BUS505 (Accounting Principles) Course Notes

BUS505 Course Notes
Course Name: Accounting Principles

Section: 1
Faculty: FJM
Semester: Summer 2023
Contents
Chapter 1: Accounting in Action ................................................................................................. 4

Accounting and Bookkeeping ..................................................................................................... 4
Users of Accounting Data ........................................................................................................... 4
Ethics in Accounting ................................................................................................................... 4
GAAP .......................................................................................................................................... 4
Measurement Principles .............................................................................................................. 5
Assumptions ................................................................................................................................ 5
Types of Businesses .................................................................................................................... 5
The Accounting Equation ............................................................................................................ 5
Transactions................................................................................................................................. 6
Effect of Transactions on the Accounting Equation .................................................................... 6
Financial Statements ................................................................................................................... 8
Exercise ..................................................................................................................................... 10
Chapter 2: The Recording Process ............................................................................................ 13
Debits and Credits ..................................................................................................................... 13
General Journal ......................................................................................................................... 14
Ledger Accounts ........................................................................................................................ 14
Trial Balance ............................................................................................................................. 15
Exercises.................................................................................................................................... 16
Chapter 3: Adjusting the Accounts ........................................................................................... 24
Fiscal and Calendar Years ......................................................................................................... 24
Accrual-Basis and Cash-Basis Accounting ............................................................................... 24
Recognizing Revenues and Expenses ....................................................................................... 24
Adjusting Entries ....................................................................................................................... 25
Examples of Adjusting Prepaid Expenses ................................................................................. 26
Example of Adjusting Unearned Revenues ............................................................................... 27
Example of Adjusting Accrued Revenues ................................................................................. 27
Examples of Adjusting Accrued Expenses ................................................................................ 27
Journalizing the Adjusting Entries ............................................................................................ 28
General Ledger with Adjustments ............................................................................................. 29
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The Adjusted Trial Balance ....................................................................................................... 32
Exercises.................................................................................................................................... 33
Chapter 4: Closing the Books .................................................................................................... 36
Closing the Accounting Books .................................................................................................. 36
Steps for Closing Entries ........................................................................................................... 36
Journalizing the Closing Entries ............................................................................................... 37
Posting the Closing Entries ....................................................................................................... 37
Post-Closing Trial Balance ........................................................................................................ 39
Exercise ..................................................................................................................................... 40
Chapter 5: Accounting for Merchandising Operations ........................................................... 49
Merchandising Businesses ........................................................................................................ 49
Inventory ................................................................................................................................... 49
Recording Purchases ................................................................................................................. 50
Freight Costs ............................................................................................................................. 50
Purchase Returns and Allowances............................................................................................. 51
Purchase Discounts ................................................................................................................... 51
Recording Purchase Discounts .................................................................................................. 52
Summary of Purchases .............................................................................................................. 52
Recording Sales ......................................................................................................................... 53
Sales Returns and Allowances................................................................................................... 54
Sales Discounts ......................................................................................................................... 55
Exercise ..................................................................................................................................... 55
Chapter 6: Inventory Valuation ................................................................................................. 58
Cost Flow Assumption .............................................................................................................. 58
Example of FIFO ....................................................................................................................... 58
Example of LIFO ...................................................................................................................... 61
Example of Moving Average Method ....................................................................................... 63
Chapter 7: Depreciation ............................................................................................................. 66
Plant Assets ............................................................................................................................... 66
Depreciation .............................................................................................................................. 66
Example of Straight-Line Method............................................................................................. 67
Example of Declining-Balance Method .................................................................................... 68
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Example of Units-of-Activity Method ...................................................................................... 70
Sale of Plant Assets ................................................................................................................... 71
Retirement of Plant Assets ........................................................................................................ 73
Determining the Cost of Land ................................................................................................... 73
Exercises.................................................................................................................................... 74
Chapter 8: Statement of Cash Flows ......................................................................................... 79
Classification of Cash Flows ..................................................................................................... 79
Preparation of the Statement of Cash Flows ............................................................................. 79
Format of the Statement of Cash Flows .................................................................................... 80
Example of a Statement of Cash Flows .................................................................................... 81
3
Chapter 1: Accounting in Action
Accounting and Bookkeeping

Accounting is the information system which identifies, records, and communicates the economic
events of a business to interested users. The process of recording the business’s economic events
is called bookkeeping.
Users of Accounting Data

The people or entities who use the accounting information of a business can be broadly divided
into the following two categories:
1. Internal users – These are the people who work within a business organization, such as
managers and supervisors.
2. External users – These are the individuals and organizations outside a business, such as
investors and creditors.
Ethics in Accounting
Ethics are standards of conduct by which actions are judged as right or wrong, honest or dishonest,
and fair or unfair. Good ethical behavior in a business is essential in order to ensure effective
financial reporting.
GAAP
There are certain standards in accounting that are generally accepted and practiced universally.
This set of standards is known as the Generally Accepted Accounting Principles (GAAP).
Some well-known organizations that are involved in setting accounting standards are as follows:
1. Financial Accounting Standards Board (FASB) – This is the main organization which sets
accounting standards in the United States.
2. Securities and Exchange Commission (SEC) – This is an agency of the U.S. government. It
oversees the financial markets and accounting standard-setting organizations in the U.S. The
SEC depends on the FASB to develop accounting standards, which must be followed by public
companies.
3. International Accounting Standards Board (IASB) – This organization sets accounting

standards that are followed by many countries other than the U.S. The standards set by this
organization are called the International Financial Reporting Standards (IFRS).
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Measurement Principles
1. Historical cost principle – Also known as the cost principle, this states that businesses should
record assets at their original cost, i.e., the assets’ price at the time of their purchase.
2. Fair value principle – This states that assets and liabilities should be reported at fair value,
i.e., the amount which was received to sell an asset or settle a liability.
Assumptions
1. Monetary unit assumption – Businesses should only record the accounting information
which can be expressed in terms of money.
2. Economic entity assumption – The activities of a business should be separate from the
activities of its owner and other economic activities.
Types of Businesses
Proprietorship Partnership Corporation
1. Generally owned by one 1. Owned by two or more 1. Ownership is divided into
person. individuals. shares of stock.
2. Usually offers small types 2. Usually involved in 2. It is a separate legal entity

of services, e.g., retailing and offering from its owners.
plumbing, beauty salon, services, e.g., lawyers,
repair shops. doctors, architects. 3. Limited liability –
stockholders are not
3. The owner receives all the 3. A partnership agreement personally liable for
profit, incurs all losses, states terms like initial paying all the debts of the
and is personally liable investments and duties of business.
for all debts. each partner.
The Accounting Equation

The basic equation of accounting is: Assets = Liabilities + Owner’s Equity.
1. Assets – These are the resources that are owned by a business, such as buildings and equipment
like machinery.
2. Liabilities – These are the debts and other finances that are owed by a business, e.g., accounts
payable (finance owed by a business to its creditors, such as suppliers), salaries and wages
payable to employees. (Any account which has the word “payable” is a liability.)
3. Owner’s equity – This refers to the resources of a business that are claimed by its owner. It is
also known as “residual equity.”
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• Increase in owner’s equity – The value of owner’s equity rises due to finance which is
invested by a business’s owner, as well as revenues earned through different business
activities.
• Decrease in owner’s equity – The value of owner’s equity falls because of the following:
i. Drawings – These are the finance or other resources that are withdrawn from a business
by its owner for personal use.
ii. Expenses – These are the costs of using assets or services that are incurred in order to
earn revenues, e.g., cost of raw materials, wages and salaries, utilities, rent, interest.
 Assets = Liabilities + Owner’s Equity
 Assets = Liabilities + (Owner’s Capital + Revenues – Expenses – Owner’s Drawings)
Transactions
A transaction is an economic event of a business which is recorded by accountants. Transactions
always have a dual effect on the accounting equation. For example, an increase in an asset must
cause either a corresponding increase in another asset or liability.
If a particular business activity does not affect the components of the accounting equation, then it
is not a transaction. Some examples of such activities are hiring employees, replying to emails,
and ordering raw materials to be delivered. These activities are not recorded in the accounting
books of a business.
Effect of Transactions on the Accounting Equation

