Preparation of Financial Statements

General Journal Entry No. 9 10 11 12 13 14 15 16 17 18 19 20 Cash Sales A/R Sales Cash A/R A/P Cash Merchandise Inventory A/P Cost of sales Merchandise Inventory Wages expenses Cash Wages expenses Accrued wages Prepaid rent Cash Prepaid insurance Cash Utilities expense Accounts payable Furniture and fixtures Cash A/P Adjusting Entries 21 22 23 Depreciation Accumulated depreciation Interest expenses Interest payable Insurnace expenses Prepaid isnurance 193 193 1250 1250 144 144 1760 660 1100 226 226 2310 2310 1485 1485 440 440 688 688 38140 38140 49940 49940 96195 96195 3614 3614 14850 14850 Account Dr. 38000 38000 Cr.

Cash Entry No. 1 2 4 5 6 7 8 9 11 12 15 17 18 20

Total Balance 84,661

Dr 165,000

Cr 1,485 15,500 1,320 935 1,100 275

38,000 3,614 96,195 688 1,485 2,310 660

206,614 121,953

P epaid Insu ance En y o 18 23 o a a ance 2 310 2 117 2 310 193 193

Furniture and Fixture Entry 4 20 Total Balance r 15,500 1,760 17,260 17,260 0 Cr

Accoun En No 10 11 o al alance

R ceivabl 14,850 3, 4,850 11, 3 3, 4 4

Rent Expenses Entry No. 2 Total Balance Dr 1485 1,485 1,485 0 Cr

Wages Exepnses Entry No. 6 15 16 Total Balance Dr 935 688 440 2,063 2,063 0 Cr

Office Suppli En y o al alance o. D

Expenses

7 1,100 1,100 1,100 0

Utility Exepnses Entry No. 8 19 Total Balance Dr 275 226 501 501 0 Cr

Merchandise Inventory Entry 13 14 Total Balance 149,300 r 3 137,500 49,940 38,140 187,440 38,140 Cr

Accounts Payable Entry No. 3 12 13 19 20 Total Balance 96,195 49,940 226 1,100 96,195 188,766 92,571 Dr Cr 137,500

cc ued Wage En o 16 o a a ance 0 440 440 440

Bank Loan Pa abl Entr otal Balance o. 1 r r 100,000 0 100,000 100,000

Proprietor's Capital Entry No. 1 Total Balance 0 Dr Cr 65,000 65,000 65,000

Prepaid Rent Entry No. Dr 17 1,485 Total Balance 1,485 1,485 0 Cr

Sal s Entry N . 9 10 Total alance 0 r r 38,000 14,850 52,850 52,850

Cost of Sales Entry No. Dr 14 38,140 Total 38,140 0 Balance 38,140 Cr

Depreciation Expenses Entry No. 21 Total Balance Dr 144 144 144 0 Cr

Contra A

et

Accumulat Entr N t B nce

n Depreciation Dr Cr 44 44 144

Interest Payable Entry No. 22 Total Balance Dr Cr 1,250 0 1,250 1,250

Ineterst Expenses Entry No. Total Balance Dr 22 1,250 1,250 1,250 0 Cr

Insurance Exepnse Entry No. 23 Total Balance Dr 193 193 193 0 Cr

Advertising Exepnse Entry No. Total Balance Dr 5 1,320 1,320 1,320 0 Cr

i B C sh p id I s F A R Offi U ii y M A A B kL p i p id R S C s D p A I I I s Adv is m m s s s fs i i y xp xp s s s s xp s s s xp dD p s s i i s C pi h W g s i sR xp xp xp dis s s s s s xp s s y s s I v y d Fix iv s

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A L L L L A R L L

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PC Depot Income Statement for September Sales Cost of sales Gross margin Exepnses Wages Advertising Office supplies Utilities Rent Insurance Interest Depreciation Net income 52,850 38,140 14,710 2,063 1,320 1,100 501 1,485 193 1,250 144

8,056 6,654

PC Depot Balance Sheet as of September 30 Assets Cash Accounts Receivable Merchandise Inventory Prepaid insurance Prepaid rent Furniture and fixtures Accumulated depreciation Total assets 11,236 Accrued wages 149,300 Bank loan payable 2,117 Ineterst payable 1,485 Proprietory's capital 17,260 Retained earnings -144 265,915 Total liabilities and owner's equity 265,915 Liabilities 84,661 Accounts Payable 92,571 440 100,000 1,250 65,000 6,654

Temporary Accounts = R & E

Permanent Accounts = A & L

Accounting Cycle
BT S J

BS Tradi iona T

I TB

Accounting Cycle
BT S TA

BS Modern

Compare
BT S J BT S TA

BS Tradi iona T

BS Modern

I TB

Why Traditional Accounting Cycle?

