What is Accounting

• Accounting is an information and measurement system that identifies, records, and communicates relevant,
reliable, and comparable information about an organization’s business activities.
• Identifying business activities requires selecting transactions and events relevant to an organization.
• Recording business activities requires keeping a chronological log of transactions and events measured in
different currencies and classified and summarized in a useful format.
• Communicating business activities requires preparing accounting reports such as financial statements. It also
requires analyzing and interpreting such reports.

Users of Accounting Information

Accountants prepare reports for both external and internal users
External Users
Creditors Shareholders Tax Agencies External Auditors Customers
External users of accounting information are not directly involved in running the organization. External users use
accounting information to answer questions that help them make decisions.
• 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?

Internal Users
Managers Officers/Directors Internal Auditors Sales Staff
Budget Officers Controllers
Internal Users are those directly involved in managing and operating an organization. They use the information to help
improve the efficiency and effectiveness of an organization. Internal users use accounting information to answer
questions that help them undertake their tasks.
• 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?

Main Branches of Accounting

For External Users Financial accounting provides external users with financial statements.

For Internal Users Managerial accounting uses financial statements and other inputs to provide information needs
for internal decision-makers.

Accounting Standards
Generally Accepted Accounting Principles (GAAP)
• Financial accounting practice is governed by concepts and rules known as generally accepted accounting
principles (GAAP), which identify three major characteristics of information.
• First, the information must be relevant, which means that accounting information impacts the decision of the
informed user.
• Second, the information must be reliable, or trusted by users.
• Finally, the information must be comparable, which helps users evaluate financial information from one period
with that of the next period, and also helps in contrasting organizations.
International Financial Reporting Standards (IFRS)
 • In today’s global economy, there is increased demand by external users for comparability in accounting reports.
This demand often arises when companies wish to raise money from lenders and investors in different countries.
• If standards are harmonized, one company can potentially use a single set of financial statements in all financial
markets.
• Therefore, the International Accounting Standards Board (IASB), an independent group (consisting of 16
individuals from many countries), issues International Financial Reporting Standards (IFRS) that identify
preferred harmonized accounting practices.
Forms of Business Ownership
• A sole proprietorship is a business owned by just one individual. A court can order an owner to sell
personal belongings to pay a proprietorship’s debt. This unlimited liability of a proprietorship is a
disadvantage.
• A partnership is owned by two or more individuals. Some partnerships have several thousand partners.
Partners can have limited or unlimited liability depending on the partnership agreement.
• A corporation is a business legally separate from its owners, meaning it is responsible for its own acts
and its own debts and its owners have limited liability.
✔ Separate legal status means that a corporation can conduct business with the rights, duties, and

responsibilities of a person.
✔ A corporation acts through its managers, who are its legal agents.

✔ A corporation is owned by individuals (called shareholders or stockholders) who normally are not

active in the day-to-day operations of that business. For example, you may become an owner of
Vodafone Egypt by purchasing shares of stock on the Egyptian Stock Exchange. While you are a
part owner, you do not necessarily work for Vodafone Egypt nor are active in the operations of the
company.

A Business Financial Position

Equation Assets = Liabilities + Owner's Equity

Expanded Owner's Owner’s

Assets = Liabilities + - + Revenues - Expenses
Equation Capital Withdrawals

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
• Analyzing business transactions is the firs step of the accounting cycle.

Financial Statements
1. The income statement describes a company’s revenues and expenses along with the resulting net
income or loss over a period of time due to earnings activities.
2. Statement of owner’s equity—explains changes in equity from net income (or loss) and from any
owner investments and withdrawals over a period of time.
 3. Statement of financial Position—describes a company’s financial position (types and amounts of
assets, liabilities, and equity) at a point in time.
4. Statement of cash flows—identifies cash inflows (receipts) and cash outflows (payments) over a period
of time.

Income Statement
• Net income is defined as the difference between revenues and expenses.
• If expenses exceed revenues, we have a net loss rather than net income.
• Financial statements have a three line title with the company name, the name of the statement, and the period covered by the
report.
• In our case, we had total revenues of $6,100 and total expenses of $1,700, so net income for the month ended December 31,
2011, was $4,400.
• After completing the income statement, we can prepare the statement of owner's equity.

STATEMENT OF OWNER’S EQUITY

• In the statement of owner's equity, we start with the balance at the beginning of the period, add new owner investments and net
income earned during the period, and deduct any withdrawals paid, resulting in the ending balance in owner's equity.
• FastForward was started this month, so the beginning balance in owner's equity was zero.
• Chas Taylor invested $30,000 in the company at the beginning of the month.
• During December, net income of $4,400 was earned. Notice that the net income flows from the income statement to the
statement of owner’s equity. We must complete the income statement before we can begin working on the statement of owner’s
equity.
• In addition, $200 withdrawal was made by Chas Taylor, so the ending balance in owner's equity is $34,200. After we complete this
statement, we can prepare the statement of financial position (balance sheet).
Statement of Financial Position
• The statement of financial position is a summary of assets, liabilities and equity at the end of the month. Our total assets are equal
to $40,400. This includes cash of $4,800, supplies of $9,600, and equipment of $26,000.
• Liabilities include accounts payable of $6,200.
• Equity is composed of C. Taylor, Capital of $34,200. The account [Link], Capital flows directly from the statement of owner’s
equity. You can see that the books are in balance because total assets are equal to total liabilities plus equity.
• Creditors have claims against our assets of $6,200. The owner has claims to assets of $34,200.

Statement of Cash Flows

 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?
 The statement reconciles to the ending cash balance of $4,800. Recall that the ending cash balance of $4,800 flows from the
balance sheet to the statement of cash flows.
 The three major types of activities in any organization can be defined as:
1. Financing Activities – Provide the means organizations use to pay for resources such as land, buildings, and equipment to
carry out plans.
2. Investing Activities - Are the acquiring and disposing of resources (assets) that an organization uses to acquire and sell its
products or services.
3. Operating Activities – Involve using resources to research, develop, purchase, produce, distribute, and market products and
services.
 Investing (assets) and financing (liabilities and equity) are set opposite each other to stress their balance.
 Operating activities are below investing and financing activities to show that operating activities are the result of investing and
financing.
 Planning is part of each activity and gives them meaning and focus.

Notice that the statement is divided into three major sections:

1. Cash flows from operating activities which report cash receipts and payments from the primary
business the company engages in (Net Income Transactions).
2. Cash flows from investing activities which involve cash transactions from buying and selling long-term
assets (Non-current Assets).
3. Cash flows from financing activities which include long-term cash borrowings and repayments to
lenders (Liabilities) and the cash investments from and withdrawals by the owner (Owner’s Equity).
Decision Analysis (Return on Assets)
• Return on assets is a useful profitability measure used in evaluating management, analyzing and
forecasting profits, and planning activities.
• Return on assets (ROA), also called return on investment (ROI) is stated in ratio form as income divided
by assets invested.
Net income
Return on assets =
Average total assets
Return on Assets (Example)
• Best Buy reports net income of $1,317 million for fiscal year 2010. At the beginning of fiscal 2010, its total assets are
$15,826 million and at the end of fiscal 2010, they total $18,302 million. Best Buy’s return on assets for fiscal 2010 is:
$1,317 million
Return on assets = = 7.7%
($15,826 million + $18,302 million)/2

 Is a 7.7% return on assets good or bad for Best Buy?

