Acctg fundamentals

Completing the Accounting Cycle

Completing the Accounting Cycle

FUNDAMETAL ACCOUNTINGPresented by:

MALIHA

FUNDAMETAL ACCOUNTINGPresented by:

MALIHA

22

OutlineOutline

What is Accounting? Who uses accounting information? Main Division Of Accounting Chart of Account Accounting Concepts/Conventions Cash VS Accrual Accounting Accounting Cycle Fundamental Accounting Equation & Concept of Double Entry System The Basic Accounting Elements General Journal & General Ledger The preparation of adjusted Trial Balance Preparation of a Worksheet & its usefulness. The Closing process & Closing entries Preparation of Financial Statement Q & A Session Conclusion

What is Accounting? Who uses accounting information? Main Division Of Accounting Chart of Account Accounting Concepts/Conventions Cash VS Accrual Accounting Accounting Cycle Fundamental Accounting Equation & Concept of Double Entry System The Basic Accounting Elements General Journal & General Ledger The preparation of adjusted Trial Balance Preparation of a Worksheet & its usefulness. The Closing process & Closing entries Preparation of Financial Statement Q & A Session Conclusion

33

What is Accounting?What is Accounting?

The Language of Business.A means to communicate

Financial information.A way to convey information

about a Business to users.

The Language of Business.A means to communicate

Financial information.A way to convey information

about a Business to users.

44

Who uses Accounting Information?

Who uses Accounting Information?

OwnersManagersInvestors (including potential)

Analysts on their behalf

Creditors (including potential)Government (tax assessment)RegulatorsCustomers

OwnersManagersInvestors (including potential)

Analysts on their behalf

Creditors (including potential)Government (tax assessment)RegulatorsCustomers

55

Main Divisions of AccountingMain Divisions of Accounting

Financial accounting Primarily prepared for users external to the

company.→Revenues, earnings, assets, etc.

Management accounting Primarily for internal purposes

→Costing, budgeting, net present value, etc.

Financial accounting Primarily prepared for users external to the

company.→Revenues, earnings, assets, etc.

Management accounting Primarily for internal purposes

→Costing, budgeting, net present value, etc.

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Recording Business Transactions

Recording Business Transactions

The Accounting Period

One YearCalendar year

Fiscal year

Less than One YearQuarterlyMonthly

77

CHART OF ACCOUNTCHART OF ACCOUNT

What is the Chart of Accounts?It is the list of accounts used by a business.Each business entity has its unique chart

of accounts.Every chart of accounts has the same

numbered account categories:

– Assets, Liabilities, Owner’s Equity

– Revenues, Expenses

What is the Chart of Accounts?It is the list of accounts used by a business.Each business entity has its unique chart

of accounts.Every chart of accounts has the same

numbered account categories:

– Assets, Liabilities, Owner’s Equity

– Revenues, Expenses

88

Accounting Concepts / Conventions

Accounting Concepts / Conventions

Business EntityMoney MeasurementRealizationDual Aspect (Double entry System)Substance over formPrudenceConsistencyMatching (Accruals)Going concern

Business EntityMoney MeasurementRealizationDual Aspect (Double entry System)Substance over formPrudenceConsistencyMatching (Accruals)Going concern

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Important ConceptsImportant Concepts

4 concepts

as “Fundamental” ARE:

1.Going Concern

2.Consistency

3.Prudence

4.Accruals

4 concepts

as “Fundamental” ARE:

1.Going Concern

2.Consistency

3.Prudence

4.Accruals

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CASH VS ACCRUAL ACCOUNTINGCASH VS ACCRUAL ACCOUNTING

Cash AccountingRevenue is recorded when cash is received.Expense is recorded when cash is disbursed.

Very straightforward. Facts determine the timing of entries. Less room for judgment.

Accrual AccountingRevenue is recorded (recognized) when the revenue has been

earned. When the product or service has been provided to the customer,

regardless of when payment is received.Expenses are matchedmatched to the revenue that they helped to

earn, regardless of when payment is made.

Cash AccountingRevenue is recorded when cash is received.Expense is recorded when cash is disbursed.

