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Chapter 2
A Review of the
19th
Edition Accounting
Cycle

Intermediate
Accounting
James D. Stice Earl K. Stice

2-1

The Accounting Process

The Recording Phase
1. Business documents are analyzed.
2. Transactions are recorded.
3. Transactions are posted.

(continued)

2-2

The Accounting Process

The Reporting Phase
4. A trial balance of the accounts in the
general ledger is prepared.
5 Adjusting entries are recorded
5. recorded.
6. Financial statements are prepared.
7. Nominal accounts are closed.
8. A post-closing trial balance may be
prepared.
2-3

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Accounting Terminology

• Transactions are events that transfer or

change goods or services between or
among two or more entities.
• Business documents, such as invoices,
provide evidence that transactions have
occurred as well as the data required to
record the transactions in the accounting
records.

2-4

Accounting Terminology

• Double-entry accounting is an old and

universally accepted system for recording
accounting data.
• Each transaction is recorded in a way that
maintains the equality of the basic accounting
equation:
Assets = Liabilities + Owners’ Equity

(continued)

2-5

Accounting Terminology

• A debit is an entry on the left side of an

account.
• A credit is an entry on the right side of
an account.
• A
Assets,
t expenses, and d dividends
di id d are
increased by debits and decreased by
credits.
• Liabilities, capital stock, retained
earnings, and revenues are increased by
credits and decreased by debits.
2-6

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Three-Step Journal Entry Process

1. Identify the accounts involved with an

event or transaction.
2. Determine whether each account
increased or decreased ((this information,,
coupled with the answer to step 1, will tell
you if the account was debited or
credited).
3. Determine the amount by which each
account was affected.
2-7

Analyzing Business Documents

• Normally, a business document, or source
document, is the first record of each
transaction.
• The business document provides support
for the data to be recorded in the journals
journals.
• Documents underlying each recorded
transaction provide a means of verifying the
accounting records and thus form a vital
part of the information and control systems.

2-8

Journalizing Transactions

• Once the information provided on business

documents has been analyzed, transactions
are recorded in chronological order in the
appropriate journal or journals.
• A special journal is used to record a
particular type of frequently recurring
transaction.
• The general journal is used to record all
transactions for which a special journal is not
maintained.

2-9

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Posting to the Ledger Accounts

• An account is used to summarize the

effects of transactions on each element
of the expanded accounting equation.
• A ledger is a collection of accounts
maintained by a business.
• The transfer of information from the
journal to the appropriate accounts in the
ledger is referred to as posting.

2-10

Establishing Separate Ledgers

• The general ledger includes all accounts
appearing on the financial statements, and
separate subsidiary ledgers afford
additional detail in support of certain general
ledger accounts
accounts.
• The general ledger account that
summarizes the detailed information in a
subsidiary ledger is known as a control
account.

2-11

Preparing a Trial Balance

• After all transactions for the period have

been posted to the ledger accounts, the
balance for each account is determined.
• A trial balance is a list of all accounts
and their balances.
• It provides a means to assure that total
debits equal total credits.

2-12

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Preparing Adjusting Entries

• Although the majority of accounts are up to date
at the end of the accounting period and their
balances can be included in the financial
statements, some accounts require adjustment
to reflect current circumstances.
• At the end of each accounting period, in order to
report all asset, liability, and owners’ equity
amounts properly and to recognize all revenues
and expenses for the period on an accrual
basis, accountants are required to make
adjusting entries prior to preparing financial
statements.
2-13

Steps to Analyze Circumstances

1. Determine whether the amounts

recorded for all asset and liabilities is
correct.
2. Determine what revenue or expense
adjustments are required as a result of
the changes in recorded amounts of
assets and liabilities indicated in step 1.

2-14

Areas Most Commonly

Requiring Analysis
Transactions where cash will be exchanged in
a future period:
1. Unrecorded assets—Assets and revenues
that have been earned but not yet recorded.
2. Unrecorded liabilities—Expenses and
liabilities that have been incurred but not yet
recorded.

(continued)
2-15

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Areas Most Commonly

Requiring Analysis
3. Prepaid expenses—Expenses that have
been recorded but not yet incurred.
4. Unearned revenues—Revenues that
have been recorded but not yet earned.

