilities and owner's equity. Each account balance in the balance sheet is reported as of the last day of the financial period. The income statement determines whether a net profit or loss was realized by matching total revenue and expenses for a specific time period. A third statement is used by some businesses. It is the statement of owner's equity which presents the changes which have taken place in owner's equity over the period.
CORPORATE ACCOUNTING STATEMENTS
The financial statements of corporations are different from those of other forms of business in several aspects. Instead of having an owner's equity section in the balance sheet statement, a corporation has a stockholders' equity. Shareholders' equity is composed of capital stock and retained earnings. Capital stock represents the initial investment of the shareholders. Retained earnings represents accumulated profits. The owner's equity statement is usually called retained earnings statement. The retained earnings statement will at times have deductions called dividends which represent payments of earnings to shareholders. Whenever shareholders buy shares of stock from the corporation, assets and stockholders' equity increase. The reverse occurs when dividends are distributed.
INCOME STATEMENTS
The income statement reports the amount of net income or loss determined by subtracting expenses from revenues during a specific time period. Only expenses which are attributable to items of income are recognized as period expenses. The net income or loss from the income statement is recorded in the statement of owner's equity.
STATEMENT OF OWNER'S EQUITY
The statement of owner's equity records the changes in the value of owner's equity. Additional investments and net profits increase owner's equity. Dividend payments, owner withdrawals, and net losses decrease owner's equity. Net profits or losses are derived from the income statement. The statement of owner's equity (or retained earnings statement for corporations) is the connecting link between the income statement and the balance sheet.
BALANCE SHEET
The balance sheet lists all assets, liabilities, and owner's equity balances as of the last day of the financial period. The balance sheet always begins with assets, then liabilities and owner's equity. Assets which are listed first are the most liquid, such as cash, accounts receivable and prepaid expenses. Liabilities are grouped by due date, with short-term liabilities listed first.
BUSINESS TRANSACTION & THE BALANCE SHEET
The following is a summary of business transactions and how they affect the items of the balance sheet.
1)- Initial and additional investments increase both assets and owner's equity.
2)- Assets purchased on credit increase both assets and liabilities.
3)- When assets are used to purchase other assets, there is no net change in the amount of total assets.
BUSINESS TRANSACTION & THE BALANCE SHEET
4)- Assets used to pay debts decrease assets and liabilities.
5)- Net income increases assets and owner's equity.
6)- Net losses decrease assets and owner's equity.
7)- Assets that are used up for the purpose of the generating revenue decrease assets and owner's equity.
8)- Withdrawals owners and dividends decrease assets and owner's equity.
9)- Expenses reduce assets and owner's equity.
Bookkeeping is concerned with the recording of business data, while accounting is concerned with the design, interpretation of data, and the preparation of financial reports. Three forms of business entities exist: 1) sole proprietorship, 2) partnership, and 3) corporations. Corporations have the unique status of being a separate legal entity in which ownership is divided into shares of stock. A shareholder's liability is limited to his/her contribution to capital. Whenever a business transaction is recorded, it must be recorded to accounting records at cost. All business transactions must be recorded. All properties owned by businesses are assets. All debts are liabilities. The rights of owners is equity.
THE ACCOUNTING EQUATION & TRANSACTIONS
Assets, liabilities and owner's equity are the basic elements of the accounting equation. The excess of assets over liabilities is owner's equity. Thus, assets are equal to liabilities plus owner's equity at all times. Any business transaction has to affect at least one of these elements.
ACCOUNTING STATEMENTS
There are two basic accounting statements used by most businesses. The balance sheet presents the assets, liabilities and owner's equity. Each account balance in the balance sheet is reported as of the last day of the financial period. The income statement determines whether a net profit or loss was realized by matching total revenue and expenses for a specific time period. A third statement is used by some businesses. It is the statement of owner's equity which presents the changes which have taken place in owner's equity over the period.
CORPORATE ACCOUNTING STATEMENTS
The financial statements of corporations are different from those of other forms of business in several aspects. Instead of having an owner's equity section in the balance sheet statement, a corporation has a stockholders' equity. Shareholders' equity is composed of capital stock and retained earnings. Capital stock represents the initial investment of the shareholders. Retained earnings represents accumulated profits. The owner's equity statement is usually called retained earnings statement. The retained earnings statement will at times have deductions called dividends which represent payments of earnings to shareholders. Whenever shareholders buy shares of stock from the corporation, assets and stockholders' equity increase. The reverse occurs when dividends are distributed.
INCOME STATEMENTS
The income statement reports the amount of net income or loss determined by subtracting expenses from revenues during a specific time period. Only expenses which are attributable to items of income are recognized as period expenses. The net income or loss from the income statement is recorded in the statement of owner's equity.