Very straightforward. Facts determine the timing of entries. Less room for judgment.

Accrual AccountingRevenue is recorded (recognized) when the revenue has been

earned. When the product or service has been provided to the customer,

regardless of when payment is received.Expenses are matchedmatched to the revenue that they helped to

earn, regardless of when payment is made.

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The Accounting CycleThe Accounting Cycle

Process by which accountants prepare financial statements for an entity for a specific period of time

Process by which accountants prepare financial statements for an entity for a specific period of time

1212

Accounting Cycle Accounting Cycle

1.Analyze 1.Analyze TransactionsTransactions

1.Analyze 1.Analyze TransactionsTransactions

2. 2. JournalizeJournalize

2. 2. JournalizeJournalize 3. Post 3. Post 3. Post 3. Post

4. Unadjusted 4. Unadjusted trial balancetrial balance

4. Unadjusted 4. Unadjusted trial balancetrial balance

5. Adjust5. Adjust 5. Adjust5. Adjust

6. Adjusted 6. Adjusted trial balancetrial balance

6. Adjusted 6. Adjusted trial balancetrial balance

7. Close 7. Close AccountsAccounts

7. Close 7. Close AccountsAccounts

8. Prepare 8. Prepare Financial Financial

statementsstatements

8. Prepare 8. Prepare Financial Financial

statementsstatements

Start the Start the next cyclenext cycle

1313

Accounting CycleAccounting Cycle

Journalize Transaction

Post to Accounts

Adjust Accounts

Close Accounts

Prepare Financial Statements

1414

Fundamental Accounting EquationFundamental Accounting Equation

Assets = Liabilities + Owners’ EquityAssets = Liabilities + Owners’ Equity This equation is always in balance

In order for this equation to remain in balance, double-entry bookkeeping is employed.

→That is, the recording of every transaction or event must have at least two parts

Either an equal impact (increase or decrease) to both sides of the equation or equal and opposite impact to one side.

→The recording of every transaction must keep this equation in balance

Assets = Liabilities + Owners’ EquityAssets = Liabilities + Owners’ Equity This equation is always in balance

In order for this equation to remain in balance, double-entry bookkeeping is employed.

→That is, the recording of every transaction or event must have at least two parts

Either an equal impact (increase or decrease) to both sides of the equation or equal and opposite impact to one side.

→The recording of every transaction must keep this equation in balance

1515

Double Entry SystemDouble Entry System

All journal entries have two “sides”:Debit and Credit

For every journal entry, the total debits must equal the total credits

→This ensures that the fundamental accounting equation (A = L + OE) is always in balance.

The basic journal entry:Debit Account name1 PKR amount Credit Account name2 PKR amountTo record…

All journal entries have two “sides”:Debit and Credit

For every journal entry, the total debits must equal the total credits

→This ensures that the fundamental accounting equation (A = L + OE) is always in balance.

The basic journal entry:Debit Account name1 PKR amount Credit Account name2 PKR amountTo record…

1616

More DetailMore Detail

“Debit” and “Credit” are just accounting-speak for “increase” and “decrease” “Debit” means “increase” for some elements and

“decrease” for other elements. Likewise for “credit”.

→For example, a company pays its Rs 500 utility bill:In English: the company has incurred an expense (the amount of

expense has increased) and the amount of cash in the company has decreased.

An expense (Utilities) has increasedAn asset (Cash) has decreased

In Journal entry:Debit Utility expense Rs 500 Credit Cash Rs 500To record the payment of utility bill

“Debit” and “Credit” are just accounting-speak for “increase” and “decrease” “Debit” means “increase” for some elements and

“decrease” for other elements. Likewise for “credit”.

→For example, a company pays its Rs 500 utility bill:In English: the company has incurred an expense (the amount of

expense has increased) and the amount of cash in the company has decreased.

An expense (Utilities) has increasedAn asset (Cash) has decreased

In Journal entry:Debit Utility expense Rs 500 Credit Cash Rs 500To record the payment of utility bill

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2 Kinds of Entries2 Kinds of Entries

1. Transactional• The recording of an exchange with another entity

2. Adjusting• Required only when financial statements are

prepared to “adjust” accounts to where they should be

• Always include at least one Balance Sheet account and one Income Statement account.• e.g. Depreciation of capital assets, earning of interest

revenue.

