ACCT 652 Accounting Week 2 Charts of accounts, Journals, T-accounts, and special journals Some slides Times Mirror Higher Education Division, Inc. Used by permission Michael D. Kinsman, Ph.D. Review of last week We did a lot. Some highlights of what we did last week are: Accounting Principles The Entity Principle The Objectivity Principle The Cost Principle The Going Concern Principle Generally Accepted Accounting Principles (GAAP) ACCT 652 Week 2 2 Review of last week (2) ASSETS: Something worth something. LIABILITIES: Debts. OWNER S EQUITY: The difference between assets and liabilities (assets minus liabilities). REVENUES: What you get for what you do. EXPENSES: What it costs you to do it. ACCT 652 Week 2 3 1
Review of how do they fit together? Assets = Liabilities + New Owner s Equity Assets + Expenses = Liabilities + Owner s Equity + Revenue Income = Revenue - Expenses New Owner s Equity = Income + Old Owner s Equity ACCT 652 Week 2 4 The T-account reviewed Left Right Assets + Liabilities + Owner s equity + Revenue + Expense + + means account increases here ACCT 652 Week 2 5 The Chart of accounts The chart of accounts is simply a listing of our accounts with account numbers assigned. That list makes finding the correct account a lot easier. Account number may include many digits to convey information. Usually, account numbers are assigned with first digits as follows: 1: Assets 2: Liabilities 3: Equities 4: Revenues 5 and up: Expenses ACCT 652 Week 2 6 2
Recording to accounts Last week, we used a simplified T-account. In practice, we usually first record to a journal, which is a sequential (time based) record of transactions. The most general journal is called The General Journal. Transactions are then posted to a T-account. The group of T accounts, taken together, is called a General Ledger. ACCT 652 Week 2 7 The General Journal The format for the General Journal appears as follows: GENERAL JOURNAL Page ## XXX M M DD Account #1 XX Account #2 XXX XX Journal Entry Explanation ACCT 652 Week 2 8 The General Journal Notice that in the General Journal hides a T account. That shows you how things should be posted to the General Ledger: GENERAL JOURNAL Page ## XXX M M DD Account #1 XX Account #2 XXX XX Journal Entry Explanation ACCT 652 Week 2 9 3
The General Journal The debits part of the entry is always written first. It always starts at the left margin of the column. GENERAL JOURNAL Page ## XXX M M DD Account #1 XX Account #2 XXX XX Journal Entry Explanation ACCT 652 Week 2 10 The General Journal The credits part of the entry always comes after the debits part and is indented to the right. GENERAL JOURNAL Page ## XXX M M DD Account #1 XX Account #2 XXX XX Journal Entry Explanation ACCT 652 Week 2 11 The General Journal Also note that an explanation is always written in to provide additional information on the transaction. GENERAL JOURNAL Page ## XXX M M DD Account #1 XX Account #2 XXX XX Journal Entry Explanation ACCT 652 Week 2 12 4
The General Journal After the explanation (which may be as many lines as required to make it clear) comes a blank line. It separates journal entries. ACCT 652 Week 2 13 Journal Entries On December 1, 20X1, Terry Dow invested $30,000 in his new business, Clear Copy Co. GENERAL JOURNAL Page ACCT 652 Week 2 14 Journal Entries On December 1, 20X1, Terry Dow invested $30,000 in his new business, Clear Copy Co. Dec. 1 Cash 30,000.00.00 ACCT 652 Week 2 15 5
T-accounts in practice: In practice, T-accounts on a manual bookkeeping system usually look like the following: Account: Acct. No. ## Balance DR (CR) ACCT 652 Week 2 16 T-accounts in practice Notice that the T-account that we started to use last week is still there: Account: Acct. No. ## Account Name Balance Ref. DR (CR) Debit Credit ACCT 652 Week 2 17 Posting: Six Basic Steps ➊ Find the account page. ➋ Enter the date. ➌ Enter the amount. ➍ Enter the journal page # in the posting reference column in the general ledger. ➎ Enter the new account balance. ➏ Enter the account # in the posting reference column in the journal. ACCT 652 Week 2 18 6
Posting Journal Entries On December 1, 20X1, Terry Dow invested $30,000 in his new business, Clear Copy Co. Dec. 1 Cash 30,000 Notice that for simplicity, cents have been left off. Do not do that in practice (or homework or exams!) ACCT 652 Week 2 19 Posting Journal Entries Dec. 1 Cash 30,000 Account: Cash Acct. No. 101 Post the debit portion of the entry for Transaction 1 to the Cash ledger account. Balance ACCT 652 Week 2 20 Step 1: Find the Account Dec. 1 Cash 30,000 1 Ac count: Cash Acct. No. 101 Balance ACCT 652 Week 2 21 7