STATEMENT OF OWNER'S EQUITY
The statement of owner's equity records the changes in the value of owner's equity. Additional investments and net profits increase owner's equity. Dividend payments, owner withdrawals, and net losses decrease owner's equity. Net profits or losses are derived from the income statement. The statement of owner's equity (or retained earnings statement for corporations) is the connecting link between the income statement and the balance sheet.
BALANCE SHEET
The balance sheet lists all assets, liabilities, and owner's equity balances as of the last day of the financial period. The balance sheet always begins with assets, then liabilities and owner's equity. Assets which are listed first are the most liquid, such as cash, accounts receivable and prepaid expenses. Liabilities are grouped by due date, with short-term liabilities listed first.
BUSINESS TRANSACTION & THE BALANCE SHEET
The following is a summary of business transactions and how they affect the items of the balance sheet.
1)- Initial and additional investments increase both assets and owner's equity.
2)- Assets purchased on credit increase both assets and liabilities.
3)- When assets are used to purchase other assets, there is no net change in the amount of total assets.
BUSINESS TRANSACTION & THE BALANCE SHEET
4)- Assets used to pay debts decrease assets and liabilities.
5)- Net income increases assets and owner's equity.
6)- Net losses decrease assets and owner's equity.
7)- Assets that are used up for the purpose of the generating revenue decrease assets and owner's equity.
8)- Withdrawals owners and dividends decrease assets and owner's equity.
9)- Expenses reduce assets and owner's equity.
Chapter 2
INTRODUCTION TO AN ACCOUNT
An account represents a document used to record all similar transactions. It consists of a title, a debit column, and a credit column. The left side of an account is the debit side, and the right side of the account is the credit side. The balance of an account is determined by subtracting the smaller sum (debit or credit) from the larger sum. Initially, all transactions are recorded in a journal in a process known as journalizing. When the information recorded in the journal is transferred to the individual accounts, this process is known as posting. Total debits and credits of any transaction must always be equal.
A single account is often called a T account because of its appearance as a T. When several related accounts grouped together is called a ledger. Accounts whose balance is carried forward from period to period are known as real accounts or balance sheet accounts. In a double entry accounting system, all journal entries require a debit entry in one account to be simulatously matched by an equal credit entry in another account. A journal entry composed of more than one debit or credit is a compound journal entry.
RULES FOR INCREASING & DECREASING ACCOUNTS
The following are rules for increasing and decreasing accounts.
1)- Asset accounts normally have debit balances and are increased by debits.
2)- Liability accounts normally have credit balances and are increased by credits.
3)- Owner's equity accounts normally have credit balances and are increased by credits.
4)- Revenue accounts are increased when credited.
5)- Expense accounts are increased when debited.
INCOME STATEMENT ACCOUNTS
Income statement accounts have a direct effect on the balance of owner's equity. Expense accounts decrease owner's equity, while revenue accounts increase owner's equity. The net gain or loss is determined by subtracting expenses from revenues. At the end of a financial period, all expense and revenue accounts are closed to a summarizing account usually called Income Summary. For this reason, all income statement accounts are considered to be temporary or nominal.
NORMAL ACCOUNT BALANCES
Assets, drawing, dividends, and expense accounts normally have debit balances. Liabilities, owner's equity, retained earnings, and revenue accounts normally have credit balances. There can be special circumstances where accounts will not have a normal balance, but this usually is an indication of an error.
BALANCE SHEET ACCOUNTS
Balance sheet accounts are classified as assets, liabilities, or owner's equity. Income statement accounts are classified as either expenses or revenues. Assets are divided into two categories, depending upon their expected life. Current assets are those that are usually sold or consumed within a year. Fixed assets are held for periods longer than a year. Among fixed assets, plant assets depreciate, while land does not. Liabilities are also divided into two categories: current, for those payable within a year, and long-term, for those with maturities beyond one year.
Current assets typically include cash, notes receivable, accounts receivable, inventories and prepaid expenses (such as insurance premiums). Fixed assets typically include property, plant and equipment, investments, patents and tradmarks. Both tangible and intangible items can be assets, provided they have some monetary value. Current liabilities include bank credit outstanding, accounts payable, interes payable, wages payable and taxes payable. Long term liabilities include loans beyond one year, notes and bonds issued by company.
CLASSIFYING BALANCE SHEET ACCOUNTS
Owner's equity is the portion that remains after liabilities are subtracted from assets. For a sole proprietorship or partnership, capital represents the owner's equity. For a corporation, capital stock is the investment made by stockholders. Retained earnings represent net income that a corporation retains. Dividends are earnings of a corporation that are distributed to shareholders. Drawings represent assets taken out by owners of proprietorships or partnerships. Drawings and dividends reduce owner's equity.
CLASSIFYING INCOME STATEMENT ACCOUNTS
Revenues increase the value of owner's equity. Revenues include sales, fees earned, services, interest income and rental income. For businesses with more than one source of income, it is recommended to maintain separate accounts. Expenses vary for different businesses, and they should be classified according to the size and type of expense.
