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Monday, January 18, 2010

Accounting In Action

What is Accounting?

The purpose of accounting is to:

(1) identify, record, and communicate the economic events of an

(2) organization to

(3) interested users.

TheBuilding Blocks of Accounting

Ethics In Financial Reporting:

Standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or not fair, are Ethics.

1. Recent financial scandals include: Enron, WorldCom, HealthSouth, AIG, and others.

2. Congress passed Sarbanes-Oxley Act of 2002.

3. Effective financial reporting depends on sound ethical behavior.

Cost Principle (Historical) – dictates that companies record assets at their cost.


1. Reported at cost when purchased and also over the time the asset is held.

2. Cost easily verified, whereas market value is often subjective.

3. Fair value information may be more useful.


Monetary Unit Assumption – include in the accounting records only transaction data that can be expressed in terms of money.

Economic Entity Assumption – requires that activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities.

1. Proprietorship.

2. Partnership.

3. Corporation.

Provides the underlying framework for recording and summarizing economic events.

Assets are claimed by either creditors or owners.

Claims of creditors must be paid before ownership claims.


1. Resources a business owns.

2. Provide future services or benefits.

3. Cash, Supplies, Equipment, etc.


1. Claims against assets (debts and obligations).

2. Creditors - party to whom money is owed.

3. Accounts payable, Notes payable, etc.

Owners’ Equity

1. Ownership claim on total assets.

2. Referred to as residual equity.

3. Capital, Drawings, etc. (Proprietorship or Partnership).

Revenues result from business activities entered into for the purpose of earning income.

Common sources of revenue are: sales, fees, services, commissions, interest, dividends, royalties, and rent.

Expenses are the cost of assets consumed or services used in the process of earning revenue.

Common expenses are: salaries expense, rent expense, utilities expense, tax expense, etc.

Are the following events recorded in the accounting records?


Barone’s Repair Shop was started on May 1 by Nancy. Prepare a tabular analysis of the following transactions for the month of May.

1. Invested $10,000 cash to start the repair shop.

2. Purchased equipment for $5,000 cash.

3. Paid $400 cash for May office rent.

4. Received $5,100 from customers for repair service.

5. Withdrew $1,000 cash for personal use.

6. Paid part-time employee salaries of $2,000.

7. Incurred $250 of advertising costs, on account.

8. Provided $750 of repair services on account.

9. Collected $120 cash for services previously billed.

Demonstration Problem

Joan Robinson opens her own law office on July, 1 2005. During the first month of operations, the following transactions occurred.

  1. Invested $10,000 in cash in the law practice.
  2. Paid $800 for July rent on office space.
  3. Purchased office equipment on account $3,000.
  4. Provided legal services to clients for cash $1,500.
  5. Borrowed $700 cash from a bank on a note payable.
  6. Performed legal services for a client on account $2,000.
  7. Paid monthly expenses: salaries $500, utilities $300, and telephone $100.


(a) Prepare a tabular summary of the transactions.

(b) Prepare the income statement, owner's equity statement, and balance sheet at July 31 for Joan Robinson, Attorney at Law.

The Recording Process

Debits and Credits

Double-entry accounting system

  1. Each transaction must affect two or more accounts to keep the basic accounting equation in balance.
  2. Recording done by debiting at least one account and crediting another.
  3. DEBITS must equal CREDITS.

Demonstration Problem

Bob Sample opened the Campus Laundromat on September 1, 2005. During the first month of operations the following transactions occurred.

  1. Invested $20,000 cash in the business.
  2. Paid $1,000 cash for store rent for the month of September.
  3. Purchased washers and dryers for $25,000, paying $10,000 in cash and signing a $15,000, 6-month, 12% note payable.
  4. Paid $1,200 for one-year accident insurance policy.

10. Received bill from the Daily News for advertising the opening of the Laundromat $200.

20. Withdrew $700 cash for personal use.

30. Determined that cash receipts for laundry services for the month were $6,200.


(a) Journalize the September transactions. (Use J1 for the journal page number.)

(b) Open ledger accounts and post the September transactions.

(c) Prepare a trial balance at September 30, 2005

Adjusting The Accounts

Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting

  1. Transactions recorded in the periods in which the events occur
  2. Revenues are recognized when earned, rather than when cash is received.
  3. Expenses are recognized when incurred, rather than when paid.

Cash-Basis Accounting

  1. Revenues are recognized when cash is received.
  2. Expenses are recognized when cash is paid.
  3. Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP).

The Basics of Adjusting Entries
  1. Adjusting entries make it possible to report correct amounts on the balance sheet and on the income statement.
  2. A company must make adjusting entries every time it prepares financial statements.
  3. Revenues - recorded in the period in which they are earned.
  4. Expenses - recognized in the period in which they are incurred.
  5. Adjusting entries - needed to ensure that the revenue recognition and matching principles are followed.

Deferrals are either:

  1. Prepaid expenses or
  2. Unearned revenues.

Prepaid Expenses
  1. Costs that expire either with the passage of time or through use.
  2. Adjusting entries (1) to record the expenses that apply to the current accounting period, and (2) to show the unexpired costs in the asset accounts.

  1. Buildings, equipment, and vehicles (long-lived assets) are recorded as assets, rather than an expense, in the year acquired.
  2. Companies report a portion of the cost of a long-lived asset as an expense (depreciation) during each period of the asset’s useful life (Matching Principle).

Depreciation (Statement Presentation)

  1. Accumulated Depreciation—is a contra asset account.
Appears just after the account it offsets (Equipment) on the balance sheet.

Unearned Revenues
  1. Company makes an adjusting entry to record the revenue that has been earned and to show the liability that remains.
  2. The adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.

Adjusting Entries for Accruals

Made to record:

  1. Revenues earned and
  2. Expenses incurred

In the current accounting period that has not been recognized through daily entries.

Accrued Revenues

An adjusting entry serves two purposes:

(1) It shows the receivable that exists, and

(2) It records the revenues earned.

Accrued Expenses

An adjusting entry serves two purposes:

(1) It records the obligations, and (2) It recognizes the expenses.

The Adjusted Trial Balance

After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance).

Its purpose is to prove the equality of debit balances and credit balances in the ledger.