Step 2: Enter the 30,000 Dec. 1 Cash 2 Ac count: Cash Acct. No. 101 Dec. 1 Balance ACCT 652 Week 2 22 Step 3: Post the Amount Dec. 1 Cash 30,000 Account: Cash Acct. No. 101 Balance Dec. 1 30,000 3 ACCT 652 Week 2 23 Step 4: Enter the Journal Page # Dec. 1 Cash 30,000 4 Account: Cash Acct. No. 101 Balance Dec. 1 J1 30,000 ACCT 652 Week 2 24 8
Step 5: Enter the Acct. Balance Dec. 1 Cash 30,000 Account: Cash Acct. No. 101 Balance Dec. 1 J1 30,000 30,000 5 ACCT 652 Week 2 25 Step 6: Enter the Account # Dec. 1 Cash 101 30,000 6 Account: Cash Acct. No. 101 Balance Dec. 1 J1 30,000 30,000 ACCT 652 Week 2 26 Posting Journal Entries Dec. 1 Cash 101 30,000 Investment Post by owner. the credit portion of the entry for Transaction 1 to Dow s Account: Cash Acct. No. 101 Capital ledger account. Balance Dec. 1 J1 30,000 30,000 ACCT 652 Week 2 27 9
Step 1: Find the Account 101 30,000 Dec. 1 Cash Account: T. Dow, Capital Acct. No. 301 1 Balance ACCT 652 Week 2 28 Step 2: Enter the 101 30,000 Dec. 1 Cash 2 Account: T. Dow, Capital Acct. No. 301 Dec. 1 Balance ACCT 652 Week 2 29 Step 3: Post the Amount 101 30,000 Dec. 1 Cash Account: T. Dow, Capital Acct. No. 301 3 Balance Dec. 1 30,000 ACCT 652 Week 2 30 10
Step 4: Enter the Journal Page # 101 30,000 Dec. 1 Cash Account: T. Dow, Capital Acct. No. 301 4 Balance Dec. 1 J1 30,000 ACCT 652 Week 2 31 Step 5: Enter the Acct. Balance 101 30,000 Dec. 1 Cash Account: T. Dow, Capital Acct. No. 301 Balance Dec. 1 J1 30,000 30,000 5 ACCT 652 Week 2 32 Step 6: Enter the Account # Dec. 1 Cash 101 30,000 T. Dow, Capital 301 30,000 6 Account: T. Dow, Capital Acct. No. 301 Balance Dec. 1 J1 30,000 30,000 ACCT 652 Week 2 33 11
Some things you may want to try Some people, me included, put brackets around credit balances (not the entry, only the balance in the General Ledger account). That makes figuring out whether a balance is debit or credit a snap: Account: T. Dow, Capital Acct. No. 301 Balance J1 30,000 (30,000) Dec. 1 ACCT 652 Week 2 34 Label this page 8 in your notes! When we refer to this, I will simply call it page 8. In the General Journal, explanations are mandatory. In the General Ledger, explanations are only used in five situations. ACCT 652 Week 2 35 General Ledger explanations ❶ Opening: A balance that has no General Journal entry gets an explanation of Opening and a check mark in the posting reference column. ❷ Closing: Any entry associated with the closing process gets an explanation of Closing. Of course, it also had a General Journal entry, so that s its posting reference. ACCT 652 Week 2 36 12
General Ledger explanations (2) ❸ Adjusting: To show that this entry is an Adjusting Journal Entry (AJE), Adjusting. ❹ Error correction: To show that this entry corrects an earlier entry, Error correction. ❺ Reversing To show that this reverses an earlier made adjustment, Reversing. We will talk about this later tonight. ACCT 652 Week 2 37 General Ledger Explanations (3) No other entry should have an explanation in the General Ledger. Why is this important? For three reasons: Neatness. General Ledgers do not need to be cluttered up with lots of explanations. Efficiency. The General Journal already has the explanation. Only in the case of unusual items does it help. Grading: I will take off points if you do. ACCT 652 Week 2 38 A note on dollar signs Dollar signs should only occur in formal financial statements, which are three in number: The Balance Sheet (including the Statement of Equity, even if that is separate) The Income Statement The Statement of Cash Flows Dollar signs do not go in non-public documents like trial balances, ledgers, journals or worksheets. I take points for dollar sign errors! ACCT 652 Week 2 39 13