1. Transactional• The recording of an exchange with another entity

2. Adjusting• Required only when financial statements are

prepared to “adjust” accounts to where they should be

• Always include at least one Balance Sheet account and one Income Statement account.• e.g. Depreciation of capital assets, earning of interest

revenue.

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The Basic Accounting Elements:


Asset Expense

Liability Revenue Owners’ Equity

1919

Basic Accounting Elements Basic Accounting Elements

Asset Has future benefit to the entity

Liability Obligation to transfer assets in the future

Owners’ Equity Owners’ interest in the company

Revenue Increase in economic resources resulting from normal

operations of the company

Expense Decrease in economic resources resulting from normal


Asset Has future benefit to the entity

Liability Obligation to transfer assets in the future

Owners’ Equity Owners’ interest in the company

Revenue Increase in economic resources resulting from normal


Expense Decrease in economic resources resulting from normal


2020



Balance Sheet Income StatementBalance Sheet/

Stmt of Retained Earnings

Debit Asset Expense

Credit Liability RevenueOwners’ Equity

2121

Going back to the Fundamental Accounting Equation:

Going back to the Fundamental Accounting Equation:

Assets =Assets = Liabilities Liabilities ++

Owners’ EquityOwners’ Equity

Debit Credit Credit

AssetsCurrent assets

Long-term assets

LiabilitiesCurrent liabilities

Long-term liabilities

Direct investmentCapital stock

Indirect investmentDividends (debit)

Retained earnings

Revenue (credit)

Expense (debit)

2222

General JournalGeneral Journal

What is the General Journal? It is the book of original entry.Transactions are written in a journal in

chronological order.The format of the journal is important.Journalizing is the process of entering

information as debits and credits to the correct accounts.

What is the General Journal? It is the book of original entry.Transactions are written in a journal in

chronological order.The format of the journal is important.Journalizing is the process of entering

information as debits and credits to the correct accounts.

2323

General LedgerGeneral Ledger

What is the General Ledger?It is the book of final entry.The information from the journal is

transferred to the ledger in the posting process.

Debits and credits in the journal remain exactly the same when posted to the accounts in the ledger.

What is the General Ledger?It is the book of final entry.The information from the journal is

transferred to the ledger in the posting process.

Debits and credits in the journal remain exactly the same when posted to the accounts in the ledger.

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MORE DETAILMORE DETAIL

So far we have discussed the major concepts involves in the accounting cycle: Analyzing Recording Posting Unadjusted Trial Balance Adjusting Adjusted Trial Balance

So far we have discussed the major concepts involves in the accounting cycle: Analyzing Recording Posting Unadjusted Trial Balance Adjusting Adjusted Trial Balance

BE BE PRACTICAPRACTICA

L L NOWNOW

2525

What are on the Worksheet? What are on the Worksheet?

A Worksheet includes following columns: Unadjusted trial balance. Adjusting entries Adjusted trial balance. Income statement Balance sheet

Worksheet can be used to simplify the preparation of financial statements.

Used to help move data from the trial balance to the financial statements

An internal document – not financial statement

A Worksheet includes following columns: Unadjusted trial balance. Adjusting entries Adjusted trial balance. Income statement Balance sheet

Worksheet can be used to simplify the preparation of financial statements.