CHART OF ACCOUNTS
All accounts of a business should be listed in a chart of accounts. Usually the accounts are classified as
1 - assets,
2 - liabilities,
3 - owner's equity,
4 - revenue, and
5 - expenses.
Accounts appear in the general ledger in a sequential order of the chart of accounts. The first digit of a number in the chart of accounts indicates the major division in which the account is placed. A second number of an account represents a specific category When the general ledger is first prepared and account balances from the previous period are entered, this is known as opening the ledger.
THE FLOW OF DATA
The accounting data normally follows a normal pattern of flow. Its order is
1)- the actual business transaction requires the preparation of documentation,
2)- the entry for the transaction is recorded in the journal, and
3)- the journal entry is posted to the ledger.
THE TWO COLUMN JOURNAL
Of all types of journals, the two column journal is the simplest to use. It has a debit column and a credit column used for recording all initial transactions. Before a transaction is entered into a journal, it is necessary to determine the following:
1)- which accounts will be affected,
2)- whether the affected account increases or decreases, and
3)- whether the transaction should be recorded as a debit or credit.
An explanation of the transaction is desirable.
When journalizing entries it is customary to enter the accounts numbers and exact name of the accounts to be debited and credited, to write in the debit portion first above the credit portion, and to indent slightly the credit entry. The complete date of a transaction must always appear. Most often expense account will have only debit entries, revenue accounts only credit entries, while balance sheets accounts may have either.
THREE-COLUMN & FOUR-COLUMN ACCOUNTS
Three-column and four-column accounts are often used instead of two-column accounts. The purpose of the additional columns is to keep running balances of both debits and credits in the four-column account, or a net of the two in the three-column account. All accounts, as well as most accounting forms used to record transactions, often have a posting reference column. In the journal, the posting reference column is used to record the account number. In the individual account, the posting reference (also called journal reference) is used to record the page number of the journal where the entry was made.
Three-column and four-column accounts must show their account number and name, year and month, at the top of each page. Three-column and four-column accounts are most conveniently used in computer based accounting since debit and credit balances are automatically calculated.
THE TRIAL BALANCE & ERRORS
The trial balance is a list of accounts with their debit or credit balances. It is usually prepared at the end of an accounting period. The advantages of using a trial balance are:
1)- it reveals mathematical errors since total debits must equal total credits, and
2)- it assists in the preparation of financial statements. It should be noted, however, that trial balances cannot detect every type of error.
The first step in preparing a trial balance is to calculate the balance of each of the accounts in the general ledger. Some of the errors that the trial balance will not reveal are for instance:
- journalizing a transaction twice,
- forgetting to record a transaction,
- entering an erroneous but identical amount in debit and credit,
- posting part of a transaction as a debit or credit to the wrong account.
Errors that cause the trial balance not to balance are
- the beginning amount of an account was incorrectly recorded,
- a debit entry was posted as a credit entry,
- a debit or credit balance was omitted,
- a digit in a number was moved one or more spaces (known as slide).
Determining the amount of the difference between debit and credit can help to look for such amount. For instance, when a debit and a credit were interchanged, the trial balance difference will be twice this amount.
A major function of an auditor is to find accounting errors.
| What can be done if a trial balance does not prove? The following steps can generally help discover errors more quickly! 1)- Add columns once more and determine the difference. 2)- Check if the error could be a transposition, slide, or mathematical error. 3)- Compare the balances of the ledger with those of the trial balance. 4)- Recompute each ledger account balance. 5)- Check all postings in the ledger by referring back to the journal. 6)- When an error is found, (or part of it) add again all debits and credits to check is they are now equal. |
Chapter 3
MATCHING REVENUES & EXPENSES
There are two methods of recording revenues and expenses in the income statement: accrual basis and cash basis. The accrual basis of accounting is a more precise method of matching revenues and expenses, and it is more widely used. It matches revenues and expenses when they are incurred rather than when cash is received or disbursed. The cash basis of accounting records revenues and expenses only when cash is received or disbursed, and this method is often not acceptable for many forms of business.
INTRODUCTION TO THE ADJUSTMENT PROCESS
At the end of a financial period, many balances listed in the trial balance are in need of some adjustment. Common adjustments pertain to prepaid expenses, plant assets, and accrued expenses. If the proper adjusting entries are not made, financial statments will be incorrect. It is not necessary to keep track of transactions that affect revenues and expenses on a day to day basis. Adjustments should be made at the end of each accounting period.
PREPAID EXPENSES - ADJUSTMENTS
At the end of an accounting period, adjustments must be made to reflect the portion of the asset that has been consumed during the period. The amount of asset or prepaid expense consumed is recorded as a debit to the expense account, and a credit to the asset account. Should an adjusting entry not be made, expenses, net income, owner's equity and assets would all be overstated.