Trial Balance At any time you are posting, you can take a Trial Balance. A Trial Balance is a listing of each account with its balance as of a specific date. All debit balances are in one column. All credit balances are in another column. The totals of each column should be the same if not, I suppose you have a Trial Un-balance! You need to find why you are out of balance. ACCT 652 Week 2 40 Preparing the Trial Balance Five Steps ➊ Find the balance of each account in the ledger. ➋ List each account and place its balance beside it; the debit balances in one column and the credit balances in another. ➌ Compute the total of the debit balances. ➍ Compute the total of the credit balances. ➎ Verify that the two column totals are equal. ACCT 652 Week 2 41 Locating Errors in the Trial Balance Verify that the trial balance columns were correctly added. Verify that account balances were accurately copied from the ledger. Check to see if a debit was misposted as a credit, or visa-versa. A good trick is to take the difference between the debit and credit totals, divide by 2, and look for that amount of posting. ACCT 652 Week 2 42 14
Locating Errors in the Trial Balance Recalculate each account balance. Verify that each of the original journal entries had equal debits and credits. Check to see if a number was transposed (for example, a 79 was posted as a 97.) With a transposition, the difference is always divisible by 9. ACCT 652 Week 2 43 The Accounting Process Next week, you will have not only the General Journal, you will also have several special journals that make bookkeeping easier. These include: Cash Receipts Journal for receipts of cash. Cash Disbursements Journal for payments of cash. Purchases Journal for purchases of merchandise on credit. Sales Journal for normal sales made on credit. ACCT 652 Week 2 44 The accounting process Dotted lines are posted daily Posted monthly ACCT 652 Week 2 45 15
Contra accounts Contra accounts are, in fact, parts of other accounts. You can usually spot them in a Balance Sheet or an Income Statement because of the words less or net of, as in Accounts receivable, less allowance for doubtful accounts Accounts receivable, net of allowance for doubtful accounts We have contra accounts because they preserve information: In the above example, we know how much accounts receivable we have and how much we expect to write off. ACCT 652 Week 2 46 Contra accounts (2) Contra asset: Accumulated depreciation is a contra asset to equipment: Net Accumulated Equipment = Equipment + Depreciation 40000 50000 10000 The advantage of using the contra account is that we know what we originally paid for the equipment. ACCT 652 Week 2 47 Other contra account examples Contra liability: Unearned interest when you record total payments of a loan as a liability. Contra equity: Owner draw is contra to owner s equity. Contra revenue: Sales returns and allowances is contra to sales. Contra expense: Purchase returns is contra to purchases. ACCT 652 Week 2 48 16
Cash versus accrual accounting When is revenue? That is to say, when do you recognize revenue? You recognize revenue when you get the cash. You recognize revenue when you send a bill. You recognize revenue when the customer gets the product. You recognize revenue when you complete a sale. You recognize revenue when you ship the product. ACCT 652 Week 2 49 It depends. What method of accounting do you use? The cash basis of accounting can be used by businesses without inventory. Those are usually going to be professionals like Kinsman & Kinsman. The advantage is that you only have to report cash you have received on your tax return as revenue. So, for cash basis businesses, the answer is: ACCT 652 Week 2 50 Cash basis businesses When is revenue? That is to say, when do you recognize revenue? You recognize revenue when you get the cash. That means cash basis businesses don t have accounts receivable on their books. They simply keep a list of receivables. They also recognize expense when they actually pay the bill. ACCT 652 Week 2 51 17
Cash basis businesses When you record revenue for a cash basis business, you make the following entry: GENERAL JOURNAL Page 1,000.00 M M DD Cash Revenue 1,000.00 Record revenue ACCT 652 Week 2 52 It depends. What method of accounting do you use? The accrual basis of accounting must be used by businesses with inventory. Those are going to be all retail and manufacturing businesses. The advantage is that you better match revenues and expenses. So, for accrual basis businesses, the answer is: ACCT 652 Week 2 53 Accrual basis businesses When is revenue? That is to say, when do you recognize revenue? You recognize revenue when you complete a sale. Completing a sale means that you have shipped product and the customer has agreed to pay. ACCT 652 Week 2 54 18