Used to help move data from the trial balance to the financial statements

An internal document – not financial statement

2626

A Blank WorksheetA Blank Worksheet

2727

Steps in preparation of the worksheetSteps in preparation of the worksheet

AccountDr Cr Dr Cr Dr Cr Dr Cr Dr Cr

Cash 171000

Short-term investment 100000

Accounts Receivable 36000

Interest receivable

Prepaid Expense 20000

Inventory 20000

Plant and Equipmemt 250000

Accumulated Depreciation

Accounts Payable 50000

Wages payable

Unearned Revenue 50000

Paid Capital 500000

Sales Revenue 36000

Interest Revenue

Cost of Sales 30000

Operating expenses 9000

total 636000 636000

Smith Inc.Work Sheet

For Year ended Dec.31 2004

Balance Sheet andStatement of Owner's

Equity

Unadjusted TrialBalance

Adjustments Adjusted Trial

Balance Income Statement


Cash 171000



Interest receivable

Prepaid Expense 20000

Inventory 20000


Accumulated Depreciation


Wages payable

Unearned Revenue 50000

Paid Capital 500000

Sales Revenue 36000

Interest Revenue

Cost of Sales 30000

Operating expenses 9000

total 636000 636000




Equity




Step 1:Step 1:Enter the Enter the

accounts and accounts and unadjusted unadjusted trial balancetrial balance

Step 1:Step 1:Enter the Enter the

accounts and accounts and unadjusted unadjusted trial balancetrial balance

2828



Cash 171000



Interest receivable 2916.67

Prepaid Expense 20000 10000

Inventory 20000


Accumulated Depreciation 2600


Wages payable 35000

Unearned Revenue 50000 25000.00

Paid Capital 500000

Sales Revenue 36000 25000

Interest Revenue 2916.67

Cost of Sales 30000

Operating expenses 9000 47600.00

total 636000 636000 75516.67 75516.67




Equity





Cash 171000



Interest receivable 2916.67

Prepaid Expense 20000 10000

Inventory 20000


Accumulated Depreciation 2600


Wages payable 35000

Unearned Revenue 50000 25000.00

Paid Capital 500000

Sales Revenue 36000 25000

Interest Revenue 2916.67

Cost of Sales 30000

Operating expenses 9000 47600.00

total 636000 636000 75516.67 75516.67




Equity




Step2:Step2:Entry the Entry the adjusting adjusting entries’entries’

Step2:Step2:Entry the Entry the adjusting adjusting entries’entries’

2929



Cash 171000 171000Short-term investment 100000 100000Accounts Receivable 36000 36000

Interest receivable 2916.67 2916. 67

Prepaid Expense 20000 10000 10000

Inventory 20000 20000

Plant and Equipmemt 250000 250000

Accumulated Depreciation 2600 2600

Accounts Payable 50000 50000

Wages payable 35000 35000

Unearned Revenue 50000 25000.00 25000. 00

Paid Capital 500000 500000

Sales Revenue 36000 25000 61000

Interest Revenue 2916.67 2916. 67

Cost of Sales 30000 30000

Operating expenses 9000 47600.00 56600. 00

total 636000 636000 75516.67 75516.67 676516. 67 676516. 67


For Year ended Dec.31 2004 Balance Sheet and

Statement of Owner's Unadjusted Trial

BalanceAdjustments

Adjusted TrialBalance

Income StatementAccountDr Cr Dr Cr Dr Cr Dr Cr Dr Cr

Cash 171000 171000Short-term investment 100000 100000Accounts Receivable 36000 36000










Sales Revenue 36000 25000 61000

Interest Revenue 2916.67 2916. 67

Cost of Sales 30000 30000

Operating expenses 9000 47600.00 56600. 00

total 636000 636000 75516.67 75516.67 676516. 67 676516. 67




BalanceAdjustments


Income Statement

Step3:Step3:Entry the Entry the adjusted adjusted

trial balancetrial balance

Step3:Step3:Entry the Entry the adjusted adjusted

trial balancetrial balance

3030



Cash 171000 171000

Short-term investment 100000 100000

Accounts Receivable 36000 36000










Sales Revenue 36000 25000 61000 61,000

Interest Revenue 2916.67 2916. 67 2,917

Cost of Sales 30000 30000 30,000

Operating expenses 9000 47600.00 56600. 00 56,600

total 636000 636000 75516.67 75516.67 676516. 67 676516. 67 86,600 63,917

Net Income (22,683)