PLANT ASSETS - ADJUSTMENTS
Plant assets represent long-term tangible property owned by the firm. Although it is often not visible, the usefulness of a plant asset declines. This loss of usefulness is known as depreciation, and it requires an adjusting entry periodically. The decline in value requires a debit to Depreciation Expense account, and a credit to Accumulated Depreciation (which is said to be a contra asset account). The difference between the balances of the asset and contra asset accounts is the book value of the asset. If the adjusting entry is not made, assets, owner's equity, and net income will be overstated, and expenses will be understated.
Example:
Purchased equipment for $36,000 that has an estimated life of 12 years with no residual value.
|
While most expenses are prepaid, a few are paid after a service has been performed. This is the case of wages and salaries. Since the expense has not been paid but services have been received, an accrued expense and a liability have taken place. The adjusting entry requires a debit to an expense account and a credit to a liability account. Failure to do so will result in net income and owner's equity being overstated, and expenses and liabilities being understated.
Example:
At the end of the accounting period, it was verified that employee wages of $1,500 and management salaries of $4,000 were not paid.
Adjusting journal entry:
Accrued expense $ 5,500
|
WORK SHEETS AND FINANCIAL STATEMENTS
The work sheet is a collection of important data that is used to determine which adjusting entries must be performed. It also assists in the preparation of financial statements. The first step of preparing a work sheet is the trial balance. Once a trial balance proves (i.e. total debits equal total credits), adjusting entries can be performed. To make certain all debits and credits still prove after all adjusting entries, an adjusted trial balance is created. Once the adjusted trial balance proves, if is separated into an income statement and a balance sheet. All columns of the work sheet should have equal balances for debits and credits.
PREPARING FINANCIAL STATEMENTS
The work sheet is used in the preparation of the financial statements. The results of the income statement (net profit or loss) are transferred to the statement of owner's equity. If additional funds have been invested or withdrawn over the period, such changes are recorded to the statement of owner's equity. The owner's equity account in the balance sheet is transferred from the statement of owner's equity. All other balances of the balance sheet are transferred from the work sheet balance sheet columns.
JOURNALIZING & POSTING CLOSING ENTRIES
After the financial statements are completed, all adjusting entries are recorded in the journal and posted to the ledger so that all financial statements are in agreement. It is necessary to close all temporary accounts and record the net change to the owner's equity account. This is accomplished by journalizing and posting closing entries for all temporary accounts. An Income Summary account is used to summarize revenue and expense accounts, and establishing the net profit or loss for the period. In addition, any transaction that increases or decreases capital should also be posted to the appropriate capital account.
| PROCEDURES TO CLOSE TEMPORARY ACCOUNTS 1)- Debit all revenue accounts, and credit Income Summary. 2)- Credit all expense accounts, and debit Income Summary. 3)- Add debit and credit columns of Income Summary. If the credit balance exceeds the debit balance, a profit has been realized. 4)- Results of the Income Summary should be posted to a capital account (Owner's or Shareholders equity). 5)- If there is activity in the Drawing or Dividend accounts, it is necessary to credit those acounts and debit a capital account. |
The accounting cycle begins with the analysis of all transactions and recording them in the journal. Once all transactions have been recorded in the journal, they are posted to the ledger and a trial balance is drawn. The trial balance, adjusting entries, and any additional information for the financial statements are recorded in the work sheet. After the completion of the work sheet, the financial statements are finalized. All adjusting and closing entries are then journalized and posted to the ledger. To ensure all entries were correctly made, a post-closing trial balance is prepared to show the equality of debits and credits, as well to confirm Assets, Liabilities, and Capital accounts with proper open balances.
ENTRIES FOR PURCHASES TRANSACTIONS ACCOUNTING ENTRIES USED TO RECORD THE PURCHASE AND PAYMENT OF GOODS
1) When goods are purchased with cash, the following entry is necessary:
debit Purchases, credit Cash
2) When goods are purchased on credit, the following entry is necessary:
debit Purchases, credit Accounts Payable
3) When goods are purchased on credit, but are paid back early due to a cash discount incentive, the following entry is necessary:
debit Accounts Payable, credit Cash, and credit Purchases Discount.
PURCHASES DISCOUNTS
A seller will often offer a cash discount to the buyer for an early payment. Credit terms are the conditions for the payment agreed upon by the buyer and the seller. Cash discounts are stated in a fractional form with the percentage of discount in the numerator and the number of days in the denominator. The credit period, or number of days a buyer can pay without incurring a finance charge, is stated in NET days or n/days. Example: terms 3/15, n/60 means a buyer will receive a 3% cash discount if paid within 15 days of the invoice date, and the buyer has a maximum of 60 days to pay the entire debt amount.
PURCHASES RETURNS AND ALLOWANCES RULES
FOR RECORDING RETURNS AND ALLOWANCES FOR GOODS PURCHASED ON CREDIT
1) If merchandise is returned or a price adjustment is necessary, the buyer should debit Accounts Payable and credit the Purchases Returns and Allowances account.