To help answer this question, we compare (benchmark) Best Buy’s return with its prior performance, the returns of competitors
(such as RadioShack, Conn’s, and Rex Stores), and the returns from alternative investments.

Return and Risk Analysis

Many different
returns may be  The trade-off between
reported. return and risk is a
normal part of business.
Risk is the  Higher risk implies
ROA
uncertainty about
Interest return on savings accounts higher, but riskier,
the return we will
Interest return on corporate bonds expected returns.
earn.
 To make better
decisions, we need to
Bonds are written promises consider both return
by organizations to repay
and risk.
amounts loaned with
interest

Return and Risk Analysis (Example)

• Banks report return from a savings account in the form of an interest return such as 4%. If we invest in a
savings account or in U.S. Treasury bonds, we expect a return of around 2% to 7%. How do we decide
among these investment options?
The answer depends on our trade-off between return and risk.
• All business investments involve risk, but some investments
involve more risk than others. The lower the risk of an
investment, the lower is our expected return. The bar graph
shows recent returns for 10-year bonds with different risks.
• U.S. Treasury bonds provide a low expected return, but they
also offer low risk since they are backed by the U.S.
government. High-risk corporate bonds offer a much larger
potential return but with much higher risk.
Accounting Cycle

The term accounting cycle refers to the steps in preparing financial statements. It is called a cycle because the
steps are repeated each reporting period. There are ten steps in the cycle which include:
1. Analyze transactions -- Analyze transactions to prepare for journalizing.
2. Journalize -- Record accounts, including debits and credits, in a journal.
3. Post -- Transfer debits and credits from the journal to the ledger.
4. Prepare unadjusted trial balance -- Summarize unadjusted ledger accounts and amounts.
5. Adjust -- Record adjustments to bring account balances up to date; journalize and post adjustments.
6. Prepare adjusted trial balance -- Summarize adjusted ledger accounts and amounts.
7. Prepare statements -- Use adjusted trial balance to prepare financial statements.
8. Close -- Journalize and post entries to close temporary accounts.
9. Prepare post-closing trial balance -- Test clerical accuracy of the closing procedures.
10. Reverse (optional step) -- Reverse certain adjustments in the next period.

1. Summarizing and Recording Process

• We begin the accounting process by analyzing source documents. For example, you usually receive a receipt when
you pay cash for something. Think about the last time you went to a fast food restaurant. When you received your
order, you were given a receipt, a source document. If you wanted a company to reimburse you for the meal
because you were traveling on company business, you must present evidence of your expenditure. This evidence
takes the form of a source document, the receipt.
• Once we identify a business transaction, we record it in a journal. A journal is arranged in chronological order.
Transactions are recorded by date of occurrence.
 • At the end of the accounting period, usually a month, transactions in the journal are posted to a ledger account.
Posting is the systematic process of transferring information from the journal to the ledger. The ledger groups
transactions by the accounts impacted. For example, we will have a ledger account for cash. All transactions that
result in increases or decreases in the cash account will be posted to the cash ledger account.
• Once all transactions have been posted, we prepare a trial balance. The purpose of the trial balance is to make sure
that all information has been transferred properly. The trial balance is a listing of all account balances.

Asset Accounts
Land/ Cash / Accounts Receivable / Buildings / Notes Receivable / Equipment / Supplies / Prepaid Accounts
Think about your auto insurance. Many of us pay our auto insurance for long periods. The payment is made in advance and is referred to as a prepaid amount.
Prepaid amounts will turn into expenses as they are used up

Liability Accounts
Accounts Payable / Notes Payable / Accrued Liabilities / Unearned Revenue
When insurance companies receive insurance payments in advance, cash is received but nothing has been done to earn the revenue. As the insurance service is
provided to customers, the company recognizes a portion of the money received as revenue. At the end of the insurance period, all the revenue will be earned
and the liability no longer exists.

Equity Accounts
Owner’s Capital / Owner’s Withdrawals / Revenues / Expenses

Debit and Credit Procedure

Double-entry system (or double-entry accounting)
• 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
Instead of using the terms increase and decrease, we use the terms debit and credit. It is important to remember
whether we are talking about an asset, liability, or equity account for the meaning of a debit or a credit.

2. The Journal
• Book of original entry
• Transactions recorded in chronological order
• Contributions to the recording process:
1. Provides a chronological record of transactions
2. Discloses the complete effects of a transaction
3. Helps to prevent or locate errors because the debit and credit amounts can be easily compared
Journalizing

• The owner of the business contributes $30,000 cash to start the business. Let’s see how we get the various pieces.
• The transaction occurred on December 1st, 2011. The date is important when recording general journal transactions
and is recorded on the left side of the journal.
 • Next we identify the accounts affected by the transactions. The cash account is an asset that has increased. We show
increases in asset accounts with a debit to that account. The C. Taylor, Capital account also increased and we show
increases in equity accounts with a credit. Debits are always listed first in the journal followed by credits that are
slightly indented below the debits.
• The dollar amount is placed in the appropriate debit or credit column. In this case, the cash account was debited for
$30,000, so we place that amount in the debit column.

On September 1, Ray Neal invested €15,000 cash in the business

GENERAL JOURNAL J1

Date Account Titles and Explanations Ref. Debit Credit

Sept. 1 Cash 15,000

Owner's Capital 15,000

3. The Ledger and Posting

The Ledger
• Entire group of accounts maintained by a company
• Keeps track of changes in account balances
• Provides the balance in each account
• Accountants often use a T-account to represent a general ledger account. It is a quick way to analyze transactions
before we enter the information in the journal.

• The account title is entered on the top of the T-account. The left side of a T-account is always called the debit side, and
the right side is always called the credit side.

• Debit and Credit terminologies come from the time when the first double-entry system was developed. We still use the
terms as a convention. The words do not have any significant meaning other than that they stand for the left and right
side of a ledger.

• When the sum of the debits exceed the sum of the credits in a particular account, the account has a debit balance.

A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions.

The Account
• Record of increases and decreases in a specific asset, liability,
owner’s equity, revenue, or expense item.
• Debit = “Left”
• Credit = “Right”

Posting to The Ledger

Balance Column Ledger Account
T-accounts are useful illustrations, but balance column ledger accounts are used in practice.
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.

1 2

The trial balance lists all account balances in the general ledger.
If the books are in balance, the total debits will equal the total
credits. If this is not the case, we may have made an error
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.

Trial Balance
Locating Errors
Errors in a trial balance generally result from
• mathematical mistakes,
• incorrect postings,
• or simply transcribing data incorrectly.

Presentation Issues
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
Ethics in Financial Reporting
• The standards of conduct by which actions are judged as right or wrong, honest or dishonest, fair or
not fair, are ethics.
• Effective financial reporting depends on sound ethical behavior.
• There is no doubt that a sound, well-functioning economy depends on accurate and dependable
financial reporting.
• Imagine trying to carry on a business or invest money if you could not depend on the financial
statements to be honestly prepared. Information would have no credibility.

Ethical Issues
Steps in Analyzing Ethics Cases and Situations
 Recognize an ethical situation and the ethical issues involved
• Use your personal ethics to identify ethical situations and issues. Some businesses and
professional organizations provide written codes of ethics for guidance in some business
situations.
 Identify and analyze the principal elements in the situation
• Identify the stakeholders—persons or groups who may be harmed or benefited. Ask the
question: What are the responsibilities and obligations of the parties involved?
 Identify the alternatives, and weigh the impact of each alternative on various stakeholders
• Select the most ethical alternative, considering all the consequences. Sometimes there will be
one right answer. Other situations involve more than one right solution; these situations
require an evaluation of each and a selection of the best alternative.