2-16

Unrecorded Assets

• Revenues should be recorded when

earned, regardless of when cash is
received.
• This ensure that all receivables are properly
reported on the balance sheet in the correct
amounts.
• The unrecorded receivables are earned
and represent amounts that are receivable
in the future.

(continued)
2-17

Unrecorded Assets

(a) If revenue is earned but not yet collected

in cash, a receivable exists. Rosi, Inc.,
has interest on a note receivable of $250.
Interest Receivable 250
Interest Revenue 250
To record accrued interest
on notes receivable.

2-18

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Unrecorded Liabilities

• Liabilities can be created by expenses

being incurred prior to being paid or
recorded.
• Adjusting
j g entries are required
q at the end of
the accounting period to recognize any
unrecorded liabilities.

(continued)

2-19

Unrecorded Liabilities

(b) Rosi, Inc., had unrecorded salaries and

wages amounting to $2,150 at the end of
the accounting period.
Salaries and Wages
g Expense
p 2,150
,
Salaries and Wages Payable 2,150
To record accrued salaries
and wages.

(continued)

2-20

Unrecorded Liabilities

(c) Rosi, Inc., firm accrued interest of $5,000

on a bond payable.
Interest Expense 5,000
Interest Payable 5,000
To record accrued interest
on bonds.

(continued)

2-21

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Unrecorded Liabilities

(d) Rosi, Inc., owed federal and state

income taxes totaling $8,000.
Income Tax Expense 8,000
Income Taxes Payable 8,000
To record income taxes
taxes.

2-22

Prepaid Expenses

• Payments that a company makes in

advance for items normally charged to
expense are known as prepaid expenses.
• An expense
p is the using
g up
p of an asset.
• The adjusting entry shows the complete
consumption of an asset.

2-23

Prepaid Expenses Originally

Debited to an Asset Account
If the asset account was originally debited,
the adjusting entry requires that an
expense account be debited for the amount
applicable
pp to the current p
period and the
asset account credited.

(continued)

2-24

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Prepaid Expenses Originally

Debited to an Asset Account
(e) The expired portion of Rosi Inc.’s prepaid
insurance is $4,200. The following
adjusting entry is required:
Insurance Expense 4,200
P
Prepaid
id Insurance
I 4 200
4,200
To record expired insurance
($8,000 – $3,800 = $4,200).

(continued)

2-25

Prepaid Expenses Originally

Debited to an Asset Account
If an expense account was originally debited,
the adjusting entry requires that an asset
account be debited for the amount applicable
to future periods and the expense account be
credited.
di d

(continued)

2-26

Prepaid Expenses Originally

Debited to an Asset Account
If Rosi’ Inc., had originally debited Insurance
Expense for $8,000, the expense account
shows $8,000, but $3,800 is applicable to
future periods. The adjusting entry would be
as follows:
f ll
Prepaid Insurance 3,800
Insurance Expense 3,800
To record prepaid insurance
($8,000 – $4,200 = $3,800).

2-27

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Unearned Revenues

• Amounts received before the actual earning

of revenues are known as unearned
revenues.
• Because the company
p y has received cash
but not yet given the customer the
purchased goods or services, the unearned
revenues are in fact liabilities.

2-28

Unearned Revenues Originally

Credited to a Revenue Account
(f) As indicated in the trial balance for Rosi,
Inc., rent receipts are recorded originally in
the rent revenue account. Unearned
revenue at the end of 2013 is $475, and is
recorded
d d as ffollows:
ll
Rent Revenue 475
Unearned Rent Revenue 475
To record unearned rent
revenue.

2-29

Unearned Revenues Originally

Credited to a Liability Account
If a liability account was originally credited,
this account is debited and a revenue
account is credited for the amount applicable
to the current period.
Unearned
U dR
Rentt R
Revenue 2 075
2,075
Rent Revenue 2,075
To record rent revenue
($2,550 – $475).