2) When the returned goods were purchased on credit, and a cash discount for early payment is available, the discount only applies to the price of the goods that are kept, (in addition, discounts are not taken on freight costs).
SALES ACCOUNTING
When goods are sold for cash or on credit, the Sales account should be credited. To encourage early payment of goods purchased on credit, the seller will often offer a cash discount. These discounts are recorded in the Sales Discounts account. When goods are returned or an allowance is requested, the adjustment is made to the Sales Returns and Allowances account. All sales discounts, returns, and allowances reduce sales revenues.
SALES ACCOUNTING - RULES FOR RECORDING SALES TRANSACTIONS
1- When goods are sold and payment is made in cash, debit Cash and credit Sales.
2- When goods are sold on credit, debit Accounts Receivable and credit Sales.
3- When goods are sold through the use of a credit card, there often will be a service fee. In such circumstances, debit Cash and Credit Card Collection Expense (for the fee) and credit Accounts Receivable.
SALES ACCOUNTING - RECORDING SALES DISCOUNTS
When a buyer takes advantage of a cash discount, Cash and Sales Discount should be debited, and Accounts Receivable should be credited.
Example: Invoice for $950 with terms 3/15, n/30 is paid early by the buyer.
Debit Cash $921.50
Debit Sales Discounts $28.50
Credit Accounts Receivable $950
SALES ACCOUNTING - RECORDING SALES RETURNS AND ALLOWANCES
When a seller grants a return or an allowance, Sales Returns and Allowances is debited, and Accounts Receivable is credited. A buyer of goods can only take a cash discount on the goods that are actually kept (cash discounts do not apply to freight either). Example: A seller receives a debit memorandum for $70 of goods that were not ordered by ABC company. If the return is granted, the following entry is necessary.
Debit Sales Returns & Allowances $70
Credit Accounts Receivable ABC company $70
SALES ACCOUNTING
Manufacturers and wholesalers often reduce catalog list prices by allowing trade (or quantity) discounts. The discounts vary depending on customer and order size. Trade discounts permit flexible prices without having to print new catalogs. Trade discounts are not reflected in accounting records, only the agreed upon price between a buyer and seller is recorded.
TRANSPORTATION COSTS
Whenever goods are sold, the buyer and the seller must agree upon who pays shipping costs. When goods are shipped FOB shipping point, the buyer agrees to pay for shipping costs and ownership passes to the buyer when the merchandise is delivered to the shipper. When goods are shipped FOB destination, the seller agrees to pay for transportation costs and ownership of goods passes to the buyer when the goods are delivered.
SALES TAXES
The majority of states in the United States levy a tax on the sale of merchandise. At the moment the sale is competed (whether payment is received or not) the amount of the sales tax is credited to the Sales Tax Payable in the books of the seller. Periodically the Sales Tax Payable account will be debited when the tax is remitted to the state tax authority. The buyer of goods does not record a sales tax expense separately in his/her accounts, it is merely added to the cost of the goods, and the entire amount is debited to Purchases.
INTERIM REPORTING FOR MERCHANDISING ENTERPRISES
Merchandising enterprises often prepare quarterly or monthly financial reports, called interim financial statements, which are useful to management. This requires the preparation of a trial balance, and an analysis of accounts to determine what adjustments are necessary. Once adjusting entries are entered on the work sheet, the adjusted trial balance is prepared. Interim financial statements are then prepared based upon the information that is provided by the work sheet.
ACCOUNTING FOR MERCHANDISE INVENTORY
There are two systems commonly used to keep track of inventory: periodic inventory and perpetual inventory systems. In the periodic inventory system, revenue is recorded each time a sale is made. However, but the cost of goods sold is not determined until a physical inventory is taken. In the perpetual system, both sales amount and the cost of goods sold are recorded each time an item is sold. This makes it possible to know quantity and the value of inventory at all times.
DETERMINING THE COST OF GOODS SOLD
The cost of goods sold is usually reported in a separate section of the income statement. In the periodic inventory system, determining the cost of goods sold requires the following steps:
1)- All purchases must be totaled.
2)- Purchases returns & allowances and purchases discounts are deducted from purchases to determine the net purchase balance.
3)- Net purchases plus transportation costs equals cost of goods purchased.
4)- Beginning inventory plus cost of goods purchased equals goods available for sale.
5)- Goods available for sale minus ending inventory equals cost of goods sold.
ADJUSTMENTS FOR MERCHANDISE INVENTORY
The merchandise inventory account only shows the beginning balance of inventory, not any purchases made during the period. It is therefore necessary to remove the beginning inventory balance and replace it with the ending inventory balance. This is performed by the following two adjusting entries:
1- Debit the beginning inventory balance to Income Summary, and credit the Merchandise Inventory account.
2- Debit the ending inventory balance to Merchandise Inventory, and credit the Income Summary account.