1. Ray Neal starts a smartphone app development company which he names Softbyte. On
September 1, 2022, he invests $15,000 cash in the business.
2. Softbyte purchases computer equipment for $7,000 cash.
3. Softbyte purchases headsets and other computer accessories for $1,600 from Mobile Solutions.
Mobile Solutions agrees to allow Softbyte to pay this bill in October.
4. Softbyte receives $1,200 cash from customers for app development services it has performed.
5. Softbyte receives a bill for $250 from the Daily News for advertising on its online website but
postpones payment until a later date.
6. Softbyte performs $3,500 of app development services for customers. The company receives
cash of $1,500 from customers, and it bills the balance of $2,000 on account.
7. Softbyte pays the following expenses in cash for September: office rent $600, salaries and
wages of employees $900, and utilities $200.
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8. Softbyte pays its $250 Daily News bill in cash.
9. Softbyte receives $600 in cash from customers who had been billed for services.
10. Ray Neal withdraws $1,300 in cash from the business for his personal use.
The effects of these transactions are shown below in tabular form. The total value of assets is equal
to the sum of liabilities and owner’s equity.
Owner’s
Assets = Liabilities + Equity
Accounts Accounts Owner’s
Cash + Receivable + Supplies + Equipment = Payable + Capital
1. $15000 $15000 Investment
2. (7000) $7000
3. $1600 $1600
4. 1200 1200 Revenue
5. 250 (250) Expense
6. 1500 $2000 3500 Revenue
7. (600) (600) Expense
(900) (900) Expense
(200) (200) Expense
8. (250) (250)
9. 600 (600)
10. (1300) (1300) Drawings
$8050 + $1400 + $1600 + $7000 = $1600 + $16450
Here, total assets = $(8050+1400+1600+7000) = $18050,
total liabilities and equity = $(1600+16450) = $18050.
 Assets = Liabilities + Owner’s Equity = $18050.
[Notes:
• If a business charges its customer “on account,” then it means that the customer can make the
payment at a later date. In this case, that customer becomes a debtor for the business, which is
called account receivable in accounting. The amount of account receivable is an asset for the
business, because it is owed finance by its debtor.
• In any financial report or document, the currency of the monetary values (e.g., $/₤) is shown
only for the first item in a column and the total value of that column.
• To indicate that an amount is subtracted from a previous value, it is written inside parentheses.
• A single line is placed below the last item in a column of values.
• A double underline is used for the total value of a column to indicate that it is the total value.]
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Financial Statements
Businesses prepare financial statements after recording transactions in their accounting books. A
financial statement is a record of the financial activities and performance of a business
organization. Three of the main financial statements are as follows:
1. Income statement – This shows the profitability of a business. It contains the revenues and
expenses for a period of time, as well as the resulting profit or loss for that period. An income
statement is also known as a “profit and loss statement.”
2. Owner’s equity statement – This is a summary of the changes in owner’s equity for a specific
period of time. It shows the reasons why the value of owner’s equity increased or decreased
during that period.
3. Balance sheet – This shows the assets, liabilities, and owner’s equity at a specific date. It
represents the financial condition of a business at a specific moment of time.
The income statement of Softbyte’s transactions which were previously listed is as follows:
Softbyte
Income Statement
For the Month Ended September 30, 2022
Revenues
Service revenue (1200+3500) $4700
Less: Expenses
Advertising expense $250
Office rent expense 600
Salaries and wages expense 900
Utilities expense 200
(1950)
Net income $2750
➢ “For the Month Ended” indicates that the income statement was created at the end of the month
of September.
➢ The total value of expenses is subtracted from the total value of revenues.
➢ If the total value of revenues is greater than the total value of expenses, then the result is a net
income. However, if the total value of expenses is greater than the total value of revenues, then
the result is a net loss. The amount of net loss is written inside parentheses to indicate that it is
a negative value.
The owner’s equity statement of Softbyte is shown in the next page:
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Softbyte
Owner’s Equity Statement
For the Month Ended September 30, 2022
Owner’s capital, September 1 $0
Add: Investments $15000
Net income 2750
17750
17750
Less: Drawings (1300)
Owner’s capital, September 30 $16450
➢ The value of “Owner’s capital, September 1” is the opening balance for the Owner’s Capital
account of Softbyte. The opening balance is the amount at the beginning of an accounting
period, which is September 1 in this case. The amount is 0 because the business did not have
any capital as it had just started.
➢ The value of “Investments” is the amount of capital which was invested into Softbyte by its
owner. It is added with the opening balance of the Owner’s Capital account.
➢ The value of net income is also added with the opening balance of the Owner’s Capital account.
The amount is obtained from the income statement.
➢ If there are any drawings, then it is subtracted from the total value of the opening balance of
owner’s capital and investments.
➢ If there is a net loss, then it is not added. Rather, it is subtracted from the total value of the
opening balance of owner’s capital and investments along with drawings.
➢ The value of “Owner’s capital, September 30” is the closing balance for the Owner’s Capital
account of Softbyte. The closing balance is the amount at the end of an accounting period,
which is September 30 in this case. This closing balance will be the opening balance of the
next accounting period, i.e., October.
The balance sheet of Softbyte is shown in the next page:
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Softbyte
Balance Sheet
September 30, 2022
Assets
Cash $8050
Accounts receivable 1400
Supplies 1600
Equipment 7000
Total assets $18050
Liabilities and Owner’s Equity
Liabilities:
Accounts payable $1600
Owner’s equity:
Owner’s capital 16450
Total liabilities and owner’s equity $18050
➢ The balance sheet shows the financial condition of a business at a specific moment of time. In
this case, the balance sheet of Softbyte shows its financial position on September 30, 2022.
This date is written in the top of the balance sheet.
➢ The value of owner’s capital is obtained from the owner’s equity statement. It is the closing
balance for the Owner’s Capital account.
➢ The total value of liabilities and owner’s equity must be equal to the total value of assets. If the
two values are not equal, then it means that an error has been made.
Exercise
Question: Joan Robinson opens her own law office on July 1, 2017. During the first month of
operations, the following transactions occurred.
1. Joan invested $11,000 in cash in the law practice.
2. Paid $800 for July rent on office space.
3. Purchased equipment on account $3,000.
4. Performed legal services to clients for cash $1,500.
5. Borrowed $700 cash from a bank on a note payable.
6. Performed legal services for client on account $2,000.
7. Paid monthly expenses: salaries and wages $500, utilities $300, and advertising $100.
8. Joan withdrew $1,000 cash for personal use.
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Instructions:
a. Prepare a tabular summary of the transactions.
b. Prepare the income statement, owner’s equity statement, and balance sheet at July 31, 2017,
for Joan Robinson, Attorney.
Solution:
a.
Owner’s
Assets = Liabilities + Equity
Accounts Accounts Owner’s
Cash + Receivable + Equipment = Payable + Capital
1. $11000 $11000 Investment
2. (800) (800) Expense
3. $3000 $3000
4. 1500 1500 Revenue
5. 700 700
6. $2000 2000 Revenue
7. (500) (500) Expense
(300) (300) Expense
(100) (100) Expense
8. (1000) (1000) Drawings
$10500 + $2000 + $3000 = $3700 + $11800
Here, total assets = $(10500+2000+3000) = $15500,
total liabilities and equity = $(3700+11800) = $15500.
 Assets = Liabilities + Owner’s Equity = $15500.
b.
Joan Robinson
Income Statement
For the Month Ended July 31, 2017
Revenues
Service revenue $3500
Less: Expenses
Office rent expense $800
Salaries and wages expense 500
Utilities expense 300
Advertising expense 100
(1700)
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Net income $1800
Joan Robinson
Owner’s Equity Statement
For the Month Ended July 31, 2017
Owner’s capital, July 1 $0
Add: Investments $11000
Net income 1800
12800
12800
Less: Drawings (1000)
Owner’s capital, July 31 $11800
Joan Robinson
Balance Sheet
July 31, 2017
Assets
Cash $10500
Accounts receivable 2000
Equipment 3000
Total assets $15500
Liabilities and Owner’s Equity
Liabilities:
Accounts payable $3700
Owner’s equity:
Owner’s capital 11800
Total liabilities and owner’s equity $15500
Workings:
Service revenue = $(1500+2000) = $3500
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Chapter 2: The Recording Process
Debits and Credits

The entries made in the accounting books are mainly of two types – debit (Dr.) and credit (Cr.).
The act of making a debit entry is called debiting, whereas the act of making a credit entry is called
crediting.
Each transaction affects two or more accounts. There is a credit entry for every debit entry. This is
why the system of recording transactions in a business’s accounting books is called the double-
entry system.
The following are the rules of debiting and crediting the main types of accounts:
1. a) If an asset account increases, then it is debited.
b) If an asset account decreases, then it is credited.
2. a) If a liability account increases, then it is credited.
b) If a liability account decreases, then it is debited.
3. a) If the owner’s capital account increases, then it is credited.
b) If the owner’s capital account decreases, then it is debited.
4. a) If the owner’s drawings account increases, then it is debited.
b) If the owner’s drawings account decreases, then it is credited.
5. a) If an expense account increases, then it is debited.
b) If an expense account decreases, then it is credited.
6. a) If a revenue account increases, then it is credited.
b) If a revenue account decreases, then it is debited.
Asset, expense, and the owner’s drawings accounts have debit balances, i.e., the total value of
their debit entries is greater than the total value of their credit entries. In contrast, liability, revenue,
and the owner’s capital accounts have credit balances, i.e., the total value of their credit entries is
greater than the total value of their debit entries.
In an account, the type of entry which is made to show an increase is called a normal balance.
For instance, the normal balance of an expense account is a debit, because making a debit entry
shows that it has increased. Similarly, the normal balance of a liability account is a credit, because
making a credit entry shows that it has increased.
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General Journal
A journal is an accounting book in which transactions are recorded initially. It is also called a
book of original entry. The transactions can be found in business documents such as sales receipts,
checks, and bills, which are then recorded in the journal.
There are different types of journals and the most basic type is called the “general journal.” Its
format is as follows:
GENERAL JOURNAL
Date Accounts Debit Credit
Year
Month & Day Name of account to be debited. ###
Name of account to be credited. ###
The act of recording transactions in a journal is called journalizing. Separate journal entries are
made for each transaction.
The advantages of using a journal are as follows:
1. It shows the complete effects of a transaction.
2. It provides a record of a business’s transactions in chronological order.
3. It helps to either prevent or locate errors, because the debit and credit entries for each
transaction can be compared easily.
Ledger Accounts
An account is a record of the increase or decrease in the value of a specific accounting item, such
as an asset, liability or owner’s equity. The whole group of accounts that are maintained by a
business is called a ledger. There are different types of ledgers but every business uses one specific
type of ledger, which is called the “general ledger.” A general ledger is a ledger which contains all
the asset, liability, and owner’s equity accounts of a business.
General Ledger
Asset Accounts Liability Accounts Owner’s Equity Accounts
Land Accounts payable Owner’s capital
Equipment Interest payable Owner’s drawings
Buildings Salaries and Salaries and

wages payable wages expense
Cash
Service revenue
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The format of a ledger account is as follows:
Name of the Account

Date Debit Credit Balance
Year
Month & Day ### ### ###
➢ This format is called the “three-column form of account.”
➢ The value in the “Balance” column is obtained by adding or subtracting the debit and credit
entries, depending on the type of account.
➢ The last value in the “Balance” column shows the total balance of the account at the end of the
accounting period.
➢ The act of transferring journal entries to the ledger accounts is called posting.
Trial Balance
A trial balance is a list of accounts and their balances on a specific date. It is usually prepared by
a business at the end of its accounting period. The purpose of the trial balance is to show that the
total value of all debit entries is equal to the total value of all credit entries.
The format of a trial balance is as follows:
Name of the Owner/Business

Trial Balance
Full Date
Debit Credit
Assets ###
Liabilities ###
Owner’s Capital ###
Owner’s Drawings ###
Revenues ###
Expenses ###
#### ####
➢ The accounts in a trial balance should be written in the order shown above.
➢ The normal balance of each account determines whether its total value will appear in the
“Debit” or “Credit” column.
➢ The total value of all debit entries must be equal to the total value of all credit entries.
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A trial balance has certain limitations. Although the total value of all debit and credit entries might
be equal, there can still be some errors. The total value of debit and credit entries can be equal even
if the following mistakes are made:
1. A transaction is not journalized.
2. A correct journal entry is not posted.
3. A journal entry is posted twice.
4. Wrong accounts are used in journalizing or posting.
5. Offsetting errors are made when the amount of a transaction is recorded.
Therefore, a trial balance does not prove that a business has recorded all transactions, or that the
ledger is correct.
Exercises
Question 1: C. R. Byrd opens an advertising company called Pioneer Advertising on October 1,
2022. During the first month of operations, the following transactions occurred:
Oct. 1 The owner invests $10,000 cash into the business.

1 Pioneer purchases office equipment costing $5,000 by signing a 3-month, 12% note
payable.
2 Pioneer receives a $1,200 cash advance from R. Knox, a client, for advertising
services that are expected to be completed by December 31.
3 Pioneer pays office rent for October in cash, $900.
4 Pioneer pays $600 for a one-year insurance policy that will expire next year on
September 30.
5 Pioneer purchases an estimated 3-month supply of advertising materials on account
from Aero Supply for $2,500.
9 Pioneer hires four employees to begin work on October 15. Each employee is to
receive a weekly salary of $500 for a 5-day work week, payable every 2 weeks – first
payment made on October 26.
20 Pioneer receives $10,000 in cash from Copa Company for advertising services
performed in October.
26 Pioneer owes employee salaries of $4,000 and pays them in cash.
31 C. R. Byrd withdraws $500 cash for personal use.
Instructions:
a. Journalize the October transactions.
b. Open ledger accounts and post the October transactions.
c. Prepare a trial balance on October 31, 2022.
16
Solution:
a.
GENERAL JOURNAL
2022
Oct. 1 Cash 10000
Owner’s Capital 10000
1 Equipment 5000
Notes Payable 5000
2 Cash 1200
Unearned Service Revenue 1200
3 Rent Expense 900
Cash 900
4 Prepaid Insurance 600
Cash 600
5 Supplies 2500
Accounts Payable 2500
20 Cash 10000
Service Revenue 10000
26 Salaries and Wages Expense 4000
Cash 4000
31 Owner’s Drawings 500
Cash 500
[Notes:
• If finance or other resources are invested into a business by its owner, then it is credited in the
account named “Owner’s Capital.”
• If a business receives a payment for a service in advance, then the amount is treated as a
liability. This is because the business has an obligation to perform that service in future. It is
credited in the account named “Unearned Service Revenue.”
• If the payment of an expense will provide benefits to a business for more than one accounting
period, then it is treated as a prepaid expense/prepayment. A prepaid expense is an asset.
• Drawings are debited in the account named “Owner’s Drawings.”
• When a business receives a payment for a service it has performed, the amount is treated as a
revenue. It is credited in the account named “Service Revenue.”]
17
b.
General Ledger
Cash
2022
Oct. 1 10000 10000
2 1200 11200
3 900 10300
4 600 9700
20 10000 19700
26 4000 15700
31 500 15200
Owner’s Capital
2022
Oct. 1 10000 10000
Equipment
2022
Oct. 1 5000 5000
Notes Payable
2022
Oct. 1 5000 5000
Unearned Service Revenue

2022
Oct. 2 1200 1200
Rent Expense
2022
Oct. 3 900 900
18
Prepaid Insurance
2022
Oct. 4 600 600
Supplies
2022
Oct. 5 2500 2500
Accounts Payable
2022
Oct. 5 2500 2500
Service Revenue
2022
Oct. 20 10000 10000
Salaries and Wages Expense

2022
Oct. 26 4000 4000
Owner’s Drawings
2022
Oct. 31 500 500
[Note: The currency of the monetary values is not shown in a journal and ledger accounts. It is
usually shown in the trial balance and financial statements.]
c.
Pioneer Advertising
Trial Balance
October 31, 2022
Debit Credit
Cash $15200
Supplies 2500
Prepaid Insurance 600
19
Equipment 5000
Notes Payable $5000
Owner’s Drawings 500
Salaries and Wages Expense 4000
Rent Expense 900
$28700 $28700
Question 2: Bob Sample opened the Campus Laundromat on September 1, 2022. During the first
month of operations, the following transactions occurred:
Sept. 1 Bob invested $20,000 cash in the business.

