Accounting Fundamentals: T-Accounts, Trial Balances, and Accrual Accounting
T-Accounts: A Fundamental Accounting Tool
T-accounts are a useful tool for accountants to determine the impact of changes from various transactions on a given account.
They are used to figure out the ending balance of an account (e.g., an ending balance for May 31 of 16,850 mentioned as an example).
T-accounts can also help determine what adjustment is needed to arrive at a given ending balance or to understand movements between beginning and ending balances.
They offer a simplified way to visualize what a general ledger might look like for a specific account, without having to enter all transactions into the actual general ledger.
From Journal Entries to Trial Balance
After completing journal entries, the next step is posting them to the General Ledger (GL).
Posting involves updating individual General Ledger accounts with the debits and credits from journal entries.
This process allows for the calculation of ending balances for all accounts.
Exercise References: The journal entry part covered in the lecture related to exercise 3.5, which instructs going back to 3.2 to do journal entries. Thus, both exercise 3.2 and 3.5 were covered.
Trial Balance for Long Computer Corporation (Example)
A trial balance lists all accounts and their respective debit or credit balances at a specific point in time (e.g., May 31, after posting all May journal entries).
The example shown for Long Computer Corporation would be an unadjusted trial balance because adjusting journal entries have not yet been made.
It can still provide a preliminary calculation of net income; for Long Computer Corporation, the unadjusted net income prior to adjustments was 1,650 for May.
A key check figure for a trial balance is that total debits must equal total credits (e.g., 34,800 in the example), confirming that the double-entry bookkeeping system has been respected. This equality, however, does not guarantee the absence of errors.
Chart of Accounts
Companies often use a Chart of Accounts, which is a listing of all accounts with assigned account numbers.
Accounts are typically categorized, e.g., asset accounts might be in the 1,000 level range, while owner's equity accounts might be in the 3,000 level range.
Errors Not Detected by an Equal Trial Balance
The fact that total debits equal total credits on a trial balance does not mean there are no errors in the accounting records. Several types of errors can exist:
Omitting a transaction or its posting altogether: If a journal entry or its posting is completely missed, both debits and credits will be equally understated, and the trial balance will still balance.
Doubling up a transaction or its posting: If a transaction or its posting is recorded twice, both debits and credits will be equally overstated, and the trial balance will still balance.
Posting to the wrong accounts: If the correct debit/credit amount is posted but to the wrong accounts (e.g., debiting Cash instead of Accounts Receivable, and crediting Service Revenue instead of Sales Revenue), the trial balance will still balance as long as the accounts are of the same type (e.g. assets) and the error is compensated.
Posting too much or too little to both debit and credit: If a transaction is recorded with an incorrect amount, but the debit and credit still match the incorrect amount, the trial balance will balance.
Transposition errors: These occur when digits are switched (e.g., 965 entered as 695). Such an error will cause the trial balance to be out of balance by a difference that is divisible by nine (965 - 695 = 270, and 270 / 9 = 30).
Investigating Errors when Trial Balance is Out of Balance
If the trial balance does not balance, one step is to divide the difference by two to check if a debit was incorrectly posted as a credit, or vice-versa, for that amount.
Another step is to divide the difference by nine, as this suggests a possible transposition error.
Other possibilities for imbalances include:
Computer system crashes during posting, leading to an incomplete posting of a journal entry.
Incorrectly calculating account balances.
Review of Journal Entry Examples (from previous class)
Issuing shares of stock for cash: Debit Cash (6,000), Credit Common Stock/Shareholders' Equity (6,000).
Services performed on account: Debit Accounts Receivable (1,500), Credit Service Revenue (1,500).
Receiving a bank loan: Debit Cash (10,000), Credit Loan Payable (10,000).
Paying for utilities: Debit Gas and Electricity Bills Expense (300), Credit Cash (300).
Paying rent: Debit Rent Expense, Credit Cash (amount not specified but implied).
Accrual Basis vs. Cash Basis Accounting
Accrual Basis Accounting (GAAP):
Revenues are recorded when they are earned, regardless of when cash is received.
Expenses are recorded when they are incurred, regardless of when cash is paid.
This method focuses on the economic substance of transactions, not just cash flows.
It is required by Generally Accepted Accounting Principles (GAAP) and even for not-for-profit organizations.
The accrual basis leads to timing differences between when revenue/expense is recognized and when cash is exchanged.
Cash Basis Accounting:
Revenues are recorded only when cash is received.
Expenses are recorded only when cash is paid.
Under cash basis, there is no need for adjusting journal entries.
It is not GAAP.
Adjusting Journal Entries (AJEs)
AJEs are necessary under the accrual basis of accounting due to timing differences.
Their purpose is to ensure that financial statements correctly report the appropriate amounts for revenues, expenses, assets, and liabilities at the end of an accounting period.
Timing Differences: These are discrepancies between when revenue is recorded/recognized and when cash is received, or when expenses are recorded/recognized and when cash is paid.
AJEs ensure revenues are recorded when earned and expenses when incurred, aligning with the matching principle.
Examples of Timing Differences leading to AJEs (already observed):
Revenue recorded after cash receipt (e.g., unearned revenue like Joe Jerry's 5,000 advance payment, where revenue wasn't recorded initially).
Expense recorded before cash payment (e.g., damage to a vehicle and agreement with a shop, incurred expense before receiving or paying the bill).
Cash flow before expense recognition (e.g., Mary Johannoux's September rent payment where expense wasn't recognized until September).
Categories of AJEs:
Deferrals: Situations where cash flow occurs before revenue or expense recognition.
Examples: Unearned Revenue (revenue recognized after cash received), Prepaid Expenses (expense recognized after cash paid), Supplies.
Accruals: Situations where cash flow occurs after revenue or expense recognition.
Examples: Accrued Interest Payable, Wages Payable (expense recognized before cash paid, or revenue recognized before cash received).
Students are advised to read Chapter 4 before the next class, which will cover more deferral examples.