BalanceAdjustments


Income StatementAccountDr Cr Dr Cr Dr Cr Dr Cr Dr Cr

Cash 171000 171000

Short-term investment 100000 100000

Accounts Receivable 36000 36000










Sales Revenue 36000 25000 61000 61,000

Interest Revenue 2916.67 2916. 67 2,917

Cost of Sales 30000 30000 30,000

Operating expenses 9000 47600.00 56600. 00 56,600

total 636000 636000 75516.67 75516.67 676516. 67 676516. 67 86,600 63,917

Net Income (22,683)




BalanceAdjustments


Income Statement

Step4:Step4:Entry Adjusted Entry Adjusted

Amounts to Amounts to Income Statement Income Statement

ColumnsColumns


Amounts to Amounts to Income Statement Income Statement

ColumnsColumns

3131



Amounts to Amounts to Balance sheet Balance sheet

ColumnsColumns


Amounts to Amounts to Balance sheet Balance sheet

ColumnsColumns

3232

Closing ProcessClosing Process

The closing process occurs at the end of an accounting period after financial statements are prepared.

Reasons for closing entries: Resets revenue and expense account balances

to zero at the end of the period. Updates the retained earnings account to

reflect net income and distributions.

The closing process occurs at the end of an accounting period after financial statements are prepared.

Reasons for closing entries: Resets revenue and expense account balances

to zero at the end of the period. Updates the retained earnings account to

reflect net income and distributions.

3333

Temporary and Permanent AccountsTemporary and Permanent Accounts

Temporary accounts are also called nominal accounts. They are opened at the beginning of a period, used to record events for that period and closed at the end of the period. They accumulate data related to one accounting period only.

Temporary accounts are also called nominal accounts. They are opened at the beginning of a period, used to record events for that period and closed at the end of the period. They accumulate data related to one accounting period only.

3434

Temporary AccountsTemporary Accounts

Income Income SummarySummary

Rev

enu

esR

even

ues

Exp

ense

sE

xpen

ses

The closing process The closing process applies only to applies only to

temporary accounts.temporary accounts.

The closing process The closing process applies only to applies only to

temporary accounts.temporary accounts.

3535

Permanent AccountsPermanent Accounts

Permanent Permanent AccountsAccounts

AssetsAssets

LiabilitiesLiabilities Owner’s Owner’s CapitalCapital

The closing process does The closing process does not apply to permanent not apply to permanent

accounts.accounts.

The closing process does The closing process does not apply to permanent not apply to permanent

accounts.accounts.

3636

Steps in the Closing ProcessSteps in the Closing Process

Set an Income Summary account. Close Revenue accounts to Income

Summary. Close Expense accounts to Income

Summary. Close Income Summary account to

Retained Earnings

Set an Income Summary account. Close Revenue accounts to Income

Summary. Close Expense accounts to Income

Summary. Close Income Summary account to

Retained Earnings

3737

Close Revenue Accounts to Income Summary

Close Revenue Accounts to Income Summary

Income Summary63,917

63,917

Income Summary63,917

63,917

…61,000 61,000

Sales Revenue…

61,000 61,000

Sales Revenue

2,917 2,917

-

Interest Revenue2,917 2,917

-

Interest RevenueThe entries :

Dr. Sales Revenue 61000 Interest Revenue 2917 Cr. Income Summary 63917

The entries :

Dr. Sales Revenue 61000 Interest Revenue 2917 Cr. Income Summary 63917

3838

Close Expense Accounts to Income Summary

Close Expense Accounts to Income Summary

…30,000 30,000

-

Cost of Sales…

30,000 30,000 -

Cost of Sales

Income Summary86,600 63,917

(22,683)


(22,683)

The entries:Dr. Income 86600 Cr. Cost of Sales 30000 Operating Expense 56600

The entries:Dr. Income 86600 Cr. Cost of Sales 30000 Operating Expense 56600

…56,600 56,600

-

Operating Expense…

56,600 56,600 -

Operating Expense

3939

Close Income Summary to Retained Earnings

Close Income Summary to Retained Earnings

Retained Earnings…

(22,683)

Retained Earnings…

(22,683)


(22,683)

(22,683) -


(22,683)

(22,683) - The Entries:

Dr. Income Summary 22683 Cr. Retained Earnings 22683

The Entries:

Dr. Income Summary 22683 Cr. Retained Earnings 22683

4040

The Closing EntriesThe Closing Entries

Close Revenue Accounts to Income Summary.