2 The company paid $1,000 cash for store rent for 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 a one-year accident insurance policy.
10 Received a bill from the Daily News for online advertising of the opening of the
laundromat $200.
20 Bob withdrew $700 cash for personal use.
30 The company determined that cash receipts for laundry services for the month were
$6,200.
Instructions:
a. Journalize the September transactions.
b. Open ledger accounts and post the September transactions.
c. Prepare a trial balance at September 30, 2022.
Solution:
a.
GENERAL JOURNAL
2022
Sept. 1 Cash 20000
2 Rent Expense 1000
Cash 1000
20
3 Equipment 25000
Cash 10000
Notes Payable 15000
Cash 1200
10 Advertising Expense 200
Cash 700
30 Cash 6200
b.
General Ledger
Cash
2022
Sept. 1 20000 20000
2 1000 19000
3 10000 9000
4 1200 7800
20 700 7100
30 6200 13300
Owner’s Capital
2022
Sept. 1 20000 20000
Rent Expense
2022
Sept. 2 1000 1000
Equipment
2022
Sept. 3 25000 25000
21
Notes Payable
2022
Sept. 3 15000 15000
Prepaid Insurance
2022
Sept. 4 1200 1200
Advertising Expense
2022
Sept. 10 200 200
Accounts Payable
2022
Sept. 10 200 200
Owner’s Drawings
2022
Sept. 20 700 700
Service Revenue
2022
Sept. 30 6200 6200
22
c.
Campus Laundromat
Trial Balance
September 30, 2022
Debit Credit
Cash $13300
Equipment 25000
Notes Payable $15000
Advertising Expense 200
Rent Expense 1000
$41400 $41400
23
Chapter 3: Adjusting the Accounts
Fiscal and Calendar Years

The accounting operations of a business are performed over a particular period of time. This is
because of the time period assumption, which is also known as the “periodicity assumption.”
According to this assumption, the economic life of a business is divided into artificial time periods
such as a month, quarter or year. Monthly and quarterly time periods are referred to as “interim
periods.” Most large companies have to prepare their financial statements both on a quarterly and
yearly basis.
If an accounting period consists of one year, then it is referred to as a fiscal year. A fiscal year
begins on the first day of a month, and it ends after twelve months on the last day of a month. The
fiscal year of many businesses is the calendar year, i.e., January 1 to December 31. In Bangladesh,
the fiscal year of most business organizations is from July 1 to June 30.
Accrual-Basis and Cash-Basis Accounting

When accounting is done on the accrual basis, it means that transactions are recorded in the time
period in which they actually occur. This entails the following:
1. A business recognizes, i.e., records, a revenue when it actually performs a service, and not
when it receives money for that service.
2. A business recognizes an expense when it is actually incurred, and not when it pays money for
that expense.
An alternative to accrual-basis accounting is cash-basis accounting. Under the cash basis, a

business recognizes a revenue only when it receives money, and it recognizes an expense only
after paying money. According to the GAAP, a business organization has to record its transactions
on the accrual basis. Medium and large companies use the accrual-basis accounting, whereas small
businesses tend to use the cash-basis accounting.
Recognizing Revenues and Expenses

When a business either sells a good or service, it has fulfilled its “performance obligation.” The
revenue recognition principle states that a business should record a revenue only when it satisfies
its performance obligation. For example, Bandbox Ltd. performs dry cleaning services for Tk.
10,000 on June 30, but the customer does not pay for the services until July 5. According to the
revenue recognition principle, Bandbox has to record the revenue on June 30 as it satisfied its
performance obligation on that day. Bandbox should not wait until July 5 to receive cash before
recording the revenue. The required journal entries for this transaction will be the following:
24
GENERAL JOURNAL
June 30 Accounts Receivable 10000
July 5 Cash 10000
Accounts Receivable 10000
Here, Bandbox credited the Service Revenue account on June 30 after performing the dry-cleaning
services. It also debited the Accounts Receivable account because the business was owed $10,000
for the services it had performed. On July 5, Bandbox debited the Cash account and credited the
Accounts Receivable account after receiving the money from its customer.
A business should record an expense in the accounting period in which the revenue associated with
that expense is earned. This is based on the expense recognition principle, which is also known
as the “matching principle.”
Adjusting Entries
In order to ensure that the revenue and expense recognition principles are followed, businesses
have to make adjusting entries. They are necessary because the information in a trial balance may
not be complete or up-to-date. The adjusting entries have to be made every time a business prepares
its financial statements at the end of an accounting period.
Adjusting entries can be divided into two main types, and they are as follows:
1. Deferrals – These are expenses and revenues that are recognized at a date after the point when
cash was originally exchanged. They are of two types:
i. Prepaid expenses – These are costs paid by a business for which it will receive a benefit
in the future. They are also called prepayments. Such expenses expire either over the
passage of time (e.g., rent, insurance) or through use (e.g., supplies). As the benefit will be
received in future, a prepaid expense is an asset. Before adjusting for a prepaid expense,
the assets remain overstated and the expenses remain understated. So, the required
adjusting entry for is as follows:
Expense account Dr.

Asset account Cr.
ii. Unearned revenues – These are money that are received for services before they are
actually performed. An unearned revenue is a liability because a business has an obligation
to offer the service in future. Before adjusting for an unearned revenue, the liabilities
remain overstated and the revenues remain understated. So, the required adjusting entry is
as follows:
Liability account Dr.

Revenue account Cr.
25
2. Accruals – These are of the following two types:
i. Accrued revenues – These are incomes for performing services that have not been
received yet. Before adjusting for an accrued revenue, the assets and revenues remain
understated. So, the required adjusting entry is as follows:
Asset account Dr.

Revenue account Cr.
ii. Accrued expenses – These are expenses that have been incurred but not yet paid or
recorded. Before adjusting for an accrued expense, the liabilities and expenses remain
understated. So, the required adjusting entry is as follows:
Expense account Dr.

Liability account Cr.
Each of these adjusting entries are explained with examples in the following sections. The
company Pioneer Advertising, which was used in question 1 of the exercise in the previous chapter,
has been used for these following examples.
Examples of Adjusting Prepaid Expenses

1. Supplies – Pioneer Advertising purchased supplies costing $2,500 on October 5. The business
recorded the payment by debiting the Supplies account. On October 31, an inventory count
revealed that $1,000 worth of supplies were still on hand. Hence, the cost of supplies that had
been used up is $1,500 ($2,500 - $1,000). The required adjusting entry is as follows:
GENERAL JOURNAL
Oct. 31 Supplies Expense 1500
Supplies 1500
2. Insurance – On October 4, Pioneer Advertising paid $600 for a one-year fire insurance policy.
The business recorded this payment by debiting the Prepaid Insurance account (it will receive
the benefit of this service in the current accounting period and also in future). The amount of
insurance which expires in each month is $50 ($600 ÷ 12). The required adjusting entry is as
follows:
GENERAL JOURNAL
Oct. 31 Insurance Expense 50
26
3. Depreciation – Assets such as buildings, equipment, and motor vehicles have long lives. The
period of time for which such assets give service is called the “useful life.” Depreciation is
the cost of using an asset over its useful life.
For example, Pioneer Advertising allocated a depreciation of $480 on equipment, which is $40
per month. The required adjusting entry is as follows:
GENERAL JOURNAL
Oct. 31 Depreciation Expense 40
Accumulated Depreciation - Equipment 40
Here, the Accumulated Depreciation account is known as a “contra asset account.”
Example of Adjusting Unearned Revenues

On October 2, Pioneer Advertising received $1,200 from R. Knox for advertising services that are
expected to be completed by December 31. The business recorded this receipt by crediting the
Unearned Service Revenue account (it received payment before the service was fully completed).
By analyzing the services that had been performed, the business determined that $400 worth of
services were performed for R. Knox in October. The required adjusting entry for this is as follows:
GENERAL JOURNAL
Oct. 31 Unearned Service Revenue 400
Service Revenue 400
Example of Adjusting Accrued Revenues

In October, Pioneer Advertising performed services worth $200. These were not recorded because
the services were not billed to customers. So, the business was owed $200. The required adjusting
entry is as follows:
GENERAL JOURNAL
Oct. 31 Accounts Receivable 200
Service Revenue 200
Examples of Adjusting Accrued Expenses

1. Accrued interest – On October 1, Pioneer Advertising signed a three-month note payable in
the amount of $5,000. The note requires the business to pay interest at an annual rate of 12%.
The amount of interest which is incurred per month is $50 {($5000 × 12%) ÷ 12}. Pioneer will
pay the interest for October three months later. Although the interest for October will not be
27
paid in this month, it is still incurred. So, the amount of interest for October has to be recorded.
The required adjusting entry is as follows:
GENERAL JOURNAL
Oct. 31 Interest Expense 50
Interest Payable 50
Here, the Interest Expense account is debited with $50, because this amount has been incurred
in the month of October. The Interest Payable account is credited with $50 as it is a liability
which has to be paid after three months.
[Note: To calculate the interest for an accounting period, a fraction of a year is used and not
the time period of the bank note. This is why in this example, the number 12 is used in the
denominator instead of 3 for calculating the amount of interest.]
2. Accrued salaries and wages: In Pioneer Advertising, the first work week started on Monday,
October 15, and ended on Sunday, October 21. The second work week started on Monday,
October 22, and ended on Sunday, October 28. The salaries and wages for these first two work
weeks were paid on October 26, and the next payment will be made on November 9. The total
salaries for one work week are $2,000.
Saturdays and Sundays are weekends, so the employees receive $2,000 for five days of work.
The salaries and wages per day is $400 ($2,000 ÷ 5). The salaries and wages for the last three
days of the month (i.e., Monday, October 29, Tuesday, October 30, and Wednesday, October
31) were incurred, but they had not been paid on October 26. Hence, the amount of salaries
and wages for the last three days of October is $1,200 ($400 × 3). This amount is an accrued
expense for Pioneer. It has to be recorded in October, so the required adjusting entries are as
follows:
GENERAL JOURNAL
Oct. 31 Salaries and Wages Expense 1200
Salaries and Wages Payable 1200
Here, the Salaries and Wages Expense account has been debited with $1,200 because this
amount was incurred in October. The Salaries and Wages Payable account has been credited
with $1,200 as it is a liability which has to be paid in future (i.e., on November 9).
Journalizing the Adjusting Entries

The adjusted entries of the previous examples are shown in the general journal in the next page:
28
GENERAL JOURNAL
Adjusting Entries
2022
Oct. 31 Supplies Expense 1500
Supplies 1500
31 Insurance Expense 50
31 Depreciation Expense 40
31 Unearned Service Revenue 400
Service Revenue 400
31 Accounts Receivable 200
Service Revenue 200
31 Interest Expense 50
Interest Payable 50
31 Salaries and Wages Expense 1200
General Ledger with Adjustments

Once the adjusted entries are journalized, they have to be posted in the general ledger. All the
ledger accounts of Pioneer Advertising, including the adjusted entries (shown in bold form), are
as follows:
General Ledger
Cash
2022
Oct. 1 10000 10000
2 1200 11200
3 900 10300
4 600 9700
20 10000 19700
26 4000 15700
31 500 15200
Owner’s Capital
2022
Oct. 1 10000 10000
29
Equipment
2022
Oct. 1 5000 5000
Notes Payable
2022
Oct. 1 5000 5000
Unearned Service Revenue

2022
Oct. 2 1200 1200
31 400 800
Rent Expense
2022
Oct. 3 900 900
Prepaid Insurance
2022
Oct. 4 600 600
31 50 550
Supplies
2022
Oct. 5 2500 2500
31 1500 1000
Accounts Payable
2022
Oct. 5 2500 2500
30
Service Revenue
2022
Oct. 20 10000 10000
31 400 10400
31 200 10600

2022
Oct. 26 4000 4000
31 1200 5200
Owner’s Drawings
2022
Oct. 31 500 500
Supplies Expense
2022
Oct. 31 1500 1500
Insurance Expense
2022
Oct. 31 50 50
Depreciation Expense
2022
Oct. 31 40 40
Accumulated Depreciation – Equipment