Ethics Insight
“I felt the pressure.”
That’s what some of the employees of the now-defunct law firm of Dewey & LeBoeuf LLP indicated when they
helped to overstate revenue and use accounting tricks to hide losses and cover up cash shortages.
These employees worked for the former finance director and former chief financial officer (CFO) of the firm.
Here are some of their comments:
• “I was instructed by the CFO to create invoices, knowing they would not be sent to clients. When I
created these invoices, I knew that it was inappropriate.”
• “I intentionally gave the auditors incorrect information in the course of the audit.”
What happened here is that a small group of lower-level employees over a period of years carried out the
instructions of their bosses. Their bosses, however, seemed to have no concern as evidenced by various e-
mails with one another in which they referred to their financial manipulations as accounting tricks, cooking the
books, and fake income.
Source: Ashby Jones, “Guilty Pleas of Dewey Staff Detail the Alleged Fraud,” Wall Street Journal (March 28,
2014).

Accounting Standards
• In order to ensure high-quality financial reporting, accountants present financial statements in
conformity with accounting standards that are issued by standard-setting bodies.
• Presently, there are two primary accounting standard-setting bodies—the International Accounting
Standards Board (IASB) and the Financial Accounting Standards Board (FASB).
• More than 149 countries follow standards referred to as International Financial Reporting Standards
(IFRS). IFRSs are determined by the IASB. The IASB is headquartered in London, with its 15 board
members drawn from around the world.
 • Most companies in the United States follow standards issued by the FASB, referred to as generally
accepted accounting principles (GAAP).
• As markets become more global, it is often desirable to compare the results of companies from
different countries that report using different accounting standards. In order to increase comparability,
in recent years the two standard-setting bodies made efforts to reduce the differences between IFRS
and U.S. GAAP. This process is referred to as convergence.

GAAP and IFRS

Similarities
• Transaction analysis is the same under IFRS and GAAP.
• 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 under IFRS.
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.
• U.S. GAAP balance sheets report current items first, while IFRS balance sheets normally (but are not
required to) present noncurrent items first, and equity before liabilities.
Looking to the Future
• The basic recording process discussed previously 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.

Global Insight
If you think that accounting standards don’t matter, consider these events in South Korea. For many years,
international investors complained that the financial reports of South Korean companies were inadequate and
inaccurate. Accounting practices there often resulted in huge differences between stated revenues and
actual revenues. Because investors did not have faith in the accuracy of the numbers, they were unwilling to
pay as much for the shares of these companies relative to shares of comparable companies in different
countries. This difference in share price was often referred to as the “Korean discount.”
In response, Korean regulators decided that companies would have to comply with international accounting
standards. This change was motivated by a desire to “make the country’s businesses more transparent” in
order to build investor confidence and spur economic growth. Many other Asian countries, including China,
India, Japan, and Hong Kong, have also decided either to adopt international standards or to create
standards that are based on the international standards.
Source: Evan Ramstad, “End to ‘Korea Discount‛?” Wall Street Journal (March 16, 2007).

Principles and Assumptions of Accounting

These are three fundamental assumptions of accounting underlying the preparation of financial statements.
Going-Concern Assumption
Reflects assumption that the business will continue operating instead of being closed or sold.
Time Period Assumption
Presumes that the life of a company can be divided into time periods, such as months and years.
Monetary Unit Assumption
Include in accounting records only transaction data that can be expressed in terms of money
Revenue Recognition Principle
Recognize revenue when it is earned (by delivering a product or providing a service). Proceeds need not be in
cash.

Matching Principle
(Expense Recognition Principle)
A company must record its expenses incurred to generate the revenues reported (Expenses need to be
matched against revenues) in the same accounting period.

Business Entity Assumption

A business is accounted for separately from other business entities, including its owner.

Income Statement
 The income statement describes a company’s revenues and expenses along with the resulting net income
or loss over a period of time due to earnings activities.
 The income statement describes the results of a company’s operations during a period of time through
revenues and expenses.

IFRS generally uses one of two measurement principles

1. Historical Cost Principle (or cost principle)
• Record assets at their cost.
• For example, if Great Wall Manufacturing purchases land for ¥300,000,000, the company initially
reports it in its accounting records at ¥300,000,000. But what does Great Wall do if, by the end of the
next year, the fair value of the land has increased to ¥400,000,000?
Under the historical cost principle, it continues to report the land at ¥300,000,000.
2. Fair Value Principle
• Assets and liabilities should be reported at fair value (the price received to sell an asset or settle a
liability) .
• Fair value information may be more useful than historical cost for certain types of assets and liabilities.
• For example, certain investment securities are reported at fair value because market value information
is usually readily available for these types of assets.
 Selection of which principle to follow generally relates to trade-offs between relevance and faithful
representation.
- Relevance means that financial information is capable of making a difference in a decision.
- Faithful representation means that the numbers and descriptions match what really existed or happened—
they are factual.
• In determining which measurement principle to use, companies weigh the factual nature of cost
figures versus the relevance of fair value.
• In general, even though IFRS allows companies to revalue property, plant, and equipment and other
long-lived assets to fair value, most companies choose to use cost.
• Only in situations where assets are actively traded, such as investment securities, do companies apply
the fair value principle extensively.

Financial Position Statement (Balance Sheet)

The Balance Sheet describes a company’s financial position at a point in time.
It’s a summary of assets, liabilities and equity at the end of the accounting period.
Full Disclosure Principle
A company is required to report the details behind financial statements if the details so disclosed would
impact the users’ decision-making process. Most of the details are reported in the notes to the financial
statements.

Decision Analysis (Debt Ratio)

• Borrowing money is risky business; therefore, an important business objective is gathering information
to help assess a company’s risk of failing to pay its debts.
• The debt to assets ratio helps evaluate the level of debt risk.
• Companies finance their assets with either liabilities or equity. A company that finances a relatively
large portion of its assets with liabilities is said to have a high degree of financial leverage.
• Higher financial leverage involves greater risk because liabilities must be repaid and often require
regular interest payments (equity financing does not).
• We determine a company’s ability to pay its debts (liabilities) using the debt ratio.
• Debt Ratio is equal to Total Liabilities divided by Total Assets.
• A higher ratio indicates that there is greater probability a company will not be able to pay its debts in
the future. Total Liabilities
Debt Ratio =
Total Assets
The Adjustments Process
A company needs to adjust its account balances to ensure that:
• All revenues have been recognized in the period earned
• All expenses have been recorded in the same period as the revenues they helped generate
• All assets and liabilities are properly stated as of the Balance Sheet date.
External Versus Internal Transactions
• We learned earlier how to prepare journal entries for external transactions. These transactions with
parties outside of the company had source documents that triggered the journal entry process, for
example we purchased $5,000 of supplies on account and debited supplies and credited accounts
payable.
• The usage of those supplies is an internal transaction. There is no source document prepared every
time we use a sheet of paper. It wouldn’t be practical, but since the supplies are being used up, the
asset account balance is becoming obsolete.
The adjustments process accounts for these internal transactions through adjustments (adjusting entries).
Accrual-Basis and Adjusting Entries
To provide timely information, accounting systems prepare reports at regular intervals and divide the
economic life of a business into artificial time periods (Time Period Assumption) or (periodicity assumption).
month, quarter, or year.
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
• When we divide business activities into arbitrary fixed periods of time, it is often necessary to have special
accounting for transactions that cross from one time period to the next, which is accounted for during the
adjustments process.
Accrual- Versus Cash-Basis Accounting
Accrual-Basis Accounting
• Transactions recorded in the periods in which the events occur
• Companies recognize revenues when earned by performing services or delivering products
(rather than when they receive cash)
• Expenses are recognized when incurred (rather than when paid)
• In accordance with International Financial Reporting Standards (IFRS)
Cash-Basis Accounting
• Revenues recognized when cash is received
• Expenses recognized when cash is paid
• Cash-basis accounting is not in accordance with International Financial Reporting Standards
(IFRS)
Revenue Recognition Principle
Recognize revenue when earned in the accounting period in which the performance obligation is satisfied (when the
product or service is delivered to our customer).
Expense Recognition Principle
Companies recognize expenses when incurred in the same accounting period as the revenues that are earned as a result
of those expenses “Let the expenses follow the revenues”.
Expenses need to be recognized in the period in which companies make efforts (consume assets or incur liabilities) to
generate revenue.
IFRS Relationships in Revenue and Expense Recognition

