Principles of Accounting II Lecture 1 Adjusting the Accounts Basic Accounting Equation What the business owns = What the business owes Assets = Liabilities (owed to creditors)+ Owners Equity (residual equity owed to owners) liabilities are shown before owners equity, because creditors claims are paid before owners claims if the business is liquidated Each transaction has a dual effect on the equation 2 1
Summary of Debits/Credits Rules Relationship among the assets, liabilities and owner s equity of a business: Illustration 2-11 Basic Equation Assets = Liabilities + Owner s Equity Expanded Basic Equation The equation must be in balance after every transaction. For every Debit there must be a Credit. LO 2 Define debits and credits and explain their use 3 in recording business transactions. Problem 2-2A (Pg 74-75) Keynes is a licensed dentist. During the first month of operations of her business, the following events and transactions occurred. April 1 Invested $20,000 cash in her business. 1 Hired a secretary at a salary of $700 per week payable monthly. 2 Paid office rent for the month $1,100. 3 Purchased dental supplies on account from Smile Company $4,000. 10 Performed dental services and billed insurance companies $5,100. 11 Received 1,000 cash advance from Heather Greene for an implant. 20 Received $2,100 cash from services performed from James Chang. 30 Paid secretary for the month $2,800. 30 Paid $2,400 to Smile Company for accounts payable due. The company uses the following chart of account: No. 101 Cash, No. 112 Accounts Receivable, No. 126 Supplies, No. 201 Accounts Payable, No. 209 Unearned Service Revenue, No. 301 Owner s Capital, No. 400 Service Revenue, No. 726 Salaries Expense, and No. 729 Rent Expense. (a) Journalize the transactions (b) Post to ledger accounts (c) Prepare a trial balance on April 30, 2014 4 2
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9 The Trial Balance The trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove debits = credits after posting. If debits and credits do not agree, the trial balance can be used to uncover errors in journalizing and posting. The Steps in preparing the Trial Balance are: List the account titles and balances. Total the debit and credit columns. Prove the equality of the two columns. 10 5
11 Steps of the Accounting Cycle: Analyze business transactions. Journalize the transactions. Post to ledger accounts. Prepare trial balance. Journalize and post adjusting entries for deferrals and accruals. Prepare an adjusted trial balance. Prepare financial statements. Income Statement. Owner s Equity Statement. Balance Sheet. Journalize and Post closing entries. Prepare a post-closing trial balance. 12 6
The Reasons for Adjusting Entries: Adjusting entries are made at the end of the accounting period before preparation of the financial statements. Adjusting entries are made to ensure that the revenue recognition principle and the matching principle are followed. That is, to ensure that revenues are recorded in the period in which they are earned and that expenses are recorded in the period in which they are incurred. Adjusting entries make it possible to report the correct amounts on the balance sheet and on the income statement. 13 The Basics of Adjusting Entries Types of Adjusting Entries Illustration 3-2 Categories of adjusting entries Deferrals 1. Prepaid Expenses. Expenses paid in cash before they are used or consumed. Accruals 1. Accrued Revenues. Revenues for services performed but not yet received in cash or recorded. 2. Unearned Revenues. Cash received before services are performed. 2. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded. LO 3 Explain the reasons for adjusting entries and Identify the 14 major types of adjusting entries. 7
Remington Repair Services Trial Balance April 30, 2014 Account Title Dr. Cr. Cash $6,300 Accounts Receivable 5,500 Supplies 4,100 Prepaid Insurance 3,600 Equipment 25,000 Accumulated depreciation- Equipment $3,600 Account Payable 3,000 Notes Payable 6,000 Unearned Revenue 3,100 Remington, Capital 26,000 Remington, Drawing 2,000 Service Revenue 10,300 Salaries Expense 4,000 Rent Expense 1,500 $52,000 $52,000 Adjustment data: 1. The remaining supplies at April 30 are $1600. 2. The insurance policy was purchased on April 1 for one year. 3. The equipment is depreciated at the rate of $400 per month. 4. $1,850 of unearned service revenue has been earned at the end of April. 5. Invoices representing $1,300 of services performed during the month have not been recorded as of April 30. 6. The notes payable represent a 6-month, 10% note that was signed on April 1. 7. Salaries of $1,000 are accrued at April 30. Instructions: 1. Journalize the adjusting entries at April 30. 2. If the adjusting entries 1 to 7 are not made. Indicate the effect on net income, assets and liabilities (i.e. Overstatement, Understatement or N/A). 8