2022
Oct. 31 40 40
31
Accounts Receivable
2022
Oct. 31 200 200
Interest Expense
2022
Oct. 31 50 50
Interest Payable
2022
Oct. 31 50 50
Salaries and Wages Payable

2022
Oct. 31 1200 1200
If an account for an adjusted journal entry already exists in the general ledger, then the entry has
to be posted in that account. For instance, one of the adjusted journal entries in this example is a
debit entry for unearned service revenue. In the general ledger, an Unearned Service Revenue
account already existed with a balance of $1,200. The new adjusted entry for unearned service
revenue of $400 was posted in that Unearned Service Revenue account.
The Adjusted Trial Balance

The trial balance has to be updated with the adjusted entries after they are posted. The adjusted
trial balance of Pioneer Advertising is the following (the adjusted entries are shown in bold form):
Pioneer Advertising
Adjusted Trial Balance
October 31, 2022
Debit Credit
Cash $15200
Supplies 1000
Equipment 5000
Accumulated Depreciation - Equipment $40
Notes Payable 5000
32
Interest Payable 50
Supplies Expense 1500
Rent Expense 900
Insurance Expense 50
Interest Expense 50
Depreciation Expense 40
$30190 $301900
Exercises
Question 1: Evan Watts, D.D.S., opened a dental practice on January 1, 2022. During the first
month of operations, the following transactions occurred:
1. Watts performed services for patients totaling $2,400. These services have not yet been
recorded.
2. Utility expenses incurred but not paid prior to January 1 totaled $400.
3. Purchased dental equipment on January 1 for $80,000, paying $20,000 in cash and signing
a $60,000, 3-year note payable. The equipment depreciates $500 per month. Interest is $600
per month.
4. Purchased a one-year malpractice insurance policy on January 1 for $12,000.
5. Purchased $2,600 of dental supplies. On January 31, determined that $900 of supplies were
on hand.
Prepare the adjusting entries on January 31.
Solution:
GENERAL JOURNAL
Adjusting Entries
2022
Jan. 31 Accounts Receivable 2400
31 Utilities Expense 400
Utilities Payable 400
Accumulated Depreciation – Equipment 500
Interest Payable 600
33
31 Supplies Expense 1700
Supplies 1700
Workings:
1. Insurance expense incurred in January = $12,000 ÷ 12 = $1,000
2. Cost of supplies used up in January = $(2,600 – 900) = $1,700
Question 2: The Green Thumb Lawn Care Inc. began operations on April 1. At April 30, the trial
balance shows the following balances for selected accounts:
Prepaid Insurance $3,600

Equipment 28,000
Notes Payable 20,000
Unearned Service Revenue 4,200
Service Revenue 1,800
Analysis reveals the following additional data:
1. Prepaid insurance is the cost of a 2-year insurance policy, effective April 1.
2. Depreciation on the equipment is $500 per month.
3. The note payable is dated April 1. It is a 6-month, 12% note. Interest will be paid upon note
repayment.
4. Seven customers paid for the company’s 6-month lawn service package of $600 beginning in
April. The company performed services for these customers in April.
5. Lawn services performed for other customers but not recorded at April 30 totaled $1,500.
Prepare the adjusting entries for the month of April. Show computations.
Solution:
GENERAL JOURNAL
Adjusting Entries
2022
Apr. 30 Insurance Expense 150
34
Interest Payable 200
30 Unearned Service Revenue 700
Service Revenue 700
Workings:
1. Insurance incurred in April = $3,600 ÷ 24 = $150
2. Interest incurred in April = ${(20,000 × 12%) ÷ 12} = $200
3. Revenue received from each customer in a month = $600 ÷ 6 = $100
 Total revenue from all customers per month = $100 × 7 = $700
35
Chapter 4: Closing the Books
Closing the Accounting Books

At the end of an accounting period, a business makes its accounts ready for the next accounting
period. This is referred to as “closing the books.” Regarding the closing of accounting books, a
distinction is made between temporary accounts and permanent accounts:
1. Temporary account – This is an account which is related to one particular accounting period.
It is also known as a “nominal account.” The Owner’s Drawings account, as well as all expense
and revenue accounts, are temporary accounts. The closing balances of these accounts are not
moved to the next accounting period.
2. Permanent account – This is an account which is related to one or more accounting periods of
the future. It is also known as a “real account.” The Owner’s Capital account, as well as all
asset and liability accounts, are permanent accounts. The closing balances of these accounts
are moved to the next accounting period.
Closing the accounting books involves only closing the temporary accounts and not the permanent
accounts. To do so, a business has to make closing entries. Such entries produce a balance of zero
in the temporary accounts. In order to close the revenue and expense accounts, a new account is
created which is known as “Income Summary.” This account is only created temporarily while
closing the accounting books. The expense and revenue accounts are closed to the Income
Summary account. The Owner’s Drawings account is not closed to the Income Summary account,
but it is rather closed to the Owner’s Capital account.
Steps for Closing Entries

Closing entries are made in the general journal after creating the adjusted trial balance. To close
an account, its balance has to be made into zero. The way of doing this is to make an entry opposite
to the normal balance of the account. For instance, the normal balance of the Owner’s Drawings
account is a debit balance. So, crediting this account will turn its balance into zero.
The steps for preparing the closing entries are listed below:
1. The Income Summary account is credited with the balances of all the revenue accounts.
2. The Income Summary account is debited with the balances of all the expense accounts.
3. Once the expense and revenue accounts are closed up, the Income Summary account itself has
to be closed. This is done by crediting the Owner’s Capital account with the balance of the
Income Summary account.
4. The Owner’s Capital account is debited with the balance of the Owner’s Drawings account.
36
Journalizing the Closing Entries
The general journal below shows how closing entries are made for the company Pioneer
Advertising:
GENERAL JOURNAL
Closing Entries
2022
Oct. 31 Service Revenue 10600
Income Summary 10600
31 Income Summary 7740
Rent Expense 900
Interest Expense 50
31 Owner’s Capital 500
Posting the Closing Entries

The closing entries have to be posted in the general ledger after they are journalized. The postings
for the closing journal entries of Pioneer Advertising are as follows:
General Ledger
Service Revenue
2022
Oct. 20 10000 10000
31 400 10400
31 200 10600
31 10600 0
Income Summary
2022
Oct. 31 10600 10600
31 7740 2860
31 2860 0
37
Rent Expense
2022
Oct. 3 900 900
31 900 0

2022
Oct. 26 4000 4000
31 1200 5200
31 5200 0
Supplies Expense
2022
Oct. 31 1500 1500
31 1500 0
Insurance Expense
2022
Oct. 31 50 50
31 50 0
2022
Oct. 31 40 40
31 40 0
Interest Expense
2022
Oct. 31 50 50
31 50 0
38
Owner’s Capital
2022
Oct. 1 10000 10000
31 2860 12860
31 500 12360
Owner’s Drawings
2022
Oct. 31 500 500
31 500 0
When the closing balance in an account is turned to zero, a double-underline is placed under it.
This is done to indicate that the account has been closed up.
Post-Closing Trial Balance

Once the closing entries have been journalized and posted, the final step is to prepare another trial
balance. This is called the post-closing trial balance. It only contains the balances of the
permanent accounts that will be carried forward to the next accounting period. As the temporary
accounts have been closed up, they will not be listed in the post-closing trial balance. The purpose
of the post-closing trial balance is to prove that the total value of the debit entries of the permanent
accounts is equal to the total value of their credit entries.
The post-closing trial balance of Pioneer Advertising is shown below:
Pioneer Advertising
October 31, 2022
Debit Credit
Cash $15200
Supplies 1000
Equipment 5000
Accumulated Depreciation – Equipment $40
Notes Payable 5000
Interest Payable 50
$21950 $21950
39
Exercise
Question: Ashley Williams opened Ashley’s Maids Cleaning Service on July 1, 2017. During July,
the company completed the following transactions.
July 1 Invested $14,000 cash in the business.

1 Purchased a used truck for $10,000, paying $3,000 cash and the balance on account.
3 Purchased cleaning supplies for $800 on account.
5 Paid $2,160 on a 1-year insurance policy, effective July 1.
12 Billed customers $3,800 for cleaning services.
18 Paid $1,000 of amount owed on truck, and $400 of amount owed on cleaning supplies.
20 Paid $1,600 for employee salaries.
21 Collected $1,400 from customers billed on July 12.
25 Billed customers $1,900 for cleaning services.
31 Paid gasoline for the month on the truck, $400.
31 Withdrew $700 cash for personal use.
Instructions:
a. Journalize and post the July transactions.
b. Prepare a trial balance at July 31.
c. Journalize and post the following adjustments:
1. Unbilled fees for services performed at July 31 were $1,300.
2. Depreciation on the truck for the month was $200.
3. One-twelfth of the insurance expired.
4. An inventory count shows $100 of cleaning supplies on hand at July 31.
5. Accrued but unpaid employee salaries were $500.
d. Prepare a trial balance with the adjustments at July 31.
e. Journalize and post the closing entries, and complete the closing process.
f. Prepare a post-closing trial balance at July 31.
40
Solution:
a.
GENERAL JOURNAL
2017
July 1 Cash 14000
1 Truck 10000
Cash 3000
3 Supplies 800
Cash 2160
18 Accounts Payable 1000
Cash 1000
Cash 400
20 Salaries Expense 1600
Cash 1600
21 Cash 1400
31 Gasoline Expense 400
Cash 400
Cash 700
41
General Ledger
Cash
2017
July 1 14000 14000
1 3000 11000
5 2160 8840
18 1000 7840
18 400 7440
20 1600 5840
21 1400 7240
31 400 6840
31 700 6140
Owner’s Capital
2017
July 1 14000 14000
Truck
2017
July 1 10000 10000
Accounts Payable
2017
July 1 7000 7000
3 800 7800
18 1000 6800
18 400 6400
Supplies
2017
July 3 800 800
Prepaid Insurance
2017
July 5 2160 2160
42
Accounts Receivable
2017
July 12 3800 3800
21 1400 2400
25 1900 4300
Service Revenue
2017
July 12 3800 3800
25 1900 5700
Salaries Expense
2017
July 20 1600 1600
Gasoline Expense
2017
July 31 400 400
Owner’s Drawings
2017
July 31 700 700
b.
Ashley’s Maids Cleaning Service

Trial Balance
July 31, 2017
Debit Credit
Cash $6140
Supplies 800
Truck 10000
Accounts Payable $6400
43
Salaries Expense 1600
Gasoline Expense 400
$26100 $26100
c.
GENERAL JOURNAL
Adjusting Entries
2017
July 31 Accounts Receivable 1300
Accumulated Depreciation – Truck 200
31 Supplies Expense 700
Supplies 700
31 Salaries Expense 500
Salaries Payable 500
Workings:
1. Insurance incurred in July = $2,160 ÷ 12 = $180
2. Cost of supplies used up in July = $(800 – 100) = $700
General Ledger
Accounts Receivable
2017
July 31 4300 4300
31 1300 5600
Service Revenue
2017
July 31 5700 5700
31 1300 7000
44
2017
July 31 200 200
Accumulated Depreciation – Truck

2017
July 31 200 200
Insurance Expense
2017
July 31 180 180
Prepaid Insurance
2017
July 5 2160 2160
31 180 1980
Supplies Expense
2017
July 31 700 700
Supplies
2017
July 3 800 800
31 700 100
Salaries Expense
2017
July 20 1600 1600
31 500 2100
45
Salaries Payable
2017
July 31 500 500
d.

Adjusted Trial Balance
July 31, 2017
Debit Credit
Cash $6140
Supplies 100
Truck 10000
Accumulated Depreciation - Truck $200
$28100 $28100
e.
GENERAL JOURNAL
Closing Entries
2017
July 31 Service Revenue 7000
Income Summary 7000
46
31 Owner’s Capital 700
Service Revenue
2017
July 31 5700 5700
31 1300 7000
31 7000 0
Income Summary
2017
July 31 7000 7000
31 3580 3420
31 3420 0
Salaries Expense
2017
July 20 1600 1600
31 500 2100
31 2100 0
Gasoline Expense
2017
July 31 400 400
31 400 0
2017
July 31 200 200
31 200 0
47
Insurance Expense
2017
July 31 180 180
31 180 0
Supplies Expense
2017
July 31 700 700
31 700 0
Owner’s Capital
2017
July 1 14000 14000
31 3420 17420
31 700 16720
Owner’s Drawings
2017
July 31 700 700
31 700 0
f.