ADJUSTMENTS ON THE WORK SHEET
The first step in preparing a work sheet requires a trial balance to be taken. Next, data should be gathered to perform adjusting entries. Accounts that typically require adjustments are Merchandise Inventory, prepaid expenses, supplies, assets that have to be depreciated, and outstanding liabilities. All these adjustments are posted to the adjustments column of the work sheet, and the debit and credit columns must prove. After the adjusting entries have been entered, the adjusted trial balance is prepared. Balances in this column reflect the correct ending balances of the accounts at the end of the fiscal period.
INCOME STATEMENTS
Income statements are commonly prepared in two formats: multiple-step and single-step. In the multiple-step format revenues are often presented in great detail, cost of goods sold is subtracted to show gross profit, operating expenses are separated from other expenses, and operating income is separated from other income. In the single-step format, all expenses are combined in a single section including cost of goods sold.
RETAINED EARNINGS STATEMENT
The retained earnings statement is a summary of what has occurred to the retained earnings account. The retained earnings statement always begins with the ending balance of the past period, then presents net income or loss, dividend payments and other elements affecting the retained earnings account. It is not unusual for the retained earnings statement and the income statement to be combined into one statement. This is primarily done for simplicity.
BALANCE SHEETS
Balance sheets can be arranged in two forms: account form and report form. The account form lists all asset accounts on the left hand side of the balance sheet, and all liabilities and equity accounts are listed on the right-hand side. The report form lists all accounts in a downward sequence beginning with assets, liabilities, and ending with equity. Both assets and liabilities should be arranged according to their liquidity or purpose. Assets that are generally liquid and are expected to be held less than a year are listed under current assets. Assets that are permanent in nature or are expected to be used for a long period of time are listed under plant assets. Liabilities are classified into short and long term depending on their maturity.
ADJUSTING AND CLOSING ENTRIES
The work sheet provides the information needed for the adjusting entries. Adjusting entries involve asset, liability, expense, and revenue accounts. Special adjusting entries are required for inventory:
- debit Income Summary and credit Inventory for the beginning balance, and
- debit Inventory and credit Income Summary for the ending balance.
ADJUSTING AND CLOSING ENTRIES
After all adjusting entries have been performed, closing entries are required for all temporary accounts. Sales, income accounts, purchases returns & allowances, and purchases discounts are debited to close, and the Income Summary account is credited for the total. Expenses, purchases, sales discounts, sales returns & allowances, and transportation in are all credited to close, and the Income Summary account is debited for the total. The Income Summary debit or credit balance is closed to the Owner's Equity or Retained Earnings account. The Dividends account is credited and Retained Earnings debited if any dividends were paid during the year.
REVERSING ENTRIES
Since some adjusting entries performed at the end of a financial period disrupt routine transactions, they are simply reversed on the first day of the new period. A reversing entry exact reverses the adjusting entry. An example of an adjusting entry that is commonly reversed is salary or wages payable. Reversing entries are performed because they reduce errors and save time. Reversing entries are optional and some firms do not perform them.
INTERIM STATEMENTS
Financial statements prepared for a period less than a complete accounting year are referred to as interim statements. Data for interim statements is obtained from work sheets. Any adjusting and closing entries performed to prepare interim statements are not recorded in the accounts, (this is only necessary at the end of a fiscal year or accounting period).
CORRECTING ERRORS
Depending upon the type of an error and the point in time it is discovered, the correcting procedure differs. 1)- When a journal entry is incorrect and has not yet been posted, a line should be drawn through the error and the correct title or amount should be entered.
2)- When a journal entry has been posted incorrectly, it is necessary to journalize and post a correcting entry.
3)- When a journal entry is correct but has been posted incorrectly, a correcting entry should be posted.
INTRODUCTION TO DEFERRALS & ACCRUALS
Deferrals and accruals are instrumental in properly matching revenues and expenses. A deferral delays the recognition of either an expense that has been paid or a revenue that has been collected. An accrual is an expense that has not been paid or a revenue that has not yet been received.
DEFERRALS - PREPAID EXPENSES
Prepaid expenses represent the cost of goods and services purchased that are not entirely used up at the end of the year. Adjusting entries are necessary so that asset and expense accounts have the proper balances. Prepaid expenses can be initially recorded as either an asset or an expense. Either method will yield the same results, but adjusting entries to obtain the final result differ. The advantage of recording a prepaid expense initially as an asset is that no reversing entry is necessary.
DEFERRALS - UNEARNED REVENUES
When revenue is received before goods are delivered or services performed, the revenue is said to be unearned. Unearned revenues can initially be recorded as either a liability or a revenue. When unearned revenues are recorded as liabilities, an unearned revenue account is credited. An advantage of this method is that no reversing entry is necessary. When unearned income is recorded as a revenue, a revenue account is credited. This method requires a reversing entry at the beginning of the new period. Both methods produce, however, the same end result.