Time Period Assumption

Economic life of business can be divided into

artificial time periods.

Revenue Recognition Principle Expense Recognition Principle

Recognize revenue in the accounting period in Recognize expense in the period that efforts are
which the performance obligation is satisfied. made to generate revenue.

Revenue and Expense Recognition

In accordance with International Financial

Reporting Standards (IFRS).

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 (effects of
internal transactions)
• Required every time a company prepares financial statements to ensure that all balances that appear
in financial statements are adjusted.
• Will include one income statement account and one statement of financial position account.

Types of Adjusting Entries

Deferrals Accruals

1. Prepaid Expenses. 1. Accrued Revenues.

2. Expenses paid in cash before they are
Revenues for services performed but not
used or consumed.
yet received in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services are Expenses incurred but not yet paid in
performed. cash or recorded.
 Q&A
1. Identify the following users as either external user (E) or internal users (I)
a. Lenders (E) b. Controllers (I) c. shareholders (E) d. Sales staff (I) e. FBI and IRS (E)
f. Consumer Group (E) g. Brokers (E) h. Suppliers (E) i. customers (E) j. mangers (I)
k. Business press (E) l. District attorney (E)

2. Identify the following users of accounting information as either an internal (I) or an external (E) user
[Link] (E) [Link] (E) [Link] employee (I)
[Link] and development director (I) 5. Purchasing manager (I) 6. Human resources director (I)
7. Production supervisors (I) 8. Distribution managers (I)

3. Identify the following question as most likely to be asked by an internal (I) or an external (E) user of
accounting information
[Link] are the costs of our service to customers? (I)
[Link] we make a five-year loan to that business? (E)
[Link] we spend further research on our product? (I)
[Link] income levels justify the current stock price? (E)
[Link] are reasonable payroll benefits and wages? (I)
[Link] firm reports the highest sales and income? (E)
[Link] are the costs of our product’s ingredients? (I)

4. The following describe several different business organization. Determine whether the description
refers to a sole proprietorship, partnership, or corporation.
a. A-I pays its own income taxes and has two owners. Corporation
b. Ownership of Zeller Company is divided into 1,000 shares of stock. Corporation
c. Waldron is owned by Mary Malone, who is personally liable for the company’s debts. Sole proprietorship
d. Micah Douglas and Nathan Logan own Financial Services, a financial services provider. Neither Douglas nor Logan
has personal responsibility for the debts of Financial Services. Corporation
e. Bailey and Kay own Squeaky Clean, a cleaning service. Both are personally liable for the debts of the business.
Partnership
f. Plasto Products does not pay income taxes and has one owner. Sole proprietorship
g. Ian LLC does not have separate legal existence apart from the one person who owns it. Sole proprietorship

5. Indicate whether each of the statements is true or false. indicate how to correct the statement.
 The three main activities in the accounting system are identification, recording, and communication.
(True)
 Bookkeeping encompasses all steps in the accounting process.
(False)
 Accountants prepare, but do not interpret, financial reports.
(False)
 The two most common types of external users are investors and company officers.
(False)
 Managerial accounting focuses on reports for internal users.
(True)
 6. Which of the following financial statements is prepared as of a specific date?
a. Statement of financial position True
b. Income statement
c. Owner's equity statement
d. Statement of cash flows

Debits:
a. increase both assets and liabilities
b. decrease both assets and liabilities
c. increase assets and decrease liabilities Debits
d. decrease assets and increase liabilities

7. Accounts that normally have debit balances are:

a. assets, expenses, and revenues
b. assets, expenses, and owner's capital
c. assets, liabilities, and owner’s drawings
d. assets, owner’s drawings, and expenses True

8. A trial balance will not balance if:

a. a correct journal entry is posted twice.
b. the purchase of supplies on account is debited to Supplies and credited to Cash.
c. a £100 cash drawing by the owner is debited to Owner’s Drawings for £1,000 and credited to Cash for
£100. True
d. a £450 payment on account is debited to Accounts Payable for £45 and credited to Cash for £45.

9. The time period assumption states that:

a. companies must wait until the calendar year is completed to prepare financial statements.
b. companies use the fiscal year to report financial information.
c. the economic life of a business can be divided into artificial time periods. True
d. companies record information in the time period in which the events occur.

10. Which of the following statements about the accrual basis of accounting is false?
a. Events that change a company’s financial statements are recorded in the periods in which the events
occur.
b. Revenue is recognized in the period in which services are performed.
c. This basis is in accordance with International Financial Reporting Standards.
d. Revenue is recorded only when cash is received, and expense is recorded only when cash is paid. False

11. Adjusting entries are made to ensure that:

a. expenses are recognized in the period in which they are incurred.
b. revenues are recorded in the period in which services are performed.
c. statement of financial position and income statement accounts have correct balances at the end of an
accounting period.
d. All the responses above are correct. True
 12. Below is a list of timing concepts in the left column, with a description of the concept in the right
column. There are more descriptions provided than concepts. Match the description to the concept
1. ___ Accrual-basis accounting. f
2. ___ Calendar year. e
3. ___ Time period assumption. c
4. ___ Expense recognition principle. b
(a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be recognized in the period in which a company uses assets or incurs liabilities to
generate results (revenues).
(c) Accountants divide the economic life of a business into artificial time periods.
(d) Companies record revenues when they receive cash and record expenses when they pay out cash.
(e) An accounting time period that starts on January 1 and ends on December 31.
(f) Companies record transactions in the period in which the events occur.