July 31, 2017
Debit Credit
Cash $6140
Supplies 100
Truck 10000
Accumulated Depreciation – Truck $200
$23820 $23820
48
Chapter 5: Accounting for Merchandising Operations
Merchandising Businesses
A merchandising business is one which buys and sells goods. It mainly earns revenue through the
purchase and sale of the merchandise. Two types of merchandising businesses are as follows:
1. Retailers – These businesses buy goods and then directly sell them to consumers, e.g.,
Shwapno.
2. Wholesalers – These businesses sell goods to retailers.
The income earned by a merchandising business is called sales revenue or sales. The expenses
incurred by a merchandising firm are divided into the following two types:
1. Cost of goods sold – This is the total cost of the merchandise sold during an accounting period.
2. Operating expenses – These are the costs that are incurred while earning sales revenue, e.g.,
adverting expense, rent expense.
The difference between sales revenue and the cost of goods sold is the gross profit. Subtracting
the operating expenses from the gross profit results in the net income. If the total amount of
operating expenses is greater than the gross profit, then the result will be a net loss.
[Note: Cost of goods sold and gross profit only exist in a merchandising business. These two values
are not present in a business which provides services.]
Inventory
The goods that are bought and sold by a merchandising business are referred to as inventory. They
are an asset for the business. Changes in inventory are recorded in the Inventory account.
There are two systems for recording the inventory of a business, and they are as follows:
1. Perpetual system – In this system, a business keeps detailed records of each purchase and sale
of inventory. The perpetual system is called such because the accounting records continuously
show the inventory that should be on hand for every item. Under this system, the business
calculates the cost of goods sold every time it makes a sale.
2. Periodic system – In this system, a business does not keep detailed records of the inventory
on hand while operating. The cost of goods sold is rather determined at the end of the
accounting period. This is done by physically counting the inventory.
The perpetual inventory system is more widely used by businesses than the periodic system. In the
examples of this chapter, the perpetual system has been used for recording inventory.
49
Recording Purchases
Inventory is bought either with cash or on credit. The transaction of purchasing inventory is
recorded when a business receives the goods from the seller. Every credit purchase should have an
associated purchase invoice, which is a business document containing written evidence of the
transaction. If goods are bought with the intention of reselling them, then this transaction is
recorded in the Inventory account. The required journal entry for the purchase of merchandise is
as follows:
Inventory Dr.
Cash/Accounts Payable Cr.
For example, on May 4, Sauk Stereo buys some merchandise totaling $3,800 on account from PW
Audio Supply. The journal entry for this transaction is given below:
GENERAL JOURNAL
May 4 Inventory 3800
Freight Costs
The cost of delivering inventory to the buyer is referred to as “freight cost.” When inventory is
being bought or sold, the buyer and seller mutually agree on who will pay the freight cost. The
terms of the freight cost are described as FOB, which stands for “free on board.” Depending on
who pays the freight cost, FOB can be divided into two types:
1. FOB shipping point – This means that the buyer gains ownership of the goods that are being
delivered. So, the buyer has to pay the freight cost.
2. FOB destination – This means that the seller retains ownership of the goods until they are
delivered to the buyer. So, the seller has to pay the freight cost.
The journal entry for a freight cost is different for a buyer and a seller:
1. Freight cost for buyers – When the freight cost is incurred by a buyer, it is included in the
cost of buying inventory. This is why the Inventory account is debited to record the freight
cost. For example, Sauk Stereo (the buyer) pays Public Carrier Co. $150 for freight charges on
May 6. The required journal entry in the accounting books of Sauk Stereo will be the following:
GENERAL JOURNAL
May 6 Inventory 150
Cash 150
50
2. Freight cost for sellers – When the freight cost is incurred by a seller, it is an operating expense
for that seller. The seller has to debit this expense in an account named “Freight-Out,” which
is also sometimes called “Delivery Expense.” For example, if PW Audio Supply (the seller)
pays the fright cost, then the required journal entry in its accounting books will be the
following:
GENERAL JOURNAL
May 4 Freight-Out 150
Cash 150
Purchase Returns and Allowances

Sometimes, a purchaser might want to return the merchandise it bought due to various reasons.
For instance, the goods may be damaged or of bad quality. If the sale was made on credit, then the
purchaser might return the goods on credit. If the sale was made for cash, then the purchaser might
choose to return the goods for a cash refund. Such a transaction in which merchandise is returned
to the seller is known as a purchase return.
As an alternative, the buyer might choose to keep the merchandise if the seller willingly provides
a decrease in the purchase price. This decrease in purchase price is called a purchase allowance.
For example, Sauk Stereo returns some goods costing $300 to PW Audio Supply on May 8. In the
accounting books of Sauk Stereo, the required journal entry will be as follows:
GENERAL JOURNAL
May 8 Accounts Payable 300
Inventory 300
Originally, Sauk Stereo bought merchandise from PW Audio Supply on credit. Here, the Accounts
Payable account has been debited because Sauk Stereo’s liability to PW Audio Supply decreased
as a result of returning some goods. The Inventory account has been credited because returning
goods decreased the quantity of merchandise held by Sauk Stereo.
Alternatively, if Sauk Stereo receives a purchase allowance of $50 from PW Audio Supply, then it
will have to debit the Accounts Payable account with $50 and credit the Inventory account with
$50. In this case, crediting the Inventory account does not indicate a fall in the quantity of
merchandise of Sauk Stereo. This is because the business did not actually return any goods. It
simply indicates a decrease in the cost of existing goods that have been bought by Sauk Stereo.
Purchase Discounts
A purchase which is made on credit can contain what are known as credit terms. These can allow
the buyer to ask for a cash discount for making the payment quickly. Such a cash discount is called
purchase discount from the buyer’s perspective. Some examples of credit terms are as follows:
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• 2/10, n/30 – Here, the “n” stands for net amount, which is the amount remaining after
subtracting any purchase returns or allowances. According to these credit terms, a buyer will
receive a cash discount of 2% if it makes the payment within the next ten days. If the payment
is not made within the next ten days, then the net amount has to be paid within the next thirty
days.
• 1/10 EOM – Here, “EOM” stands for end of month. According to these credit terms, a buyer
will receive a cash discount of 1% if it makes the payment within the first ten days of the next
month.
Recording Purchase Discounts

Let us assume that Sauk Stereo received credit terms of 2/10, n/30 when buying merchandise from
PW Audio Supply on May 4. Sauk Stereo makes the due payment on May 14, which is the last day
of the cash discount period. The following journal entry is made to record this transaction:
GENERAL JOURNAL
May 14 Accounts Payable 3500
Cash 3430
Inventory 70
On May 8, Sauk Stereo returned $300 worth of goods. The due amount after this purchase return
was $3,500 ($3,800 - $300). The cash discount has to be applied on this net amount. According to
the credit terms, Sauk Stereo received a 2% cash discount. So, the amount of cash discount was
$70 ($3,500 × 2%). Therefore, the amount which the business actually paid to PW Audio Supply
was $3,430 ($3,500 - $70).
If Sauk Stereo did not make the due payment by May 14 but instead paid the net amount on June
3, then the required journal entry will be as follows:
GENERAL JOURNAL
June 3 Accounts Payable 3500
Cash 3500
Summary of Purchases
The following Inventory account shows a summary of the effects on inventory of the transactions
that have occurred so far:
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Inventory
May 4 3800 3800
6 150 3950
8 300 3650
14 70 3580
1. On May 4, Sauk Stereo purchased $3,800 worth of inventory on credit.
2. On May 6, the business paid freight costs of $150.
3. On May 8, the business returned $300 worth of inventory to the seller.
4. On May 14, Sauk Stereo received a cash discount of $70 because it paid the due amount within
the discount period.
Recording Sales
A business can sell goods either for cash or on credit. According to the revenue recognition
principle, the sales revenue has to be recorded when the performance obligation is fulfilled. A
seller fulfills its performance obligation when the goods are delivered to the buyer. Every credit
sale should have an associated sales invoice, which is a business document containing written
evidence of the transaction.
To record a sale, a seller has to make two journal entries which are as follows:
Cash/Accounts Receivable Dr.

Sales Revenue Cr.
Cost of Goods Sold Dr.
Inventory Cr.
For example, on May 4, PW Audio Supply sold some merchandise totaling $3,800 on account to
Sauk Stereo. The cost of the merchandise for PW Audio Supply was $2,400. The required journal
entries for this transaction are as follows:
GENERAL JOURNAL
May 4 Accounts Receivable 3800
Sales Revenue 3800
4 Cost of Goods Sold 2400
Inventory 2400
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Sales Returns and Allowances
A sales return is when a seller receives some goods back from the buyer. A sales allowance is
when the seller provides a decrease in the purchase price so that the buyer will keep the goods.
For example, PW Audio Supply received $300 worth of goods back from Sauk Stereo on May 8.
The cost of these goods was $140. Assuming that the goods were not defective, PW Audio Supply
has to make the following two journal entries in its accounting books:
GENERAL JOURNAL
May 8 Sales Returns and Allowances 300
8 Inventory 140
Cost of Goods Sold 140
Here, the selling price of the goods that were returned has been debited in the account named
“Sales Returns and Allowances.” The Accounts Receivable account has been credited because the
sales return decreased the debt owed by Sauk Stereo. The Inventory account has been debited with
the cost of the goods that were returned. This is because the quantity of goods held by PW Audio
Supply increased due to the sales return.
If the returned goods were defective, then PW Audio Supply has to make entries in the Inventory
and Cost of Goods Sold accounts with the residual value of the goods. For example, the goods that
were returned by Sauk Stereo had a residual value of $50. The required journal entries in this case
would be the following:
GENERAL JOURNAL
8 Inventory 50
If PW Audio Supply does not get back any goods that it sold but instead offers a sales allowance
of $50 to the buyer, then the following journal entry has to be made:
GENERAL JOURNAL
The required journal entry for a sales allowance is debiting the Sales Returns and Allowances
account and crediting the Accounts Receivable account with the amount of the allowance. As a
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sales allowance does not involve any goods being returned to the seller, this transaction does not
affect the Inventory or Cost of Goods Sold account.
Sales Discounts
A sales discount is a decrease in the amount of payment which is charged to a buyer. It is given
by a seller to encourage the buyer to make the payment more quickly. The seller records a sales
discount in an account named “Sales Discounts.” The amount of sales discount is debited in this
account. A sales discount is applied on the net amount, i.e., the amount of payment remaining after
subtracting any sales returns and allowances.
For example, Sauk Stereo pays the net amount of $3,500 to PW Audio Supply on May 14, which
is the last day of the discount period. To record this transaction, PW Audio Supply has to make the
following journal entry in its accounting books:
GENERAL JOURNAL
May 14 Cash 3430
Sales Discounts 70
On May 8, PW Audio Supply received $300 worth of goods back from Sauk Stereo. So, Sauk
Stereo was liable to pay a net amount of $3,500 ($3,800 - $300). The sales discount of 2% is
applied on this amount. The amount of sales discount is $70 ($3,500 × 2%), which has been debited
in the Sales Discounts account. The amount which was actually paid by Sauk Stereo is $3,430
($3,500 - $70).
Exercise
Question: Kern’s Book Warehouse distributes hardcover books to retail stores and extends credit
terms of 2/10, n/30 to all of its customers. At the end of May, Kern’s inventory consisted of books
purchased for $1,800. During June, the following merchandising transactions occurred:
June 1 Purchased books on account for $1,600 from Binsfeld Publishers, FOB destination,
terms 2/10, n/30. The appropriate party also made a cash payment of $50 for the
freight on this date.
3 Sold books on account to Reading Rainbow for $2,500. The cost of the books sold
was $1,440.
6 Received $100 credit for books returned to Binsfeld Publishers.
9 Paid Binsfeld Publishers in full, less discount.
15 Received payment in full from Reading Rainbow.
17 Sold books on account to Rapp Books for $1,800. The cost of the books sold was
$1,080.
20 Purchased books on account for $1,800 from McGinn Publishers, FOB destination,
terms 2/15, n/30. The appropriate party also made a cash payment of $60 for the
freight on this date.
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24 Received payment in full from Rapp Books.
26 Paid McGinn Publishers in full, less discount.
28 Sold books on account to Baeton Bookstore for $1,600. The cost of the books sold
was $970.
30 Granted Baeton Bookstore $120 credit for books returned costing $72.
Journalize the transactions for the month of June for Kern’s Book Warehouse using a perpetual
inventory system.
Solution:
GENERAL JOURNAL
June 1 Inventory 1600
Sales Revenue 2500
Inventory 1440
Inventory 100
Cash 1470
Inventory 30
15 Cash 2500
Sales Revenue 1800
Inventory 1080
20 Inventory 1800
24 Cash 1764
Sales Discounts 36
Cash 1764
Inventory 36
Sales Revenue 1600
Inventory 970
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30 Sales Returns and Allowances 120
30 Inventory 72
Workings:
1. Net amount due to Binsfeld Publishers on June 9 = $(1,600 – 100) = $1,500.
Amount of purchase discount received = $1,500 × 2% = $30
 Amount paid to Binsfeld Publishers on June 9 = $(1,500 – 30) = $1,470
2. Amount of sales discount given to Rapp Books = $1,800 × 2% = $36
 Amount received from Rapp Books on June 24 = $(1,800 – 36) = $1,764
3. Amount of purchase discount received from McGinn Publishers = $1,800 × 2% = $36
 Amount paid to McGinn Publishers on June 26 = $(1,800 – 36) = $1,764
57
Chapter 6: Inventory Valuation
Cost Flow Assumption