The entries are:

Dr. All Revenue

Cr. Income Summary

Close Revenue Accounts to Income Summary.

The entries are:

Dr. All Revenue

Cr. Income Summary

4141


Close Expense Accounts to Income Summary.The entries are:Dr. Income Summary Cr. All Expenses

Close Expense Accounts to Income Summary.The entries are:Dr. Income Summary Cr. All Expenses

4242


Close Income Summary account to Retained Earnings.

If there is a profit, the entries are:Dr. Income Summary Cr. Retained Earnings

If there is a loss, the entries are:Dr. Retained Earnings Cr. Income Summary

Close Income Summary account to Retained Earnings.

If there is a profit, the entries are:Dr. Income Summary Cr. Retained Earnings

If there is a loss, the entries are:Dr. Retained Earnings Cr. Income Summary

4343

Post-Closing Trial BalancePost-Closing Trial Balance

Post-Closing Trial Balance is a list of balances for all accounts that not closed.

The purpose of a post-closing trial balance is to verifies that: Total debits = total credits for permanent

accounts. All temporary accounts have zero balances

Post-Closing Trial Balance is a list of balances for all accounts that not closed.

The purpose of a post-closing trial balance is to verifies that: Total debits = total credits for permanent

accounts. All temporary accounts have zero balances

4444

Post-Closing Trial BalancePost-Closing Trial Balance

Account

Dr Cr

Cash 171000Short-term investment 100000Accounts Receivable 36000Interest receivable 2916. 67Prepaid Expense 10000Inventory 20000Plant and Equipmemt 250000Accumulated Depreciation 2600Accounts Payable 50000Wages payable 35000Unearned Revenue 25000Paid Capital 500000Retained Earnings (22683)Sales Revenue

Interest Revenue

Cost of Sales

Operating expenses

total 589,917 589,917

Smith Inc.

Post-Closing Trial Balance


Balance SheetAccount

Dr Cr

Cash 171000Short-term investment 100000Accounts Receivable 36000Interest receivable 2916. 67Prepaid Expense 10000Inventory 20000Plant and Equipmemt 250000Accumulated Depreciation 2600Accounts Payable 50000Wages payable 35000Unearned Revenue 25000Paid Capital 500000Retained Earnings (22683)Sales Revenue

Interest Revenue

Cost of Sales

Operating expenses

total 589,917 589,917

Smith Inc.

Post-Closing Trial Balance


Balance Sheet

4545

Preparing the Financial StatementsPreparing the Financial Statements

Financial Statements can be prepared easily using the completed worksheet.

Financial Statements can be prepared easily using the completed worksheet.

4646

Financial StatementsFinancial Statements

There are 4 statements in a standard set of financial statements1. Balance Sheet

→ The “what do we have?” statement→ Shows what the entity owns and owes (the difference being the

owners’ residual interest)

2. Income Statement→ The “what did we do?” statement→ Shows the activity the entity undertook in its normal course of

operations.

3. Statement of Retained Earnings→ Shows the changes in Retained earnings in the year

Often shown at the bottom of the Income Statement

4. Statement of Cash Flows→ Shows the sources and uses of cash in the year

Information is derived from the B/S and I/S and other

There are 4 statements in a standard set of financial statements1. Balance Sheet

→ The “what do we have?” statement→ Shows what the entity owns and owes (the difference being the

owners’ residual interest)

2. Income Statement→ The “what did we do?” statement→ Shows the activity the entity undertook in its normal course of

operations.

3. Statement of Retained Earnings→ Shows the changes in Retained earnings in the year

Often shown at the bottom of the Income Statement

4. Statement of Cash Flows→ Shows the sources and uses of cash in the year

Information is derived from the B/S and I/S and other

4747

The Classified Balance SheetThe Classified Balance Sheet

Debit sideCurrent assetsLong-term assets

Credit side Current liabilities

Long-term liabilities

The END But Knowledge has No

END

The END But Knowledge has No

END

Economy & Finance

Acctg fundamentals