Accounting done manually, but still volume of data to be captured Accounted on a continuous basis Multiple points of error correction

Process of Book Keeping --- Accounting Identifying accounting transactions Initial record of accounting transactions Preparation of ledger accounts Balancing ledger accounts Preparing trial balance Preparing financial statements
Balance Sheet Income and Expenses Statements Cash Flow Statements

Branches of Accounting

Financial accounting Cost accounting Management accounting

Objectives of Accounting

Maintaining proper record of business transactions Calculation of profits or loss Depiction of financial position Providing effective control over business Making information available to various groups

Advantages of Accounting Replacing machinery Assisting the performance of business Assessing the financial status of the business Documentary evidence Assisting in realization of debts Facilitating the sale of business Preventing and detecting frauds Helpful to management

Limitations of Accounting

Incomplete information Inexactness Showing valueless assets Manipulation Ignorant about the present value of business

Users of Financial statements

Internal users
Owners Shareholders Investors Creditors Employees Customers Lenders Management Tax authorities Regulatory agencies Researchers Labor unions Stock exchanges Public

External users

Quality Characteristics of Accounting Information

Reliability of accounting information Relevance of accounting information Understandability of accounting information Comparability of accounting information

Classifications of Assets

Fixed assets Current assets Fictitious assets Tangible assets Intangible assets Wasting assets depleting assets Liquid assets

Classification of Capital

Fixed capital Current floating capital Working capital

Expense vs. Expenditure

Short term / Long term P&L / BS Salary / Machinery bought

Basic Accounting Concepts Pillars of Accounting

Business as separate entity Money measurement Going concern Accounting period Cost Dual aspect Revenue recognition Matching Full disclosure Consistency Conservations Materiality Objectivity based on documentary evidence

Financial Statements
Translates events into financial statements

Need for Accounting Standards

Uniform and standard presentation of accounts Removal of ambiguity Prevention of accounting scandals Globalization of business Internationalization of financial institutions

Basis of Accounting

Cash basis Accrual basis

Source Documents Cash memo Invoices and bills Receipts Pay-in-slip Cheques Debit notes Credit notes Correspondence Other

Classifications of Transactions
Increase in assets with corresponding increase in capital Increase in assets with corresponding increase in liabilities Increase and decrease in assets Decrease in assets with corresponding decrease in liabilities Decrease in assets with corresponding decrease in capital Increase and decrease in liabilities Increase and decrease in capital Increase in liabilities and decrease in capital Increase in capital and decrease in liabilities

Treatment of Revenue Payments and Receipts

Expenses
Treatment of expenses paid Treatment of outstanding expenses Treatment of prepaid or unexpired expenses

Receipts
Income received Income due but not received or accrued income Unearned income or income received in advance

Treatment of Purchases and Sales

Purchases
Cash purchases Credit purchases

Sales
Cash sales Credit sales

Treatment of Other Transactions

Amount withdrawn by proprietor Depreciation on assets Interest on capital Interest on drawings

Limitations of Double Entry System

Fails to detect errors Fails to detect errors of principles Fails to detect compensating errors

Important Business Transactions Started or commenced business Cash purchase Credit purchase Purchase returned Cash sales Credit sales Sales return Asset purchased for cash

Important Business Transactions Assets sold for cash Expenses paid using cash Expenses accrued Rent received Discount allowed to customers Depreciation on assets Interest received Interest paid Interest owed

Important Business Transactions Prepaid expenses Expensing prepaid expenses Cash drawings by owner Drawings in kind by owner Charity given Provisioning for bad debt Writing of bad debts Bad debts recovered Distribution of goods as free sample

Important Business Transactions

Loss of goods by thefts Loss of goods by fire Advance received from customer Goods supplied against advance receipts Paid tax

Discounts

Cash discounts Trade discounts

Accounts Charts

Special Features of Depreciation

Loss in the value of assets Loss should be gradual and constant Exhaustion of effective life of business Normal feature Maintenance of asset is not depreciation Continuous decrease in the value of assets Allocation of cost of assets to the period of its life

Alternative Word for Depreciation

Obsolescence Depletion Amortisation Fluctuation

Causes for Depreciation

Constant use Expiry of time Obsolescence Depletion Permanent fall in price Loss due accident and damage

Need for Charging Depreciation

Determination of net profit and loss Showing assets at fair and true value in balance sheet Provision of funds for replacement of assets Ascertaining accurate cost of production Distribution of dividend out of profits only Avoiding over payment of income-tax

Factors Affecting the Amount of Depreciation

Total cost of the assets Estimated useful life of the assets Estimated scrap value Chances of obsolescence Addition to assets Legal provisions

Methods of Calculating Depreciation

Fixed / equal installment / straight line Diminishing / reducing / written down value Annuity Depreciation fund Insurance policy Revaluation Depletion Machine hour rate Sum of years digit Replacement

Special Features of Provisions

Meet known losses Meet expected contingencies Meet an outstanding liability

Types of Provisions

Provision for bad and doubtful debts Provision for discount on debtors Provision for taxation