(continued)

2-30

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Unearned Revenues Originally

Credited to a Liability Account
The following T-accounts illustrate the effect
that this adjusting entry would have on the
relevant accounts:

2-31

Transactions Involving Estimates

Asset Depreciation
• Operations are charged with a portion of
the asset’s cost, and the carrying value of
the asset is reduced by that amount.
• A reduction in an asset for depreciation is
usually recorded by a credit to a contra
account, which is set up to record
subtractions from related accounts.
(continued)
2-32

Transactions Involving Estimates

Asset Depreciation
(g) Rosi Inc., estimated depreciation at the
end of the year to be five percent for
buildings and ten percent for furniture and
equipment.
Depreciation Expense—Building 7,800
Accumulated Depreciation—
Building 7,800
To record depreciation on
buildings at 5% per year.
(continued) 2-33

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Transactions Involving Estimates

Asset Depreciation
(g) Depreciation Expense—Furniture
& Fixtures 1,900
p
Accumulated Depreciation—
Furniture & Fixtures 1,900
To record depreciation on
furniture and equipment at
10% per year.

2-34

Bad Debts

• Invariably, when a business allows

customers to purchase goods and services
on credit, some of the accounts receivable
will not be collected.
• Under the accrual concept, an adjustment
should be made for estimated expense in
the current period rather than when
specific accounts become uncollectible.

(continued)

2-35

Bad Debts

(i) Rosi Inc.’s estimated Allowance for Bad

Debts is to be increased by $1,100.
Bad Debt Expense 1,100
Allowance for Bad Debts 1,100
To adjust for estimated bad
debt expense.

2-36

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Adjusting Entry Summary

• Adjusting entries do not involve cash.

• Adjusting entries always involve a
balance sheet account and an income
statement account
account.

2-37

Preparing Financial Statements

1. Identify all revenues and expenses—these

account balances are used to prepare the
income statement.
2. Compute the net income—subtract expenses
from revenues
revenues.
3. Compute the ending Retained Earnings
balance.
4. Prepare a balance sheet using the balance
sheet accounts from the trial balance and the
modified retained earnings balance.

2-38

Using a Spreadsheet

• Nominal (or temporary) accounts:

 Closed to a zero balance at the end of
each accounting period.
 All income statement accounts and the
dividend account are closed.
• Real (or permanent) accounts:
 Not closed to a zero balance at the end
of the accounting period.
 Carried forward to the next period.
2-39

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The Closing Process

Revenues Retained Earnings

xx Bal. xxx Beg. Bal. xxx
Revenues

Since the revenue account is a

nominal account, it is closed at
the end of the period to
Retained Earnings.
(continued)
2-40

The Closing Process

Retained Earnings
Expenses Beg. Bal. xxx
Revenues

Each expense account

Expenses is credited in order to
close the account at
Bal. xxx xx
the end of the period.

(continued)
2-41

The Closing Process

Retained Earnings
The dividends Expenses Beg. Bal. xxx
account, which is Dividends Revenues
also nominal, is
credited
dit d tto close
l
out the balance.

Dividends
Bal. xxx x
(continued) x 2-42

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The Closing Process

Retained Earnings
Retained Earnings Expenses Beg. Bal. xxx
is a real account Dividends Revenues
and always carries
a balance.

Net Income for the Dividends reduce

period is determined Retained Earnings.
by these two items.
2-43

Post-Closing Trial Balance

• Provides a listing of all real account

balances at the end of the closing process.
• The post-closing trial balance is
prepared to verify the equality of debits
and credits for all real accounts.

2-44

Accrual Accounting

• Accrual accounting recognizes

revenues as they are earned, not
necessarily when cash is received.
• Expenses are recognized as they are
incurred, not necessarily when cash is
paid.
• Provides a better basis for financial
reporting, according to the FASB.

2-45

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Cash-Basis Accounting

• Cash-basis accounting is focused on cash

receipts and cash disbursements.
• Typically used by service businesses, such
as CPAs, dentists, and engineers.
• AICPA holds that it is appropriate for small
service companies.

2-46

Computers and Accounting

• Many steps of the accounting cycle are

performed using computers.
• Typical computerized functions include
generating reports and computational
analysis.
• The computer will never replace a good
accountant!

(continued)

2-47

Computers and Accounting

A recent development in the use of computers in

financial reporting is the spread of XBRI:
• Stands for eXtensible Business Reporting
Language.
• Is a method of embedding computer
computer-readable
readable
tags in financial report documents.
• Allows a company to download its financial
statements into spreadsheets where they can
be compared to the financial statements of
other companies that have also been
downloaded.
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Chapter 2

₵
The End
$
2-49

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