ACCRUALS - LIABILITIES OR EXPENSES
Many expenses which accumulate on a daily basis are only recorded at set intervals. At the end of an accounting period a portion of such expenses (for instance, salaries) often remains unpaid. Such accruals are considered to be both liabilities or expenses. An adjusting entry is necessary at the end of an accounting period to properly reflect the portion of the accrued but yet unpaid expense and liability. At the start of the next period, the adjusting entry is reversed to simplify accounting.
ACCRUALS - ASSETS OR REVENUES
Many businesses only record revenues when they are actually received. At the end of an accounting period, all revenues earned but not yet collected require adjusting entries. The adjustment is performed by debiting an asset account and crediting a revenue account. As a result, financial statements will be able to properly match revenues and expenses. A reversing entry is performed at the first day of the new period to simplify accounting.
REVIEWING ACCRUALS AND DEFERRALS
Although all accruals and deferrals require adjusting entries at the end of an accounting period, reversing entries are not necessary for all adjustments. Reversing entries should only be performed under the following circumstances:
1) when an accrued asset or an accrued liability is adjusted,
2) when a prepaid expense is initially recorded as an expense,
3) when an unearned revenue is initially recorded as revenue.
PRINCIPLES OF ACCOUNTING SYSTEMS
The accounting system of an organization should provide all necessary information. The type of accounting system used depends on the information needs of an organization. All accounting systems should have the following characteristics:
1) cost effectiveness,
2) adequate internal controls,
3) flexibility to a changing environment, and
4) compatibility and adaptability to an organization's structure.
INSTALLING & REVISING ACCOUNTING SYSTEMS
The installation and revision of an accounting system requires a complete knowledge of a business operation. The following steps are necessary when installing or changing an accounting system.
1)- Systems analysis: this stage determines data needs, the sources of data and any problem in processing current data.
2)- Systems design: this stage involves designing new or revising current accounting systems based upon the results of the systems analysis.
3)- Systems implementation: this final stage installs and evaluates the new or revised accounting system.
INTERNAL CONTROLS
Internal controls are designed to safeguard assets, check accuracy of accounting data, promote efficiency, and encourage adherence to company policies. Internal accounting controls are specifically concerned with the protection of assets and the reliability of accounting information. Internal administrative controls are concerned with operational efficiency, and help determine whether business goals are being met.
SUBSIDIARY LEDGERS
Subsidiary ledgers are used for accounts that have a large number of individual accounts with common characteristics. Subsidiary ledgers are commonly used for accounts receivable and accounts payable; both consist of a large number of smaller accounts. The general ledger contains all balance sheet and income statement accounts. Every subsidiary ledger has a controlling account which can be found in the general ledger. The sum of the balances of the subsidiary ledger must be equal to the controlling account.
SPECIAL JOURNALS
Special journals are designed to record a specific type of transaction which occurs frequently. The following is a summary of the four most commonly used special journals:
1)- purchases journal: used to record purchases on credit,
2)- sales journal: used to record all sales made on credit,
3)- cash payments journal: records all cash disbursements, and
4)- cash receipts journal: records all cash receipts.
In certain instances, business documents such as purchases and sales invoices are used instead of special journals to reduce expenses.
PURCHASES JOURNAL
Items commonly purchased on account are goods held in inventory for sale, supplies, and equipment. The accounts payable account is always credited, and an asset account is debited. Assets purchased on a recurring basis have their own column in the journal. Assets purchased less regularly are posted in the sundry accounts section of the journal. At all times, total debits must equal total credits. At the end of an accounting period, all entries should be posted to a subsidiary ledger or the general ledger.
CASH PAYMENTS JOURNAL
When the cash payments journal is used, the cash column is always credited whenever a payment is issued. When a payment is made for goods previously purchased on credit, the accounts payable column is credited. In the event a discount is offered for early payment, the purchases discounts column should be debited. The sundry accounts column is used for debits to accounts which do not have an individual column. At the end of the month, all data from the journal should be posted to subsidiary ledgers or the general ledger. The sum of the accounts payable subsidiary ledger must be equal to the controlling account. In the event it is not, errors must be found and corrected.
SALES JOURNAL
The sales journal is only used to record sales of merchandise on account. A unique feature of the sales journal is that accounts receivable debits and credits share the same column. A column also often exists to record sales tax payable. Any sales returns or allowances granted for goods sold on credit require an entry to the general journal. If a cash refund is given, the transaction should be recorded to the cash payments journal.
CASH RECEIPTS JOURNAL
The cash receipts journal is used to record all transactions that increase the cash balance. The most common sources of cash receipts are cash sales and payments for goods on account. When debtors pay for goods purchased on account, the accounts receivable column should be credited. If a cash discount is taken by a customer, the sales discount column should be debited for the cash discount. All accounts in the cash receipts journal are posted periodically to the general ledger. Accounts receivables should be posted monthly to the accounts receivable subsidiary ledger.