Review Problem- Your turn David Advertising Trial Balance December 31, 2014 Account Title Dr. Cr. Cash $7,600 Accounts Receivable 8,400 Supplies 4,700 Prepaid Insurance 3,600 Equipment 24,000 Accumulated depreciation- Equipment $6,500 Accounts Payable 4,400 Notes Payable 9,000 Unearned Revenue 3,600 Owner s, Capital 20,000 Owner s, Drawings 2,500 Service Revenue 14,000 Salaries Expense 5,200 Rent Expense 1,500 $57,500 $57,500 Adjustment data: 1. The remaining supplies at December 31 are $1,500. 2. The insurance policy was purchased on December 1 for one year. 3. The equipment is depreciated at the rate of $500 per month. 4. $2,000 of the unearned service revenue has been earned at the end of December. 5. Invoices representing $1,600 of services performed during December have not been recorded as of December 31. 6. The notes payable represent a 3-month 10% note that was signed on December 1. 7. Salaries of $1,800 are accrued at December 31. Instructions: 1. Journalize the adjusting entries for David Advertising at December 31. 9
Pioneer Advertising Agency Trial Balance October 31, 2010 Account Title Dr. Cr. Cash $15200 Advertising Supplies 2500 Prepaid Insurance 600 Office Equipment 5000 Notes Payable $5000 Accounts payable 2500 Unearned Revenue 1200 C. R. Byrd, Capital 10000 C. R. Byrd, Drawing 500 Service Revenue 10000 Salaries Expense 4000 Rent Expense 900 $28700 $28700 19 Exercise 3 (solved) Assume the following adjustments: 1. Supplies on hand at October 31 total $500. 2. Expired insurance for the month is $50. 3. Depreciation for the equipment for the month is $50. (Note: the company uses straight line depreciation; useful life= 7 years, salvage value= $800). 4. Services related to unearned service revenue in October worth $600 were performed. 5. Services performed but not recorded at October 31 are $300. 6. Interest accrued at October 31 is $95. 7. Accrued salaries at October 31 are $1,625. Instructions a) Determine the type of adjustment required for each of the cases above b) Prepare the adjusting entries for the items above. 20 10
Prepaid Expenses 1. Oct.31 Supplies Expense 2,000 Supplies ($2,500 $500) 2,000 Note: supplies used= supplies balance $2500 supplies on hand $500 = $2000 2. 31 Insurance Expense 50 Prepaid Insurance 50 Note: annual insurance = $600; hence monthly insurance= $600 12 months = $50/ month 3. 31 Depreciation Expense 50 Accumulated Depreciation Equipment 50 21 Depreciation Any business owns a variety of assets such as equipment, building, trucks,.etc., These long-lived assets provide services for a number of years called the useful life of the asset. Depreciation is the process of allocating the cost of the long-lived asset to expense over its useful life in a systematic manner. From an accounting standpoint, the purchase of equipment or a building is viewed as a long term prepayment for services. Companies need to make periodic adjusting entries for depreciation. These entries record the portion of the asset that has been used (an expense) during the period, and report the unexpired portion (an asset) at the end of the period. A common procedure in computing depreciation is to divide the cost of the asset by its useful life. 22 11
Pioneer Advertising Agency estimates depreciation on the office equipment to be $600 a year, or $50 ($600 12) per month. 23 Unearned Revenues 4. Oct. 31 Unearned Service Revenue 600 Service Revenue 600 24 12
Accrued Revenues 5. 31 Accounts Receivable 300 Service Revenue 300 25 Accrued Expenses 6. Oct.31 Interest Expense 95 Interest Payable 95 7. 31 Salaries and Wages Expense 1,625 Salaries and Wages Payable 1,625 26 13
The Basics of Adjusting Entries Summary of Basic Relationships Illustration 3-22 LO 5 Prepare adjusting entries for accruals. 27 End of Lecture 1 14