13. Match each transaction ort event to one of the following activities of an organization: financing
activities (F), investing activities (I), or operating activities (O).
1. _____________ An owner contributes resources to the business . Financing
2. _____________ An organization purchases equipment. Investing
3. _____________ An organization advertises a new product. Operating
4. _____________ The organization borrows money from a bank. Financing
5. _____________ An organization sells some of its land. Investing

*Would also be listed as “investing” if resources contributed by owner were in the form of non-financial
resources.
Note that the three categories of cash flows are operating activities, investing activities, and financing
activities.
- Operating activities include cash activities related to net income.
- Investing activities include cash activities related to noncurrent assets.
- Financing activities include cash activities related to noncurrent liabilities and owners’ equity.
14. Identifying accounting principles and assumptions- Match each of the numbered descriptions with
the principle or assumption it best reflects.
 Revenue is recorded only when the earnings process is complete.
Revenue recognition principle
 Information is based on actual costs incurred in transactions.
Cost principle
 Financial statements reflect the assumption that the business continues operating.
Going-concern assumption
 A company reports details behind financial statements that would impact users' decisions.
Full disclosure principle
 A company records the expenses incurred to generate the revenues reported.
Matching (expense recognition) principle
 Every business is accounted for separately from its owner or owners.
Business entity assumption
 Derived from long-used and generally accepted accounting practices such as the concepts,
assumptions, and guidelines for preparing the financial statements.
General accounting principle
 Revenue is recorded when products and services are delivered.
Revenue recognition principle
 Usually created by a pronouncement from an authoritative body.
Specific accounting principle
 Multiple-Choice Questions
15. The accounting process begins with:
A. Analysis of business transactions and source documents.
B. Preparing financial statements and other reports.
C. Summarizing the recorded effect of business transactions.
D. Presentation of financial information to decision-makers.
E. Preparation of the trial balance.

16. An account used to record the owner's investments in the business is called a(n):
A. Withdrawals account.
B. Capital account.
C. Revenue account.
D. Expense account.
E. Liability account.

17. A formal promise to pay (in the form of a promissory note) a future amount is a(n):
A. Unearned revenue.
B. Prepaid expense.
C. Credit account.
D. Note payable.
E. Account receivable.
18. A credit is used to record:
A. An increase in an expense account.
B. A decrease in an asset account.
C. A decrease in an unearned revenue account.
D. A decrease in a revenue account.
E. A decrease in a capital account.
19. Of the following accounts, the one that normally has a credit balance is:
A. Cash.
B. Office Equipment.
C. Wages Payable.
D. Owner, Withdrawals.
E. Sales Salaries Expense.
20. Cool Tours had beginning equity of $72,000; revenues of $90,000, expenses of $65,000, and
withdrawals by owners of $9,000. Calculate the ending equity.
A. $88,000.
B. $25,000.
C. $97,000.
D. $38,000.
E. $47,000.
21. Della's Donuts had cash inflows from operating activities of $27,000; cash outflows from investing
activities of $22,000, and cash outflows from financing activities of $12,000. Calculate the net
increase or decrease in cash.
A. $61,000 increase.
B. $37,000 increase.
C. $7,000 decrease.
D. $7,000 increase.
E. $34,000 decrease.
 22. Rent expense that is paid with cash appears on which of the following statements?
A. Balance sheet.
B. Income statement.
C. Statement of owner's equity.
D. Income statement and statement of cash flows.
E. Statement of cash flows only.
23. A company borrows $125,000 from the Eastside Bank and receives the loan proceeds in cash. This
represents a(n):
A. Revenue activity.
B. Operating activity.
C. Expense activity.
D. Investing activity.
E. Financing activity.
24. Use the following information as of December 31 to determine equity.

A. $57,000.
B. $141,000.
C. $297,000.
D. $438,000.
E. $579,000.
25. Byron, Inc. has total current assets of $800,000; total current liabilities of $450,000; long-term assets
of $300,000; and long-term debt of $200,000. How much is the firm's total equity?
$450,000

26. Byron, Inc. has total current assets of $800,000; total current liabilities of $450,000; and long-term
assets of $300,000. How much is the firm's Total Liabilities & Equity?
1,100,000
Framework for Adjustments

Pa

Type of Adjustment Accounts Before Adjustment Adjusting Entry

Prepaid expenses Assets overstated. Dr. Expense

Expenses understated. Cr. Assets or
Contra Assets

Unearned revenues Liabilities overstated. Dr. Liabilities

Revenues understated. Cr. Revenues

Accrued revenues Assets understated. Dr. Assets

Revenues understated. Cr. Revenues

Accrued expenses Expenses understated. Dr. Expenses

Liabilities understated. Cr. Liabilities
Which of the following statements is incorrect concerning the adjusted trial balance?
A. An adjusted trial balance proves the equality of the total debit balances and the total credit balances in
the ledger after all adjustments are made.
B. The adjusted trial balance provides the primary basis for the preparation of financial statements.
C. The adjusted trial balance lists the account balances segregated by assets and liabilities.
D. The adjusted trial balance is prepared after the adjusting entries have been journalized and posted.
Quick Test; Classified Statement of Financial Position
Patents and copyrights are
a. Current assets
b. Intangible assets
c. Long-term investments
d. Property, plant, and equipment
Which of the following is not a non-current liability?
A. Bonds payable
B. Current maturities of long-term obligations
C. Long-term notes payable
D. Mortgages payable
Match each of the following to its proper statement of financial position classification. If the item
would not appear on a statement of financial position, use “NA.”
CL Salaries and wages payable LTI Stock investments (long-term)
NA Service revenue PPE Equipment
CL Interest payable PPE Accumulated depreciation
IA Goodwill NA Depreciation expense
CA Debt investments (short-term) OE Owner’s capital
NCL Mortgage payable (due in 3 years) CL Unearned service revenue

Current assets (CA) Current liabilities (CL)

Long-term investments (LTI) Non-current liabilities (NCL)
Property, plant, and equipment (PPE) Owner’s equity (OE)
Intangible assets (IA)
Exercise (1): Choose the correct answer.
1-A broad principle that requires identifying the activities of a business with specific time periods such
as months, quarters, or years is the:
A. Operating cycle of a business.
B. Time period assumption.
C. Going-concern assumption.
D. Matching principle.
E. Accrual basis of accounting.
2-The length of time covered by a set of periodic financial statements is referred to as the:
A. Fiscal cycle.
B. Natural business year.
C. Accounting period.
D. Business cycle.
E. Operating cycle.
3-The accounting principle that requires revenue to be recorded when earned is the:
A. Matching principle.
B. Revenue recognition principle.
C. Time period assumption.
D. Accrual reporting principle.
E. Going-concern assumption.

4-The broad principle that requires expenses to be reported in the same period as the revenues that
were earned as a result of the expenses is the:
A. Recognition principle.
B. Cost principle.
C. Cash basis of accounting.
D. Matching principle.
E. Time period principle.

5-The system of preparing financial statements based on recognizing revenues when the cash is
received and reporting expenses when the cash is paid is called:
A. Accrual basis accounting.
B. Operating cycle accounting.
C. Cash basis accounting.
D. Revenue recognition accounting.
E. Current basis accounting.
Exercise (2): Match the following terms with the appropriate definition.
Depreciation expense The expense created by allocating the cost of plant and equipment to
the periods in which they are used.
Cash basis accounting The accounting system where revenues are recognized when cash is
received and expenses are recorded when cash is paid.
Matching principle The principle that requires expenses to be reported in the same period
as the revenues that were earned as a result of the expenses.
Accrual basis accounting The accounting system that recognizes revenues when earned and
expenses when incurred.
Time period principle A principle that assumes that an organization's activities can be divided
into specific time periods such as months, quarters, or years.
Prepaid expenses Items paid for in advance of receiving their benefits.
Straight-line depreciation Allocates equal amounts of an asset's cost (less any salvage value) to
depreciation expense during its useful life.
Revenue recognition principle The accounting principle that requires revenue to be recorded
when earned is the
Accounting period The length of time covered by a set of periodic financial statements is
referred to as the
Time period assumption A broad principle that requires identifying the activities of a business
with specific time periods such as months, quarters, or years is the

Exercise (3): Consider each of the following separate cases to prepare necessary adjustments.