BANK ACCOUNTS
The most effective tool used to control cash is a bank account. It provides a double record of all cash transactions. In order to provide effective controls on the use of bank accounts, special documents are used to evidence transactions. Signature cards are kept by the bank for all employees authorized to make withdrawals. Deposit tickets must accompany deposits, and checks must be issued for all payments. A remittance advice is sent with each payment to ensure that proper credit is recorded by creditors. Banks commonly require that a minimum balance (compensating balance) be held.
BANK STATEMENTS
An advantage of using a bank account to control cash is that banks send a bank statement monthly reporting all the transactions in the account. Information normally present in the bank statement consists of the beginning and ending balances, deposits, other credits, withdrawals and other debits. The cancelled checks are enclosed with the statement, as well as debit and credit memorandums (for items processed by the bank usually unknown to the depositor). Rarely will the bank statement balance and the depositor's Cash in Bank account balance be exactly the same, and they must be reconciled.
BANK RECONCILIATIONS
A bank reconciliation is a method used to determine the reasons for discrepancies between the bank statement balance and the Cash in Bank account balance and to calculate an adjusted balance. Discrepancies are usually due to outstanding items which have not yet been recorded by either of the bank or the company, and which typically include checks not yet presented for collection, deposits in transit and bank service charges. Errors are another common cause of discrepancies, which the reconciliation will help correct. Finally, the reconciliation may uncover irregularities.
|
A bank reconciliation is divided into two sections, the balance per bank statement and the balance per depositor's records. Although it is possible to reconcile one balance to the other, common practice adjusts both balances to prove to one another. Outstanding transactions unknown to the depositor discovered when the bank statement was sent require journal entries.
Example: Prepare a bank reconciliation based on the following:
|
There are often several cash accounts because they serve different purposes. The Cash in Bank account represents the checking account that processes deposits, checks and memorandum items. The Cash Short and Over account is used to record any variance by sales clerks. The Cash on Hand Fund is used to provide change to conduct business with customers. The Petty Cash Fund is used to pay for small items with cash. Each of these cash accounts needs to be strictly controlled to prevent mishandling.
Receipts Repairs to tables $ 15 Delivery to customers $ 25
|
Numerous procedures are available to control cash accounts. Monthly bank statements help verify the cash account balance. The bank reconciliation is particularly useful in controlling cash receipts. The voucher system is used to control cash payments. Different cash funds exist for specific purposes to keep track of each type of cash transaction. It should be noted that it is of utmost importance to separate cash handling and cash related accounting duties.
THE VOUCHER SYSTEM
One of the most common methods to control cash payments is the voucher system. The components of a voucher system are 1)- vouchers: documents establishing proof of payment,
2)- a voucher register: to record every voucher,
3)- an unpaid voucher file,
4)- a paid voucher file, and the
5)- a check register: to record the payment of each voucher.
The voucher system provides effective accounting controls and aids management decision making.
THE VOUCHER SYSTEM
IMPORTANT FACTS CONCERNING VOUCHERS
1)- Vouchers must be prepared for all payments.
2)- Vouchers represent written authorization of a payment.
3)- Before a voucher can be approved; the receiving report,
invoice and purchase order should be compared keeping in mind possible discounts.
4)- All vouchers should be recorded in the voucher register in a numerical order.
THE VOUCHER SYSTEM
FACTS CONCERNING THE VOUCHER REGISTER
1)- All vouchers must be recorded in the voucher register.
2)- Vouchers are listed in numerical order.
3)- The register records the payee, the date the payment is made and the number of the check issued for payment,
4)- The Accounts Payable account is always credited, but there may be different accounts to be debited.
5)- The Sundry Accounts is used to debit accounts not listed in the other Register columns.
THE VOUCHER SYSTEM
VOUCHER FILES PROCEDURES
1)- Unpaid vouchers are filed in the unpaid voucher file.
2)- Unpaid vouchers should be filed in the order they are due.
3)- Paid vouchers are filed in the paid voucher file.
4)- Paid vouchers are filed in numerical order.
THE VOUCHER SYSTEM
USING THE CHECK REGISTER
1)- When a voucher is paid, it is recorded in the check register.
2)- The check register is similar to the cash payments journal.
3)- All checks should be listed numerically, even those thatare voided.
4)- Cash in Bank account should always be credited. If a discount is taken, credit the Purchases Discount account.
5)- Voucher numbers and a running cash balance column are used in the check register.
ELECTRONIC FUNDS TRANSFER
The evolution of electronic funds transfer (EFT) will change the way cash transactions are processed. EFT uses electronic impulses that are computerized to perform cash transactions. This eliminates the need for checks and physical money. EFT has a particularly strong presence in retail sales. Point-of-sale systems are used by customers to pay for purchases using credit cards, charge cards, and bank cards. The greatest benefit EFT can provide is reduced costs, and quicker and more accurate information.
No comments:
Post a Comment