Module 3: Preparing Financial Statements

Financial transactions

• Broadly defined as events that have an economic impact on the business

  > sale of merchandise, purchase of inventory, payment of salaries and utilities

  > because a business will experience  thousands of transactions in a year, a system is needed to track them

  > the system most commonly used consists of a general journal and ledger of accounts.  

Financial transaction

• The basic component of the system is the account

• There is a separate account for every asset, liability, owner’s equity, revenue and expense that appears on the financial statements.

Accounts

• kept in a ledger of accounts

• appear in the ledger  in the same order as they appear on the financial statements as follows:

  • current assets, noncurrent assets, current liabilities, non current liabilities, owner’s equity, revenues and expenses.

Journal

• contain the original entry of every transaction. 

• Include the date of transaction, the account titles, the amounts involved, a brief explanation of the transaction, and the page of the ledger to which the entry is later transferred. 

• All transactions are recorded chronologically

Journalizing

• process of recording transactions in the journal

Analysis

In journalizing in the journal, this process involves:

>determine the accounts involved

> determine what account is to be debited and credited.

Recording

In journalizing in the journal, this process involves:

> write the date

> write the account and amount of debit entry

> write a brief and concise explanation

> write the account and amount of credit entry

Ledger

• where entries in the journal are later posted

• classifies transactions by type of account

Posting

When each transaction (entry) in the journal is transferred to a ledger

Posting in the ledger

1. Transact the debit entry to the debit side of the ledger

2. Transfer the credit entry to the credit side of the ledger

3. Cross index the two records by writing their page in the Folio column. 

Double entry method

also called the debit/credit method, where debit refers to value received and credit refers to value parted with.

Bookkeeping

• is the term used to refer to the recording function of accounting based on this debit/credit method

Debit, Credit

_____ refers to value received and _____ refers to value parted with.

Debit

An increase in an asset

Credit

An increase in a liability or owner’s equity

Credit

A decrease in an asset

Debit

A decrease in a liability or owner’s equity

Expense

• decreases owner’s equity, it is a debit and is recorded on the left side of the expense account.  

Revenue

• increases owner’s equity, it is a credit  and is recorded on the right  side of the revenue account.  

Account Categories	Incr. (Normal Balance)	Decrease
Assets	Debit	Credit
Liabilities	Credit	Debit
Owner’s Equity
Capital	Credit	Debit
Withdrawals	Debit	Credit
Revenue	Credit	Debit
Expenses	Debit	Credit

Rules on Debit and Credit

Trial Balance

• Prepared at the end of the accounting period , after all journal entries have been posted to the ledger of accounts

• List of all accounts, in the order in which they appear in the ledger, and their debit or credit balances.

• Prepared to check for errors and to place data in convenient form for making financial statements.

• The cash basis of accounting states that

  • 1) revenues  is recognized and recorded  at the point in time when cash is received, regardless of when  it is earned and

    2) expense  is recognized and recorded at the point in time  when payment is made for the good or services, regardless of when  it is consumed.

• The accrual  basis of accounting states that

  • 1) revenue is recognized and recorded at the point  in time when  compensation is earned regardless of when it is received and an

  • 2) expense is recognized at the point in time when the good or services is consumed regardless of when payment is made  

Accrual vs Cash basis

Accrual

The ___ basis of accounting is recommended for adoption in pharmacy.

the end of the accounting period after all the transactions have been journalized and posted, but before the preparation of financial statements.

Adjustment process occurs at

Prepaid Expenses

• occurs when an expense is paid in advance.

• Example rent and insurance expense paid in advance of the time covered by the rental contract or insurance policy.

(merchandise/asset cost - salvage value) / useful life

Annual depreciation

Interest = Principal x Rate x Time

Interest

Adjusted Trial Balance

• Journal adjustments normally are prepared after the preparation of the trial balance. Thus, it is necessary to prepare a second trial balance.

Balance sheet items

• are called real accounts or permanent accounts because their measurement functions spans all the accounting periods in the life of the firm. 

• Example cash account does not cease with the end of a particular accounting period.  

Opening balance

Closing balance on the last day of one accounting period becomes its ____ e on the next accounting period.

Nominal or temporary accounts

• revenue , expenses and owner’s withdrawal accounts

• they have a functional life of one accounting period only in order to permit measurement of net income.

• balances of nominal accounts are reset at zero  at the end of each accounting period through the journalizing of closing entries. 

income summary account (ISA)

• a temporary account used to make year end adjusting and closing entries.

•  is a nominal account that is used only during the closing process.  Since it does not represent a specific item on the financial statements , it does not appear in any of them

Closing Entries

1. It transfers net income (or net loss) to the capital account.

2. It establishes zero balance in each of the income statement accounts so they are ready for use in the next accounting period.