1- Prior to recording adjusting entries on December 31, a company's Store Supplies account had an $880
debit balance. A physical count of the supplies showed $325 of unused supplies available as of
December 31. Prepare the required adjusting entry.

2- Estimated depreciation on office equipment for the year, $4,000.

3- The Prepaid Insurance account has a $3,680 debit balance before adjustment. An examination of
insurance policies shows $950 of insurance expired.

4- The Prepaid Insurance account has a $2,400 debit balance before adjustment. An examination of
insurance policies shows $600 of unexpired insurance.
 5- An insurance policy examination showed $1,240 of expired insurance

6- An inventory count showed $210 of unused shop supplies still available out of $990 at the beginning of
the period.

7- Depreciation expense on shop equipment, $350.

8- The Company purchased a building 10 years ago at $88,600, that is supposed to have a total useful life
of 30 years, with a salvage value of 22,000. How much depreciation expense should be recorded for
the current year using the straight-line depreciation method.

88600−22000
Annual depreciation = = $2,220/year
30

1. B 4. F
2. E 5. D
3. C 6. A
 a. Unearned Fee Revenue................................................................... 10,000
Fee Revenue............................................................................... 10,000
To record earned portion of fee received in advance.

b. Wages Expense............................................................................... 9,000

Wages Payable............................................................................ 9,000
To record wages accrued but not yet paid.

c. Depreciation Expense—Equipment.................................................. 19,127

Accumulated Depreciation—Equipment...................................... 19,127
To record depreciation expense for the year.

d. Office Supplies Expense.................................................................. 5,242

Office Supplies*............................................................................ 5,242
To record office supplies used ($480 + $5,349 - $587).

e. Insurance Expense........................................................................... 2,800

Prepaid Insurance**...................................................................... 2,800
To record insurance coverage expired ($5,000 - $2,200).

f. Interest Receivable........................................................................... 750

Interest Revenue......................................................................... 750
To record interest earned but not yet received.

g. Interest Expense............................................................................... 3,500

Interest Payable............................................................................ 3,500
To record interest incurred but not yet paid.
Notes:
* **
Office Supplies Prepaid Insurance
.Beg. Bal 480 .Beg. Bal 5,000
.Purch 5,349
? Used ? Used
.End. Bal 587 .End. Bal 2,200
a. Depreciation Expense—Equipment.................................................. 16,000
Accumulated Depreciation—Equipment...................................... 16,000
To record depreciation expense for the year.

b. Insurance Expense........................................................................... 5,960

Prepaid Insurance*....................................................................... 5,960
To record insurance coverage that expired
($7,000 - $1,040).

c. Office Supplies Expense.................................................................. 2,626

Office Supplies**........................................................................... 2,626
To record office supplies used ($300 + $2,680 - $354).

d. Unearned Fee Revenue................................................................... 5,000

Fee Revenue............................................................................... 5,000
To record earned portion of fee received in advance
($10,000 x 1/2).

e. Insurance Expense........................................................................... 4,600

Prepaid Insurance........................................................................ 4,600
To record insurance coverage that expired.

f. Wages Expense............................................................................... 4,000

Wages Payable............................................................................ 4,000
To record wages accrued but not yet paid.

Notes:
Prepaid Insurance* Office Supplies**
Bal. Bal. 7,000 Beg. Bal. 300
Purch. 2,680
? Used ? Used
End. Bal. 1,040 End. Bal. 354
 QUICK SUMMARY FOR ADJUSTMENTS

Product Used to
Benefit Revenue Benefit Expense
or Generate
Provided Earned Received
Revenues
Incurred
Service

Revenues
Expenses
(Revenue
(Matching
Recognition
Principle)
Principle)

End of
Period
Adjustments

# Adjustments for Description Record Adjustment Adjusting Entries

Cash paid prior to Dr. Exp. xx
1 Prepaid Insurance When benefit is received
receiving benefit Cr. Asset xx
Cash paid prior to Dr. Exp. xx
Deferrals

2 Supplies When benefit is received

receiving benefit Cr. Asset xx
Cash paid prior to Dr. Exp. xx
3 Depreciation When benefit is received
receiving benefit Cr. Asset xx
Cash received prior Dr. Liab. xx
4 Unearned Revenues When benefit is Provided
to providing benefit Cr. Rev. xx
Benefit received Dr. Exp. xx
5 Accrued Expenses When benefit is received
prior to paying cash Cr. Liab. xx
Accruals

Benefit provided
Dr. Asset. xx
6 Accrued Revenues prior to receiving When benefit is Provided
Cr. Rev. xx
cash
- Adjustments can also be categorized as either; Revenue adjustments (Unearned Revenues and
Accrued Revenues), or Expense Adjustments (Prepaid Expenses and Accrued Expenses).
- Adjustments are internal transactions that occur due to the timing difference between exchanging cash
and benefits.
- We always record adjustments at the time of exchanging (providing or receiving) benefits which is
usually before or after exchanging (receiving or paying) cash.
Requirement: Prepare the necessary adjusting entries as of the end of the accounting period.
Required:
1- Prepare the necessary adjusting entries.
2- Prepare the adjusted trial balance.
3- Prepare the income statement, owners’ equity statement and the balance sheet.
 Answers

PROBLEM (3-1) A IS TO BE SOLVED BY JOINTLY BY THE INSTRUCTOR AND THE STUDENTS

Problem (3-1) A
Adjustment (a)
Dec. 31Dr. Office Supplies Expense........................................12,760
Cr. Office Supplies........................................ 12,760

($3,000 + $12,400 - $2,640).

Adjustment (b)
31Dr. Insurance Expense...............................................12,312
Cr. Prepaid Insurance................................... 12,312

Policy Cost per Month Months Active in 2011 2011 Cost

A $660 ($15,840/24 mo.) 12 $ 7,920
B 363 ($13,068/36 mo.) 9 3,267
C 225 ($ 2,700 /12 mo.) 5 1,125
Total $12,312
Adjustment (c)
31Dr. Salaries Expense (2 days x $2,100).....................4,200
Cr. Salaries Payable..................................... 4,200

Adjustment (d)
31Dr. Depreciation Expense—Building..........................27,000
Cr. Accumulated Depreciation—Building...... 27,000

[($855,000 -$45,000) / 30 years = $27,000].

Adjustment (e)
31Dr. Rent Receivable....................................................2,400
Cr. Rent Earned (Rent Revenue).................. 2,400

Adjustment (f)
31DR. Unearned Rent....................................................4,350
Cr. Rent Earned (Rent Revenue).................. 4,350

The amount of rent earned for November and December (2 x 2,175).

PAROBLEM (3-3)B REQUIREMENTS 1 AND 2 ARE TO BE SOLVED BY THE STUDENTS IN THE CLASS
TO TEST THEIR UNDERSTANDING OF THE ADJUSTMENTS. HOWEVER, REQUIREMENT NO. 3 IS TO
BE SOLVED AS A HOMEWORK FOR STUDENTS.
Problem (3-3) B
REQUIREMENT (1)
Adjustment (a)
Dec. 31Dr. Insurance Expense................................................................6,400
Cr. Prepaid Insurance...................................................6,400

Adjustment (b)
31Dr. Teaching Supplies Expense..................................................57,500
Cr. Teaching Supplies...................................................57,500

The cost of supplies used ($60,000-$2,500).