Accrual basis businesses When you record revenue for an accrual basis business, you make the following entries: GENERAL JOURNAL Page 1,000.00 M M DD Accounts receivable Revenue 1,000.00 Record sale made MM DD+ Cash 1,000.00 Accounts receivable 1,000.00 Record revenue collected ACCT 652 Week 2 55 Can you switch back and forth from cash to accrual if you want? The IRS has some real problems with that. Furthermore, consider the issues of consistency between your statements. The answer is, in general, NO. However, some cash basis firms keep their books on an accrual basis, and some accrual basis firms keep their books on a cash basis, both for simplicity. So... ACCT 652 Week 2 56 How do you convert from cash to accrual statements? Think about what is different between cash and accrual. ❶ The accrual basis business recognized income earlier (its beginning accounts receivable are income it took in a previous year on accrual that cash did not). That cash was probably received this year, and will be recognized as revenue by the cash basis business in this year. ACCT 652 Week 2 57 19
How do you convert from cash to accrual statements? ❷ The accrual basis company s ending receivables are already in its income, but should not be in the cash businesses income because they have not been received in cash. ACCT 652 Week 2 58 How do you convert from cash to accrual statements? ❸ The beginning payables of the accrual business have already been taken as expense last year by the accrual business, even though no cash was paid for them. They were probably paid this year. ❹ The accrual basis company has ending payables that were taken as expense this year, even though no cash was paid for them. ACCT 652 Week 2 59 How do you convert from accrual to cash statements? So, in general, you do the following: ACCT 652 Week 2 60 20
An example to try A company had accrual basis profits of $95,000 in 2015. It had ending 2014 (beginning 2015) A/R of $5,000, and ending 2015 A/R of $10,000. It had ending 2014 (beginning 2015) A/P of $3,000, and ending 2015 A/P of $5,000. What is the company s cash basis profit for 2015? ACCT 652 Week 2 61 An example to try answered! Accrual basis income 95,000.00 Minus change in accounts receivable -Ending receivables (10,000.00) +Beginning receivables 5,000.00 (5,000.00) Plus change in accounts payable: +Ending payables 5,000.00 -Beginning payables (3,000.00) 2,000.00 Cash basis income 92,000.00 ACCT 652 Week 2 62 Of course, if you were asked to go from Cash basis to Accrual Cash basis income 92,000.00 Plus change in accounts receivable +Ending receivables 10,000.00 -Beginning receivables (5,000.00) 5,000.00 Minus change in accounts payable: -Ending payables (5,000.00) +Beginning payables 3,000.00 (2,000.00) Cash basis income 95,000.00 ACCT 652 Week 2 63 21
Reversing entries When a bookkeeper is keeping books on a cash basis, and we convert them to an accrual basis with adjusting entries, there is a chance the bookkeeper will become confused. Consider the set of adjusting entries we made in the next slide. ACCT 652 Week 2 64 Adjusting entries On December 31, we made two adjustments to the books to get them current: GENERAL JOURNAL Page Adjusting journal entries 12 31 Rent expense 10,000.00 Accrued rent payable 10,000.00 Accrue rent for December 12 31 Salaries expense 25,000.00 Accrued salaries payable 25,000.00 Accrue salaries for the last week of December, unpaid ACCT 652 Week 2 65 Now we close Of course, the next step after the adjusting process is to close the books. That will leave the expense accounts we adjusted salaries and rent with zero balances. ACCT 652 Week 2 66 22
Reversing entries On January 1, we make two reversals to the books so the bookkeeper would not be messed up: ACCT 652 Week 2 67 After reversing After we reverse, we have a credit balance in the two expense accounts we adjusted. Now when the bookkeeper makes the expense payments, the balance of the expense accounts is zero which correctly reflects the expense for this year. The expense paid was last year s expense! ACCT 652 Week 2 68 Reversing entries concluded After we make these entries, there will be a zero balance in both accrual accounts, and a negative balance in the expense accounts. When the bookkeeper pays the bills, that will wipe out the balance in the expense accounts. We do this because of accounting ease for the bookkeeper. ACCT 652 Week 2 69 23
I m tired! That finishes what I d planned to do in our night 2 together. Please keep asking questions. They re important. ACCT 652 Week 2 70 24