Chapter 2

Debit is on the…

Left

Credit is on the…

Right

Double-entry

Transactions (journal entry) are recorded in such a way to affect at least two accounts.

Each transaction must maintain…

Debits = Credits

Permanent accounts

Assets, liabilities, paid-in capital, retained earnings

Temporary accounts

Revenues, expenses, gains, losses… (eventually accumulated under Retained Earnings)

Issued 30,000 shares of common stock in exchange for $300,000 in cash

Cash (A+) 300k / CS (SE+) [Paid-in capital] 300k

Purchased equipment at a cost of $40,000. $10,000 cash was paid and a note payable was signed for the balance owed

Equipment (A+) 40k / Note Payable (L+) 30k, Cash (A-) 10k

Purchased inventory on account at a cost of $90,000. The company uses the perpetual inventory system

Inventory (A+) 90k / Accounts payable (L+) 90k

Credit sales for month totaled $120,000. The cost of the goods sold was $70,000

A/R 120K / Sales Revenue 120k

COGS 70k / Inventory 70k

Used the warehouse buildings for the month of March and paid $5,000

Rent expense 5k / Cash 5k

Paid $6,000 to an insurance company for fire and liability insurance for a one‐year period beginning April 1, 2023

Prepaid insurance 6k / Cash 6k

Paid $70,000 on account for the merchandise purchased in 3

Account payable 70k / Cash 70k

Collected $55,000 from customers on account

Cash 55k / A/R 55k

Accounting cycle 1

What happens during the fiscal year

Accounting cycle 1 includes…

Analyzing transactions

Journalizing & Posting

Preparing unadjusted trial balance

Accounting cycle 2

What happens at the end of the period

Accounting cycle 2: Big Picture

Sequential steps leading to the preparation of financial statements (repeated each accounting period)

Accounting cycle: Analyzing transactions

By “analyze”, we mean to determine (1) which accounts are affected, and (2) by how much

Accounting cycle 1 Summary

Analyze transactions

Journalize and post

Accounting cycle: Journalizing

To “journalize” is to record each transaction as a journal entry

Journal

A book of original entry: date of transaction, accounts and amounts to be debited/credited, an optional explanation

Accounting Cycle: Posting to Ledger (T-accounts)

To “post” is to transfer journal entries to the T-Accounts

– Purpose is to summarize the amounts in each account

Two types of T-accounts (or ledgers)

Permanent accounts: balance sheet accounts that always stay open

Temporary accounts: income statement accounts and dividends; we close every period

Within permanent and temporary accounts, there are also the following:

Adjunct accounts: the balance is added to the account to which it relates (e.g., premium on bonds payable)

Contra accounts: the balance is deducted from the account to which it relates (e.g., allowance for doubtful accounts, accumulated depreciation, discount on bonds)

Adjunct accounts and Contra accounts…

Are accessory accounts (they aren’t standalone accounts)

Adjunct accounts are…

a plus to the main account

Contra accounts are…

a minus to the main account

Received $60,000 cash from investors; each was issued 1,000 shares of capital stock

Cash 60k / Pain-in-capital 60k

Purchased equipment for use in the business at a cost of $12,000; one- fourth was paid in cash and the company signed a note for the balance (due in six months)

Equipment 12k / Cash 3k, N/P 9k

Agreed with a cleaning service to pay it $120 per week for cleaning the corporate offices

No transaction

Loaned $2,000 to one of the suppliers who signed a note due in six months

N/R 2k / Cash 2k

Received an additional contribution from investors who provided $4,000 in cash and land valued at $10,000 in exchange for stock in the company

Land 10k, Cash 4k / CS 4k

James Parillo borrowed $10,000 for personal use from a local bank, signing a one-year note

No transaction. Not from company’s point of view

Accounting Cycle 2: Big Picture

When we end the accounting period to prepare financial statements, account balances don’t reflect everything that has happened in the period - So we make adjusting entries!

Accounting Cycle: Adjusting Entries

Adjusting entries are made at the end of accounting periods to bring accounts up to date and ensure proper revenue/expense recognition

Adjusting entries is split in two:

(1) Economic activities (accounting) ≠ cash transactions (mismatch in timing)

(2) Other adjusting entries: depreciation, bad debt expense, adjusting ending inventory

Two rules of thumb to remember for AJE:

Do not use cash in an adjusting entry

Adjusting entries affect at least one temporary account (R, E, G, L)

Types of adjusting entries (economic activities ≠ cash transactions):

Accruals and Prepayments (deferrals)

Accruals:

economic activities precede cash transactions

Accrued Revenues (A):

revenues earned but not yet received in cash. A/R

Accrued Expenses (L)

expenses incurred but not yet paid in cash

Prepayments (deferrals):

cash transactions precede economic activities

Prepaid Expenses (A):

expenses paid in cash as assets before they are used or consumed

Unearned Revenues (L):

payments received in cash as liabilities until they are earned

Accounting cycle 2 Summary

Adjusting Entries

Prepare Statements

Closing Entries