Adjustment (c)
31 Dr. Depreciation Expense—Equipment....................................... 4,000
Cr. Accumulated Depreciation—Equipment..................4,000

Adjustment (d)
31Dr. Depreciation Expense—Professional Library........................2,000
Cr. Accumulated Depreciation—Professional Library... 2,000

Adjustment (e)
31Dr. Unearned Training Fees.........................................................9,200
Cr. Training Fees Earned..............................................9,200

Adjustment (f)
31Dr. Accounts Receivable...............................................................5,500
Cr. Tuition Fees Earned................................................5,500

Tuition earned ($2,200 x 2 1/2 mo).

Adjustment (g)
31Dr. Salaries Expense.....................................................................540
Cr. Salaries Payable..................................................... 540

Accrued salaries expense (3 days x $180).

Adjustment (h)
31Dr. Rent Expense .........................................................................2,600
Cr. Prepaid Rent.........................................................................2,600
REQUIREMENT (2)
ALCORN INSTITUTE
Adjusted Trial Balance
December 31, 2011
Debit Credit
Cash............................................................................................... $ 50,000
Accounts receivable......................................................................... 5,500
Teaching supplies............................................................................ 2,500
Prepaid insurance............................................................................ 11,600
Prepaid rent..................................................................................... 0
Professional library........................................................................... 10,000
Accumulated depreciation—Professional library.................................. $ 3,500
Equipment....................................................................................... 30,000
Accumulated depreciation—Equipment.............................................. 20,000
Accounts payable............................................................................. 12,200
Salaries payable............................................................................... 540
Unearned training fees...................................................................... 18,400
M. Alcorn, Capital............................................................................. 68,500
M. Alcorn, Withdrawals..................................................................... 20,000
Tuition fees earned........................................................................... 110,500
Training fees earned......................................................................... 71,200
Depreciation expense—Professional library........................................ 2,000
Depreciation expense—Equipment.................................................... 4,000
Salaries expense.............................................................................. 43,740
Insurance expense........................................................................... 6,400
Rent expense.................................................................................. 31,200
Teaching supplies expense............................................................... 57,500
Advertising expense......................................................................... 18,000
Utilities expense............................................................................... 12,400 _______
Totals.............................................................................................. $304,840 $304,840
REQUIREMENT (3)
ALCORN INSTITUTE
Income Statement
For Year Ended December 31, 2011
Revenues
Tuition fees earned......................................................................$110,500
Training fees earned.................................................................... 71,200
Total revenues............................................................................. $181,700
Expenses
Depreciation expense—Professional library................................2,000
Depreciation expense—Equipment.............................................4,000
Salaries expense.........................................................................43,740
Insurance expense......................................................................6,400
Rent expense...............................................................................31,200
Teaching supplies expense.........................................................57,500
Advertising expense....................................................................18,000
Utilities expense........................................................................... 12,400
Total expenses............................................................................ 175,240
Net income ...............................................................................$ 6,460

ALCORN INSTITUTE
Statement of Owner’s Equity
For Year Ended December 31, 2011

M. Alcorn, Capital, December 31, 2010................................ $68,500

Plus: Net income................................................................... 6,460
74,960
Less: Owner withdrawals...................................................... 20,000
M. Alcorn, Capital, December 31, 2011................................ $54,960
 ALCORN INSTITUTE
Balance Sheet
December 31, 2011
Assets
Cash ............................................................................... $50,000
Accounts receivable....................................................................... 5,500
Teaching supplies.......................................................................... 2,500
Prepaid insurance.......................................................................... 11,600
Professional library........................................................................$10,000
Accumulated depreciation—Professional library........................... (3,500)
............................................................................... 6,500
Equipment ...............................................................................30,000
Accumulated depreciation—Equipment........................................(20,000)
............................................................................... 10,000
Total assets ............................................................................... $86,100

Liabilities
Accounts payable.......................................................................... $12,200
Salaries payable............................................................................ 540
Unearned training fees.................................................................. 18,400
Total liabilities ............................................................................... 31,140
Equity
M. Alcorn, Capital.......................................................................... 54,960
Total liabilities and equity.............................................................. $86,100
Extra Applications_Lecture Week 8_Part 1
 Answers

PROBLEM (4-4) A IS TO BE SOLVED JOINTLY BY THE INSTRUCTOR AND THE STUDENTS

Problem 4-4A (75 minutes)

Part 1
SHARP CONSTRUCTION
Income Statement
For Year Ended December 31, 2011
Revenues
Professional fees earned $96,000
Rent earned 13,000
Dividends earned 1,900
Interest earned 1,000
Total revenues $111,900
Expenses
Depreciation expense—Building 10,000
Depreciation expense—Equipment 5,000
Wages expense 31,000
Interest expense 4,100
Insurance expense 9,000
Rent expense 12,400
Supplies expense 6,400
Postage expense 3,200
Property taxes expense 4,000
Repairs expense 7,900
Telephone expense 2,200
Utilities expense 3,600
Total expenses 98,800
Net income $ 13,100

SHARP CONSTRUCTION
Statement of Owner's Equity
For Year Ended December 31, 2011
J. Sharp, Capital, December 31, 2010 $32,700
Add: Investments by owner $50,000
Net income 13,100 63,100
95,800
Less: Withdrawals by owner (12,000)
J. Sharp, Capital, December 31, 2011 $83,800
Problem 4-4A (Continued)

SHARP CONSTRUCTION
Balance Sheet
December 31, 2011
Assets
Current assets
Cash $ 4,000
Short-term investments 22,000
Supplies 7,100
Prepaid insurance 6,000
Total current assets $ 39,100
Plant assets
Equipment 39,000
Accumulated depreciation—Equipment (20,000) 19,000
Building 130,000
Accumulated depreciation—Building (55,000) 75,000
Land 45,000
Total plant assets 139,000
Total assets $178,100

Liabilities
Current liabilities
Accounts payable $ 15,500
Interest payable 1,500
Rent payable 2,500
Wages payable 1,500
Property taxes payable 800
Unearned professional fees 6,500
Current portion of long-term note payable …... 6,600
Total current liabilities $ 34,900
Long-term liabilities
Long-term notes payable* 59,400
Total liabilities 94,300
Equity
J. Sharp, Capital 83,800
Total liabilities and equity $178,100
* $66,000-$6,600
Problem 4-4A (Concluded)
Part 2
Closing entries (all dated December 31, 2011):
(1)Professional Fees Earned 96,000
Rent Earned 13,000
Dividends Earned 1,900
Interest Earned 1,000
Income Summary 111,900
To close the revenue accounts.
(2)Income Summary 98,800
Depreciation Expense, Building 10,000
Depreciation Expense, Equipment 5,000
Wages Expense 31,000
Interest Expense 4,100
Insurance Expense 9,000
Rent Expense 12,400
Supplies Expense 6,400
Postage Expense 3,200
Property Taxes Expense 4,000
Repairs Expense 7,900
Telephone Expense 2,200
Utilities Expense 3,600
To close the expense accounts.
(3)Income Summary 13,100
J. Sharp, Capital 13,100
To close the income summary account.
(4)J. Sharp, Capital 12,000
J. Sharp, Withdrawals 12,000
To close the withdrawals account.
EXERCISE (4-2) IS TO BE SOLVED BY THE STUDENTS IN THE CLASS TO TEST THEIR UNDERSTANDING OF THE CLOSING
PROCESS. HOWEVER, EXERCISE (4-3) CAN BE USED BY STUDENTS FOR PRACTICE AT HOME.
Exercise 4-2 (40 minutes)