Reserves

Appropriation of profits General reserve also called..,

Free reserve Revenue reserve

Types of Reserves

Capital reserve Revenue reserve General reserve Specific reserve Secret reserve

Classification of Expenditures

Capital expenditure Revenue expenditure Deferred revenue expenditures

Classification of Receipts

Capital receipts Revenue receipts

Limitations of Financial Statements Ignores qualitative aspect Based upon convention and practices Ignores human resources Ignores price level changes Ignores interest of all concerned parties Fails to display profitability, efficiency and financial soundness of the business Fails to highlight the inflow and outflow of funds

Need for Income and Expenses Account

Evolution in Financial Accounting

Rule based to principle based Cost approach to fair value based approach Global convergence

Remember

Chart of accounts Adjusting entries..,

Prepayments
Prepaid expenses Unearned revenues

Accruals
Accrued revenues Accrued expenses

Accounting Cycle

Financial Reporting and Ongoing Business

Income

Opening B/S
Assets Liabilities

Expenses

P&L Statement Cash Flow Statement

Cash

Ending B/S
Assets Liabilities

Cash and non cash Non-cash Paid and outstanding Received and yet to receive Known with certainty and unknown Complete and incomplete Covering single period and covering multiple period Regular events and irregular events

Identifiable and non identifiable Direct and indirect Visible and invisible Single ownership and multiple ownership

Financial Accounting
One period world

Multi period world

Accounting is Complex and Interesting

Diversity of business events Many different players Diverse incentives
Economic Other

Uncertainty Many regulations Accounting is a complex field contrary to common perceptions

Accounts
Device used for calculating net change Simplest form is T-account Increases listed on one side; decreases listed on other side Balanced periodically Types
Temporary Permanent

General ledger

Terminology
Chart of accounts Debit and credit Entries..,
Asset accounts and expenses:
Increases on LHS (Dr.) Decreases on RHS (Cr.)

Liability, OE and revenues:

Increases on RHS (Cr.) Decreases on LHS (Dr.)

Accounting Cycle
Analysis of transactions. (Judgment) Journalize original entries . (Mechanical) Post from journal to ledger. (Mechanical) Make adjusting entries. (Judgment) Journalize and post closing entries. (Mech.) Prepare financial statements (Judgment)

Trial Balance
List of all accounts & amounts; separate columns for dr. and cr. Shows equality of dr. and cr. Still could be errors. Convenient for making adjusting entries and preparing financial statements (BS & IS).

Adjusting Entries
Modifies account balances at end of period. Types:
Prepayments
Prepaid expenses Unearned revenues

Accruals
Accrued revenues Accrued expenses

Closing Entries
Temporary or IS accounts are closed out to the clearing account Income Summary (=Profit & Loss=Expense and Revenue Summary).
Close out = zero out = transfer balance to another account

Income summary account is closed out to RE. Only Permanent Accounts remain open.

Accounting System
Consists of:
Journals. Ledgers. Rules for using them.

Manual, computerized, or anything between. In a computerized system:

Bookkeeping steps are done electronically.

Normal Accounting Balances

Assets
Increase Debit Normal Balance Decrease Credit

Liabilities
Decrease Debit Increase Credit Normal Balance

Normal Accounting Balances

Revenues
Decrease Debit Increase Credit

Expenses
Increase Debit Decrease Credit

Normal Balance

Normal Balance

Normal Accounting Balances

Assets = Liabilities + Stockholders Equity

Expanded Basic Equation

Assets Dr. + Cr. -

= Liabilities + Common Stock

Dr. Cr. + Dr. Cr. +

Retained + Earnings Dr. Cr. +

+ Revenues
Dr. Cr. +

- Dividends - Expenses
Dr. + Cr. Dr. + Cr. -

Normal Accounting Balances

PIONEER ADVERTISING AGENCY Trial Balance October 31, 2002
Cash Advertising Supplies Prepaid Insurance Office Equipment Notes Payable Accounts Payable Unearned Revenue Common Stock Dividends Service Revenue Salaries Expense Rent Expense Debit $ 15,200 2,500 600 5,000 Credit

The total debits must equal the total credits

500

$ 5,000 2,500 1,200 10,000 10,000 4,000 900 $ 28,700

$ 28,700

Temporary and Permanent Accounts

Temporary Accounts
All revenue accounts All expense accounts Dividends accounts

Permanent Accounts
All assets accounts All liabilities accounts Stockholders equity account

Closing Process
(IN IVI UA ) EX ENSES (IN IVI UA ) REVENUES

2
INCOME SUMMARY

1 Debit each revenue account for its balance, and credit Income Summary for total revenues. 2 Debit Income Summary for total expenses, and credit each expense account for its balance.

Closing Process
INCOME SUMMARY

3
RETAINED EARNINGS

3 Debit (credit) Income Summary and credit (debit) Retained Earnings for the amount of net income (loss).

Closing Process
RETAINED EARNINGS

DI IDENDS

4 Debit Retained Earnings for the balance in the Dividends account and credit Dividends for the same amount.

Accounting Cycle