Adjusted Post-Closing
Trial Balance Closing Entry Information Trial Balance
No. Account Title Dr. Cr. Dr. Cr. Dr. Cr.
101 Cash 8,200 8,200
106 Accounts receivable 24,000 24,000
153 Equipment 41,000 41,000
154 Accumulated depre-
ciation—Equipment 16,500 16,500
193 Franchise 30,000 30,000
201 Accounts payable 14,000 14,000
209 Salaries payable 3,200 3,200
233 Unearned fees 2,600 2,600
301 H. Sundance, Capital 64,500 (4) 14,400 (3) 16,800 66,900

302 H. Sundance, Withdrawals 14,400 (4) 14,400

401 Marketing fees earned 79,000 (1) 79,000

611 Depreciation expense—

Equipment. 11,000 (2) 11,000
622 Salaries expense 31,500 (2) 31,500
640 Rent expense 12,000 (2) 12,000
677 Miscellaneous expense 7,700 (2) 7,700
901 Income summary (2) 62,200 (1) 79,000

______ ______ (3) 16,800 ______ ______ ______

Totals 179,800 179,800 172,400 172,400 103,200 103,200

Exercise 4-3 (30 minutes)
1.
2011
Dec. 31 Services Revenue 36,000
Income Summary 36,000
To close the revenue account.

31 Income Summary 28,100

Depreciation Expense--Equipment 2,000
Salaries Expense 21,000
Insurance Expense 1,500
Rent Expense 2,400
Supplies Expense 1,200
To close the expense accounts.

31 Income Summary 7,900

R. Showers, Capital 7,900
To close Income Summary.

31 R. Showers, Capital 6,000

R. Showers, Withdrawals 6,000
To close the withdrawals account.

2.
SHOWERS COMPANY
Post-Closing Trial Balance
December 31, 2011
Debit Credit
Cash $18,000
Supplies 12,000
Prepaid insurance 2,000
Equipment 23,000
Accumulated depreciation–Equipment $ 6,500
R. Showers, Capital* 48,500
Totals $55,000 $55,000

*$46,600 + $7,900 - $6,000 = $48,500

 QUICK SUMMARY FOR BASIC CONCEPTS OF
ACCOUNTING FOR MERCHANDISING OPERATIONS
- 3 basic types of company operations;
Services-Merchandisers-Manufacturers
- Merchandising Companies buy Products for resale to earn revenue (called net sales).
- Products purchased for resalse are called inventory (also can be called merchandise inventory or
merchnadise).
- Merchandising companies can sell inventory in the wholesale market or to consumers in the retail
market.
- Operating Cycle for a Merchandiser

- The flow of costs in an inventory system

Beg. Inventroy + Net Purchases = Merchandise Available for Sale = Ending Inventory + COGS
- Two alternative inventory accounting systems can be used to collect information about cost of goods
sold and cost of inventory:
1- perpetual system or
2- periodic system.
- The perpetual inventory system continually updates accounting records for merchandising
transactions.
- The periodic inventory system updates the accounting records for merchandise transactions only at
the end of a period.
- The key components of a merchandiser’s net income.
Sales – Sales Discount – Sales Returns and Allowances – Net Sales – COGS – Gross Profit – Operating
Expenses – Selling Expenses – General and Adminitstrative Expenses – Operating Income (Income from
Operations) – Other Revenues and Gains or Expenses and Losses (Non-Operating Activities) – Net
income.

All of the above represent basic concepts of Accounting for merchandising businesses, that can be part of MCQs or
similar questions in the Final Exam.
 Extra Applications_Lecture Week 8_Part 2

Problem (5-1): From the adjusted trial balance given below for the Mirror Company, prepare a multiple-step income
statement in a good form. Salaries expense and depreciation expense on the building are equally divided between
selling activities and the general and administrative activities.
 Answers

PROBLEM (5-1) A IS TO BE SOLVED JOINTLY BY THE INSTRUCTOR AND THE STUDENTS

GAAP and IFRS
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.
 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.
 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 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.
 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.
 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.
 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.

Looking to the Future

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.
Income and Comprehensive Income Statements
• IFRS requires companies to adjust the recorded values of certain types of assets and liabilities to their fair
values at the end of each reporting period. In some instances, the unrealized gains or losses that result
from adjusting recorded amounts to fair value are included in net income.
• However, in other cases, these unrealized gains and losses are not included in net income. Instead, these
excluded items are reported as part of a more inclusive earnings measure, called comprehensive income.
Examples of such items include certain adjustments to pension plan assets, gains and losses on foreign
currency translation, and unrealized gains and losses on certain types of investments.
• Items that are excluded from net income but included in comprehensive income are either reported in a
combined statement of net income and comprehensive income, or in a separate schedule that reports only
comprehensive income.

Wild, J., Shaw, K., Chiappetta, B. and Samaha, K., 2017. Fundamental Accounting Principles. 2nd ed. McGraw-
Hill Education.
Weygandt, J., Kimmel, P. and Kieso, D., 2019. Accounting Principles IFRS Version. Global Edition. Wiley.
 Quick Review
1- The Accounting Cycle
2- The adjusting process takes place at the end of the accounting period (commonly one year, ending

Transaction
Analysis

?? Journal

?? Ledger
The
Accounting
Cycle
(9 Steps)

Financial Trial
Statements Balance

Adjustment
??
s

December 31).
3- The adjusting process is based on the accrual basis of accouting; which identifies when to recognize
revenues and expenses (Revenue Recognition Principle and Matching Principle).
4- Revenue Recongnition Principle; revenues are recorded when earned by delivering a product or
providing a service (i.e. provding a benefit; a product or service).
5- Matching Principle; expenses are recorded when incurred, in the same accounting period as the
revenues that are eanred as a result of those expenses (i.e. receiving a benefit; generating revenues).
6- The first group of adjusting entries includes prepayments; examples include prepaid expenses;
insurance, supplies and deperciation.
7- Prepaid expenses; are paid for prior to receiving a benefit (generating revenues). Therefore, at the time
of cash payments, it includes a benefit to be received in the future (future benefit, an asset). Then
expenses are recorded later on when incurred.
8- Insurance; recorded as an asset when paid for (prepaid insurance), then we record expenses when
incurred (in the same accounting period as insurance expires, during which the company benefits from
the insurance coverage that enahnces the business and helps generate better earnings).
9- Supplies ; recorded as an asset when purchased (supplies), then we record expenses when incurred (in
the same accounting period as supplies are used and benefit the company).
10- Depreciation; recorded as an asset when purchased (plant assets; that are used in the company’s
operations for more than one year or the company’s operating cycle), then we record expenses when
incurred (through allocating the cost of the asset over its useful life using the straight-line depreication
method to match revenues against expenses for each period).
11- Straight-line depreciation is calcualted for all plant assets except for land.

Cost−Slavege
Anuual Depreciation =
Useful Life