Businesses record inventory with the value of their cost price. At present, most businesses do not
keep a record of the cost of each individual item of inventory as doing so is not practical. Rather,
a business tends to assume which stocks of goods it sold. This is referred to as the cost flow
assumption. Based on this assumption, a business tries to determine the value of its inventory.
According to the cost flow assumption, there are three methods of finding out the cost of inventory.
They are as follows:
1. First-in, first-out (FIFO).
2. Last-in, first-out (LIFO).
3. Average-cost.
The following sections explain these methods of inventory valuation. In this chapter, each of these
methods has been explained in accordance with the perpetual system.
Example of FIFO
The FIFO method assumes that the goods which were bought first are the ones that are sold first.
In FIFO, the costs of the earliest goods that were purchased are considered to determine the cost
of goods sold.
For example, Dempsey Inc. is a retailer operating in British Columbia. Dempsey uses the perpetual
inventory system. All sales returns from customers result in the goods being returned to inventory;
the inventory is not damaged. The following is some information of Dempsey Inc. for the month
of January, 2022 (there are no credit transactions; all amounts are settled in cash):
Unit Cost or
Date Description Quantity Selling Price
January 1 Beginning inventory 100 $15
January 5 Purchase 140 18
January 8 Sale 110 28
January 10 Sale return 10 28
January 16 Purchase return 5 20
January 20 Sale 90 32
The following table shows how the value of inventory of Dempsey Inc. has been determined with
the FIFO method. It contains four columns: Date, Receipts, Issues, and Balance. The Receipts
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column records the stocks of goods that “come into” a business, such as purchases. The Issues
column records the stocks of goods that “go out” of the business, such as sales. Under the Receipts,
Issues, and Balance columns, there are three sub-columns: Quantity, Cost, and Total. The Quantity
column shows the amount of goods in a stock, the Cost column shows the cost per unit of the
goods, and the Total column shows the total cost of the goods in a stock.
Receipts Issues Balance

Date Quantity Cost Total Quantity Cost Total Quantity Cost Total
Jan. 1 100 $15 $1500 100 $15 $1500
5 140 18 2520 100 15 1500
140 18 2520
8 110 $28 $3080 130 18 2340
10 (10) 28 (280) 140 18 2520
15 55 20 1100 140 18 2520
55 20 1100
16 (5) 20 (100) 140 18 2520
50 20 1000
20 90 32 2880 50 18 900
50 20 1000
25 20 22 440 50 18 900
50 20 1000
20 22 440
Total $5460 $5680 $2340
The steps below explain how the value of the inventory has been determined:
1. On January 1, Dempsey Inc. had 100 units of inventory on hand at a cost of $15 per unit. This
information is recorded on January 1 in the Receipts and Balance columns. The total cost of
these goods was $1,500 (100 × $15).
2. On January 5, Dempsey Inc. bought 140 units of inventory at a cost of $18 per unit. In the
Balance column, the information of the 100 units of goods from the previous date is brought
down to the current date. The total cost of the 140 goods was $2,520 (140 × $18). This is
recorded in the Receipts and Balance columns.
3. On January 8, Dempsey Inc. sold 110 units of inventory at a cost of $28 per unit. The total cost
of these goods was $3,080 (110 × $28). This information is recorded in the Issues column.
According to FIFO, the business sold the inventory from the first stock of goods it had on the
previous date, which was 100 units. Once those goods had been sold, the business sold the
remaining 10 units of inventory from the second stock of goods, which was 140 units. Hence,
the stock of goods remaining with Dempsey Inc. on January 8 was 130 units (140 – 10) at a
cost of $18 per unit. This is recorded in the Balance column. The total cost of these 130 units
was $2,340 (130 × $18).
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4. On January 10, Dempsey Inc. received 10 units of goods back from a customer; they had a unit
cost of $28. The total cost of these goods was $280 (10 × $28). This sales return decreased the
sales revenue of the business, which is why it is deducted in the Issues column. The returned
goods are added with the last stock that the business had on the previous date, which was 130
units. Then the business had 140 units (130 + 10) on January 10, and their total cost was $2,520
(140 × $18).
down to the current date. The total cost of the 55 goods was $1,100 (55 × $20). This is recorded
in the Receipts and Balance columns.
6. On January 16, Dempsey Inc. gave 5 units of goods back to a seller; their unit cost was $20.
The total cost of these goods was $100 (5 × $20). This purchase return decreased the quantity
of goods bought by the business, which is why it is deducted in the Receipts column. The
returned goods are subtracted from the last stock that the business had on the previous date,
which was 55 units. Then the business had 50 units (55 – 5) in the last stock on January 16,
and their total cost was $1,000 (50 × $20).
According to FIFO, the business sold the inventory from the first stock of goods it had on the
previous date, which was 140 units. Then the goods remaining in the first stock was 50 units
(140 – 90). This is recorded in the Balance column. The total cost of these 50 units was $900
(50 × $18).
Balance column, the information of the two stocks of goods from the previous date is brought
down to the current date. The total cost of the 20 goods was $440 (20 × $22). This is recorded
The total value of all the amounts in the Total sub-column of the Receipts column is the “cost of
goods available for sale,” which was $5,460. The total value of all the stocks of goods on the last
day is the closing inventory of the business, which was $2,340 ($900 + $1,000 + $440). The value
of the cost of goods sold can be obtained by subtracting the closing inventory from the cost of
goods available for sale, as shown below:
Cost of goods available for sale $5460

Less: Closing inventory (2340)
Cost of goods sold $3120
The total value of all the amounts in the Total sub-column of the Issues column is the total sales
revenue earned by Dempsey Inc., which was $5,680. Subtracting the cost of goods sold from this
value will give the amount of gross profit made by the business, which is shown as follows:
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Sales revenue $5680
Less: Cost of goods sold (3120)
Gross profit $2560
Example of LIFO
The LIFO method assumes that the latest goods which were bought are the ones that are sold first.
In LIFO, the cost of the last goods that were purchased are considered to determine the cost of
goods sold.
Based on the information of Dempsey Inc. which was given earlier, the following table shows how
the value of the business’s inventory has been determined with the LIFO method:

Jan. 1 100 $15 $1500 100 $15 $1500
Jan. 5 140 18 2520 100 15 1500
140 18 2520
Jan. 8 110 $28 $3080 100 15 1500
30 18 540
Jan. 10 (10) 28 (280) 100 15 1500
40 18 720
Jan. 15 55 20 1100 100 15 1500
40 18 720
55 20 1100
Jan. 16 (5) 20 (100) 100 15 1500
40 18 720
50 20 1000
Jan. 20 90 32 2880 100 15 1500
Jan. 25 20 22 440 100 15 1500
20 22 440
Total $5460 $5680 $1940
these goods was $1,500 (100 × $15).
down to the current date. The total cost of the 140 goods was $2,520 (140 × $18). This is
recorded in the Receipts and Balance columns.
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According to LIFO, the business sold the inventory from the last stock of goods it had on the
previous date, which was 140 units. Then the goods remaining in the last stock was 30 units
(140 – 110) at a cost of $18 per unit. This is recorded in the Balance column. The total cost of
these 30 units was $540 (30 × $18).
goods are added with the last stock that the business had on the previous date, which was 30
units. Then the business had 40 units (30 + 10) on January 10, and their total cost was $720
(40 × $18).
Balance column, the information of the two stocks of goods from the previous date is brought
down to the current date. The total cost of the 55 goods was $1,100 (55 × $20). This is recorded
returned goods are subtracted from the last stock that the business had on the previous date,
which was 55 units. Then the business had 50 units (55 – 5) in the last stock on January 16,
and their total cost was $1,000 (50 × $20).
According to LIFO, the business sold the inventory from the last stock of goods it had on the
previous date, which was 50 units. Once these goods had been sold, the business sold the
remaining 40 units of inventory from the second stock of goods, which fully consisted of 40
units. Hence, the stock of goods remaining with Dempsey Inc. on January 20 was 100 units at
a cost of $15 per unit. This is recorded in the Balance column. The total cost of these 100 units
was $1,500 (100 × $15).
down to the current date. The total cost of the 20 goods was $440 (20 × $22). This is recorded
The value of the cost of goods available for sale was $5,460, which is the total value of all the
amounts in the Total sub-column of the Receipts column. The total value of all the stocks of goods
on the last day is the closing inventory of the business, which was $1,940 ($1,500 + $440). The
value of the cost of goods sold can be calculated in the following way:
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Less: Closing inventory (1940)
Cost of goods sold $3520
The total sales revenue earned by Dempsey Inc. was $5,680, which is the total value of all the
amounts in the Total sub-column of the Issues column. The gross profit of the business can be
calculated in the way shown below:
Sales revenue $5680

Less: Cost of goods sold (3520)
Gross profit $2160
Example of Moving Average Method

In a perpetual inventory system, the average-cost method is known as the moving average
method. Every time a business makes a purchase, it calculates a new weighted-average unit cost.
This is done by dividing the value of the cost of goods available for sale by the quantity of goods
that are on hand.
Based on the information of Dempsey Inc. which was given earlier, the following table shows how
the value of the business’s inventory has been determined with the moving-average method:

Jan. 1 100 $15 $1500 100 $15 $1500
Jan. 5 140 18 2520 240 16.75 4020
Jan. 8 110 $28 $3080 130 16.75 2177.5
Jan. 10 (10) 28 (280) 140 16.75 2345
Jan. 15 55 20 1100 195 17.667 3445.065
Jan. 16 (5) 20 (100) 190 17.606 3345.14
Jan. 20 90 32 2880 100 17.606 1760.6
Jan. 25 20 22 440 120 18.338 2200.56
Total $5460 $5680 $2200.56
these goods was $1,500 (100 × $15).
2. On January 5, Dempsey Inc. bought 140 units of inventory at a cost of $18 per unit. The total
cost of those goods was $2,520 (140 × $18). This is recorded in the Receipts column. These
new purchased goods are added with the quantity of goods that the business had on the previous
date, which was 100 units. So, the business had 240 units (100 + 140) on January 5, which is
recorded in the Quantity sub-column of the Balance column.
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As the business made a purchase, a weighted-average unit cost has to be calculated. The value
of the cost of goods available for sale on the current date is added with that of the previous
date. Then the result is divided with the quantity of goods on hand, which was 240 units. Hence,
the calculation for the weighted-average unit cost is done as follows: $(1,500 + 2,520) ÷ 240
= $16.75. This value is recorded in the Cost sub-column of the Balance column.
The quantity of goods sold is subtracted from the quantity that the business had on the previous
date, which was 240 units. Then the business had 130 units (240 – 110) on January 8. The
weighted-average unit cost which was calculated on the previous date is used to obtain the total
cost of the goods that are on hand, which was $2,177.5 (130 × $16.75). Therefore, the moving
average method is called such, because the weighted-average unit cost which was calculated
on a previous date is used for obtaining the total cost of a stock of goods on a later date.
goods are added with the quantity which the business had on the previous date. Then the
business 140 units (130 + 10) on January 10. The weighted-average unit cost from the previous
date is used to obtain the total cost of the goods that are on hand, which was $2,345 (140 ×
$16.75).
cost of those goods was $1,100 (55 × $20). This is recorded in the Receipts column. These new
purchased goods are added with the quantity of goods that the business had on the previous
As the business made a purchase, a new weighted-average unit cost has to be calculated. The
value of the cost of goods available for sale on the current date is added with that of the previous
date. Then the result is divided with the quantity of goods on hand, i.e., 195 units. Hence, the
calculation for the weighted-average unit cost is done as follows: $(2,345 + 1,100) ÷ 195 =
$17.667. This value is recorded in the Cost sub-column of the Balance column.
returned goods are subtracted from the quantity which the business had on the previous date.
Then the business had 190 units (195 - 5) on January 16.
As the business’s purchases decreased, a new weighted-average unit cost has to be calculated.
The value of the cost of goods available for sale on the current date is subtracted from that of
the previous date. Then the result is divided with the quantity of goods on hand, i.e., 190 units.
Hence, the calculation for the weighted-average unit cost is done as follows: $(3,445.065 –
100) ÷ 190 = $17.606. This value is recorded in the Cost sub-column of the Balance column.
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The quantity of goods sold is subtracted from the quantity that the business had on the previous
date, which was 190 units. Then the business had 100 units (190 – 90) on January 20. The
weighted-average unit cost which was calculated on the previous date is used to obtain the total
cost of the goods that are on hand, which was $1,760.6 (100 × $17.606).
cost of those goods was $440 (20 × $22). This is recorded in the Receipts column. These new
purchased goods are added with the quantity of goods that the business had on the previous
As the business made a new purchase, a new weighted-average unit cost has to be calculated.
The value of the cost of goods available for sale on the current date is added with that of the
previous date. Then the result is divided with the quantity of goods on hand, i.e., 120 units.
Hence, the calculation for the weighted-average unit cost is done as follows: $(1760.6 + 440)
÷ 120 = $18.338. This value is recorded in the Cost sub-column of the Balance column.
The value of the cost of goods available for sale is $5,460, which is the total value of all the
amounts in the Total sub-column of the Receipts column. The total value of all the goods on the
last day is the closing inventory of the business, which was $2,200.56. The value of the cost of
goods sold can be calculated in the following way:

Less: Closing inventory (2200.56)
Cost of goods sold $3259.44
The total sales revenue earned by Dempsey Inc. was $5,680, which is the total value of all the
amounts in the Total sub-column of the Issues column. The gross profit of the business can be
calculated in the way shown below:
Sales revenue $5680

Less: Cost of goods sold (3259.44)
Gross profit $2420.56
65
Chapter 7: Depreciation
Plant Assets
A plant asset is a resource of a business which has the following three characteristics:
1. It is tangible, i.e., it can be seen and touched.
2. It is used in the operations of the business.
3. The business does not intend to sell it.
Plant assets are also referred to as “property, plant, and equipment,” “plant and equipment,” and
“fixed assets.” Their value decreases over time as they are used. An exception to this is land; its
value increases instead of decreasing.
According to the historical cost principle, businesses have to record plant assets at their original
cost. The cost includes all expenses that are incurred to obtain an asset and make it ready for its
intended use. For example, if a business buys equipment, then the purchase price, freight, and
installation costs are a part of its total cost.
Depreciation
Depreciation is the process of allocating the cost of a plant asset over its useful life. The amount
of depreciation represents the value of an asset which has been used up. It is recorded as an expense
in the accounting books of a business.
Plant assets such as buildings and equipment are depreciated. This is because the capacity of these
assets to generate revenue decreases over time. The ability of a plant asset to generate revenue can
decrease due to wear and tear or obsolescence, i.e., the asset becomes out of date.
To calculate the depreciation of an asset, three factors are taken into account. They are as follows:
1. Cost – This includes all the expenses that are incurred for acquiring the asset and making it
ready for its intended use.
2. Useful life – An estimate of the productive life of the asset. It can be expressed in terms of
time, units of activity (e.g., machine hours) or units of output.
3. Salvage value – The estimated value of the asset at the end of its useful life. It is also called
“scrap value” and “residual value.”
There are three methods of calculating depreciation, and they are listed below:
1. Straight-line.
2. Declining-balance.
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3. Units-of-activity.
Each of these methods has been explained in the following sections.
Example of Straight-Line Method

On January 1, 2022, Barb’s Florists purchased a small delivery truck. Its relevant data is shown
below:
Cost $13,000
Expected salvage value $1,000
Expected useful life in years 5
Expected useful life in miles 100,000
The first step is to calculate the “depreciable cost.” This is the amount of the asset which is
depreciated. It is obtained by subtracting the salvage value from the cost. In this case, the
depreciable cost of the delivery truck is $12,000 ($13,000 - $1,000).
Once the depreciable cost is calculated, it is divided by the asset’s useful life in years. This gives
the amount of depreciation of the asset for the current year. In this case, the depreciation of the
delivery truck for 2022 is $2,400 ($12,000 ÷ 5).
Under the straight-line method, the amount of depreciation of an asset is the same every year. The
following is a depreciation schedule of the delivery truck:
Computation End of Year

Depreciable Useful Annual Accumulated Book
Year Cost ÷ Life = Depreciation Depreciation Value
2022 $12000 5 $2400 $2400 $10600
2023 12000 5 2400 4800 8200
2024 12000 5 2400 7200 5800
2025 12000 5 2400 9600 3400
2026 12000 5 2400 12000 1000
The accumulated depreciation is the sum of the asset’s depreciation for the current and previous
years. The book value is the amount which is obtained by subtracting the accumulated
depreciation from the cost. Here, the book value of the delivery truck in 2022 is $10,600 ($13,000
- $2,400). At the end of the asset’s useful life in 2026, its book value is equal to its expected salvage
value, i.e., $1,000 ($13,000 - $12,000).
The depreciation of an asset is recorded by debiting the Depreciation Expense account and
crediting the Accumulated Depreciation account with the amount of depreciation for the current
accounting period. For example, the journal entry for the depreciation of the delivery truck in 2022
is as follows:
67
GENERAL JOURNAL
2022
Dec. 31 Depreciation Expense 2400
Accumulated Depreciation - Truck 2400
If an asset is bought in the middle of an accounting period, then that has to be taken into
consideration while calculating its depreciation. For example, if Barb’s Florists bought the delivery
truck on April 1, 2022, then it would be owning that for nine months of the year, i.e., Apil to
December. In this case, the amount of depreciation for the truck in 2022 will be $1,800 {($12,000
÷ 5) × (9/12)}. The depreciation schedule would be as follows:

Depreciable Useful Partial Annual Accumulated Book
Year Cost ÷ Life × Year = Depreciation Depreciation Value
2022 $12000 5 9/12 $1800 $1800 $11200
2023 12000 5 2400 4200 8800
2024 12000 5 2400 6600 6400
2025 12000 5 2400 9000 4000
2026 12000 5 2400 11400 1600
2027 12000 5 3/12 600 12000 1000
At the end of the useful life of a plant asset, its book value should be equal to the salvage value. In
this scenario, the book value of the delivery truck in 2026 was greater than its salvage value. This
is why the asset has to be depreciated further in the next year so that the book value becomes equal
to the expected salvage value of $1,000. In 2027, depreciation of the truck is calculated for the
first three months only, i.e., January to March. This is done to make up for the first three months
that had not been accounted for in the calculation of depreciation in 2022.
The journal entry for the depreciation of the delivery truck in 2022 will be as follows:
GENERAL JOURNAL
2022
Example of Declining-Balance Method

When the declining-balance method is used, the amount of depreciation per year decreases over
the useful life. In this method, the annual amount of depreciation of an asset is obtained by
multiplying its book value with a specific rate. This rate is called the “declining-balance rate” and
it is the same every year.
68
A declining-balance rate which is commonly used is a rate that is double the straight-line rate. The
straight-line rate of the delivery truck bought by Barb’s Florists can be obtained by dividing 100%
by its useful life. This would be 20% (100% ÷ 5). The declining-balance rate is double of this rate,
which is 40% (20% × 2). This process of obtaining the declining-balance rate is referred to as the
double-declining-balance method.
Under the declining-balance method, the following would be the depreciation schedule of the
delivery truck bought by Barb’s Florists with the rate of 40%:
Computation Annual End of Year

Book Value Depreciation Depreciation Accumulated Book
× = Expense
Year Beginning of Year Rate Depreciation Value
2022 $13000 40% $5200 $5200 $7800
2023 7800 40 3120 8320 4680
2024 4680 40 1872 10192 2808
2025 2808 40 1123 11315 1685
2026 1685 40 685 12000 1000
[Note: The book value of an asset should be equal to the expected salvage value at the end of its
useful life. This is why in the example above, the amount of depreciation in 2026 is adjusted to
$685 instead of $674 ($1,685 × 40%). The steps for getting this adjusted amount are as follows:
1. Writing $1,000 in the Book Value column for the year 2026.
2. Calculating the accumulated depreciation in 2026 in this way:
Cost – Accumulated Depreciation = Book Value

 $13,000 – Accumulated Depreciation = $1,000
 – Accumulated Depreciation = $1000 – $13,000
 – Accumulated Depreciation = – $12,000
 Accumulated Depreciation = $12,000
3. Calculating the amount of depreciation for 2026 in this way:
Accumulated Depreciation = Previous Year Accumulated Depreciation + Current Year

Depreciation
 $12,000 = $11,315 + Current Year Depreciation
 Current Year Depreciation = $12,000 - $11,315
 Current Year Depreciation = $685]
In this case, the journal entry for the depreciation of the delivery truck in 2022 will be as follows:
69
GENERAL JOURNAL
2022
If the truck is bought in the middle of the accounting period, then that has to be taken into
consideration while calculating its depreciation. For example, if Barb’s Florists buys the delivery
truck on April 1, 2022, then its depreciation schedule would be the following:

Book Value Annual
Beginning of × Depreciation × Partial = Depreciation Accumulated Book
Year Year Rate Year Expense Depreciation Value
2022 $13000 40% 9/12 $3900 $3900 $9100
2023 9100 40 3640 7540 5460
2024 5460 40 2184 9724 3276
2025 3276 40 1310 11034 1966
2026 1966 40 786 11820 1180
2027 1180 40 180 12000 1000
In this case, the journal entry for the depreciation of the delivery truck in 2022 will be as follows:
GENERAL JOURNAL
2022
Example of Units-of-Activity Method

The units-of-activity method is also known as the “units of production method.” Under this
method, the useful life of an asset is not expressed as a period of time but as total units of
production or expected use. This method is often used for depreciating machinery that are used in
factories. The production of these assets can be measured either in units of output or machine
hours, i.e., the time period for which the machinery are operated. The units-of-activity method is
also used to depreciate assets like delivery vehicles (miles driven) and airplanes (hours used). In
contrast, this depreciation method is not suitable for assets such as buildings and furniture.
To use this method, the total units of activity of an asset is first estimated for its useful life. The
depreciable cost of that asset is divided by the total units of activity, which results in the depreciable
cost per unit. To obtain the amount of depreciation for a year, this value is multiplied by the actual
units of activity of that asset in that year.
70
For example, the depreciable cost per unit of the delivery truck bought by Barb’s Florists is $0.12.
This is obtained by dividing the depreciable cost ($12,000) by the asset’s expected useful life in
miles, which is 100,000 miles. Let us assume that the actual mileage of the truck during its useful
life are as follows: 15,000 miles in 2022, 30,000 miles in 2023, 20,000 miles in 2024, 25,000 miles
in 2025, and 10,000 miles in 2026. The depreciation schedule of the truck will be as follows:

Units of Depreciable Depreciation Accumulated Book
× = Expense
Year Activity Cost/Unit Depreciation Value
2022 15000 $0.12 $1800 $1800 $11200
2023 30000 0.12 3600 5400 7600
2024 20000 0.12 2400 7800 5200
2025 25000 0.12 3000 10800 2200
2026 10000 0.12 1200 12000 1000
[Note: The depreciable cost per unit of an asset is the same every year.]
Sale of Plant Assets

A business disposes plant assets that are not useful to it anymore. One way to dispose it is by
selling the asset. Its book value on the disposal date has to be determined in order to know whether
a gain or loss has been made by disposing it. If the disposal does not take place on the first day of
the year, then depreciation for the fraction of the year up to the disposal date has to be calculated.
When selling an asset, a business has to compare its book value with the finance received through
its sale. If the amount of finance is greater than the book value, then a gain on disposal occurs.
However, if the finance is less than the book value, then a loss on disposal occurs.
For example, an organization named Wright Company sells office furniture for $16,000 cash on
July 1, 2022. Its original cost was $60,000. As of January 1, 2022, the furniture had accumulated
depreciation of $41,000. Depreciation for the first six months of 2022 is $8,000. In this scenario,
the depreciation for 2022 has to be recorded with the following journal entry:
GENERAL JOURNAL
2022
July 1 Depreciation Expense 8000
Accumulated Depreciation - Furniture 8000
The next step is to calculate the gain or loss on disposal of the furniture. This is done as follows:
71
Cost of office furniture $60000
Less: Accumulated depreciation ($41000 + $8000) (49000)
Book value at date of disposal 11000
Less: Proceeds from sale (16000)
Gain on disposal of plant asset ($5000)
Here, Wright Company has made a gain by selling the furniture because the proceeds from its sale
are greater than its book value. The sale of the furniture and the gain on its disposal are recorded
with the following journal entry:
GENERAL JOURNAL
2022
July 1 Cash 16000
Furniture 60000
Gain on Disposal of Plant Assets 5000
The amount of gain on disposal is a revenue for the business. It is recorded in the income statement
in the “Other Revenues and Gains” section.
If Wright Company sells the office furniture for $9,000 instead of $16,000, then it will make a loss
on disposal. This is shown below:
Cost of office furniture $60000

Less: Accumulated depreciation ($41000 + $8000) (49000)
Loss on disposal of plant asset $2000
In this case, the company has made a loss by selling the furniture because the proceeds from its
sale are less than its book value. The sale of the furniture and the loss on its disposal are recorded
with the following journal entry:
GENERAL JOURNAL
2022
July 1 Cash 9000
Loss on Disposal of Plant Assets 2000
Furniture 60000
72
In the income statement, a loss on disposal of an asset is recorded in the “Other Expenses and
Losses” section.
Retirement of Plant Assets

Another way of disposing a plant asset is by retiring it. This means to discard that asset.
For example, an organization named Hobard Company retires its computer printers, which cost
$32,000. They have an accumulated depreciation of $32,000. Hence, these printers are fully
depreciated, i.e., their book value is zero. To record this retirement, the following journal entry has
to be made:
GENERAL JOURNAL
Equipment 32000
When an asset is fully depreciated, it is not depreciated further, even if that asset continues to be
used by a business. The value of accumulated depreciation of an asset can never be greater than its
cost.
If a business retires an asset before it is fully depreciated and does not receive any finance for its
residual value, then a loss on disposal occurs. The amount of this loss is the difference between
the cost of the asset and its accumulated depreciation. For example, an organization named Sunset
Company discards delivery equipment that cost $18,000 and has an accumulated depreciation of
$14,000. The required journal entry is as follows:
GENERAL JOURNAL
Loss on Disposal of Plant Assets 4000
Equipment 18000
Determining the Cost of Land

Business organizations use land as a place for a manufacturing plant or office building. The cost
of land includes all of the following:
1. Price of the land.
2. Closing costs such as title and attorney fees.
3. Real estate broker commissions.
4. Accrued property taxes and other liens that are assumed by the purchaser of the land.
73
In addition to these, the cost of land includes all expenses that are incurred to make it ready for its
intended use. Sometimes, land acquired by a business has a building on it which must be removed
before constructing a new building. The difference between the cost of removing the building and
any proceeds from salvaged materials is also added to the cost of land.
For example, an organization named Hayes Company acquires real estate at a price of $100,000.
This property contains an old warehouse which is razed at a net cost of $6,000 (difference between
$7,500 of demolition costs and proceeds of $1,500 from salvaged materials). Additional
expenditures are the attorney’s fees, $1,000, and the real estate broker’s commission, $8,000. The
cost of the land is $115,000 and it is calculated as follows:
Land
Price of the property $100000
Add: Net removal cost of warehouse ($7500 - $1500) 6000
Attorney’s fees 1000
Real estate broker’s commission 8000
Cost of land $115000
Structural additions that are made to land are referred to as land improvements. Some examples
are driveways, parking lots, fences, and landscaping. The cost of such land improvements includes
all expenditures that are incurred to make them ready for their intended use. Land improvements
have limited useful lives. This is why unlike land itself, land improvements are depreciated.
Exercises
Question 1: On January 1, 2022, Evers Company purchased the following two machines for use
in its production process.
Machine A: The cash price of this machine was $48,000. Related expenditures also paid in
cash included: sales tax $1,700, shipping costs $150, insurance during shipping
$80, installation and testing costs $70, and $100 of oil and lubricants to be used
with the machinery during its first year of operations. Evers estimates that the
useful life of the machine is 5 years with a $5,000 salvage value remaining at the
end of that time period. Assume that the straight-line method of depreciation is
used.
Machine B: The recorded cost of this machine was $180,000. Evers estimates that the useful
life of the machine is 4 years with a $10,000 salvage value remaining at the end
of that time period.
Instructions:
a. Prepare the following for Machine A:
1. The journal entry to record its purchase on January 1, 2022.
2. The journal entry to record annual depreciation at December 31, 2022.
74
b. Calculate the amount of depreciation expense that Evers should record for Machine B each
year of its useful life under the following assumptions.
1. Evers uses the straight-line method of depreciation.
2. Evers uses the declining-balance method. The rate used is twice the straight-line rate.
3. Evers uses the units-of-activity method and estimates that the useful life of the machine is
125,000 units. Actual usage is as follows: 2022, 45,000 units; 2023, 35,000 units; 2024,
25,000 units; 2025, 20,000 units.
Solution:
a.
Machine A
Cash price $48000
Add: Sales tax 1700
Add: Shipping costs 150
Add: Insurance during shipping 80
Add: Installation and testing costs 70
Cost of machine A $50000
Depreciable cost of machine A = $(50,000 – 5,000) = $45,000
 Depreciation of machine A in 2022 = $45,000 ÷ 5 = $9,000
GENERAL JOURNAL
2022
Jan. 1 Machinery 50000
Cash 50000
Accumulated Depreciation – Machinery 9000
b.
Depreciable cost of machine B = $(180,000 – 10,000) = $170,000
 Depreciation schedule of machine B under the straight-line method:
75
Depreciable Useful Annual Accumulated Book
÷ =
Year Cost Life Depreciation Depreciation Value
2022 $170000 4 $42500 $42500 $137500
2023 170000 4 42500 85000 95000
2024 170000 4 42500 127500 52500
2025 170000 4 42500 170000 10000
Declining-balance rate for machine B = 2 × (100% ÷ 4) = 50%
 Depreciation schedule of machine B under the declining-balance method:

Book Value Depreciation Depreciation Accumulated Book
× = Expense
Year Beginning of Year Rate Depreciation Value
2022 $180000 50% $90000 $90000 $90000
2023 90000 50 45000 135000 45000
2024 45000 50 22500 157500 22500
2025 22500 50 12500 170000 10000
Depreciable cost per unit of machine B = $170,000 ÷ 125,000 units = $1.36
 Depreciation schedule of machine B under the units-of-activity method:

Units of Depreciable Depreciation Accumulated Book
× = Expense
Year Activity Cost/Unit Depreciation Value
2022 45000 $1.36 $61200 $61200 $118800
2023 35000 1.36 47600 108800 71200
2024 25000 1.36 34000 142800 37200
2025 20000 1.36 27200 170000 10000
Question 2: At December 31, 2022, Grand Company reported the following as plant assets.
Land $4,000,000
Buildings $28,500,000
Less: Accumulated depreciation - buildings (12,100,000)
16,400,000
Equipment 48,000,000
Less: Accumulated depreciation – equipment (5,000,000)
43,000,000
Total plant assets $63,400,000
76
During 2023, the following selected cash transactions occurred.
April 1 Purchased land for $2,130,000.

May 1 Sold equipment that cost $750,000 when purchased on January 1, 2019. The
equipment was sold for $450,000.
June 1 Sold land purchased on June 1, 2013 for $1,500,000. The land cost $400,000.
July 1 Purchased equipment for $2,500,000.
Dec. 31 Retired equipment that cost $500,000 when purchased on December 31, 2013.
Instructions:
a. Journalize the transactions. The company uses straight-line depreciation for buildings and
equipment. The buildings are estimated to have a 50-year life and no salvage value. The
equipment is estimated to have a 10-year useful life and no salvage value. Update depreciation
on assets disposed of at the time of sale or retirement.
b. Record adjusting entries for depreciation for 2023.
Solution:
a.
Accumulated depreciation of the equipment sold for the first four years = ($750,000 ÷ 10) × 4 =
$300,000
Depreciation of the equipment sold for 2022 = ($750,000 ÷ 10) × (4/12) = $25,000
 Total accumulated depreciation of the equipment sold = $(300,000 + 25,000) = $325,000
Cost of equipment $750000

Less: Accumulated depreciation (325000)
Gain on disposal of plant asset ($25000)
Depreciation of the retired equipment for 2022 = ($500,000 ÷ 10) = $50,000
Accumulated depreciation of the retired equipment = ($500,000 ÷ 10) × 10 = $500,000
77
GENERAL JOURNAL
2023
April 1 Land 2130000
Cash 2130000
May 1 Depreciation Expense 25000
May 1 Cash 450000
Equipment 750000
June 1 Cash 1500000
Land 400000
July 1 Equipment 2500000
Cash 2500000
Dec. 31 Accumulated Depreciation – Equipment 500000
Equipment 500000
b.
Depreciation of buildings for 2023 = $28,500,000 ÷ 50 = $570,000
Depreciation of equipment for 2023 = {($48,000,000 – $750,000 – $500,000) ÷ 10} +

{($2,500,000 ÷ 10) × (6/12)} = $4,675,000 + $125,000 = $4,800,000
GENERAL JOURNAL
Accumulated Depreciation – Buildings 570000
78
Chapter 8: Statement of Cash Flows
The statement of cash flows is a financial statement which contains a summary of the cash which
comes in and goes out of a business. It reports cash receipts, cash payments, as well as net change
in cash from operating, financing, and investing activities during an accounting period. This
financial statement can be useful to various stakeholders in the following ways:
1. By examining the relationships between different items in the statement of cash flows,
investors can better understand the ability of a business to generate cash flows in future.
2. If a company does not have sufficient cash, then it cannot pay wages and salaries, debts or
dividends. This is why employees, creditors, and stockholders are likely to be interested in the
statement of cash flows.
3. Under accrual-basis accounting, net income is calculated with many estimates. The users of
the statement of cash flows can know the reasons for the difference between net income and
net cash from operating activities. Then they can assess whether the amount of net income is
reliable or not.
4. Information about the business’s investing and financing transactions can enable a stakeholder
to understand how assets and liabilities changed during an accounting period.
Classification of Cash Flows

In the statement of cash flows, cash receipts and cash payments are classified into the following
three categories:
1. Operating activities – These include the effect on cash of transactions that generate revenues
and expenses. They involve items in the income statement.
2. Investing activities – These are cash flows from changes in investments and long-term assets.
3. Financing activities – These are cash flows from changes in long-term liabilities and
stockholders’ equity.
Preparation of the Statement of Cash Flows

In order to prepare the statement of cash flows, a business needs information from the following
three sources:
1. Comparative balance sheets – Comparing balance sheets from two points of time will show
how the assets, liabilities, and stockholders’ equity changed from the beginning to the end of
the accounting period.
2. Current income statement – This helps to determine the amount of net cash provided or used
by operating activities during the accounting period.
79
3. Additional information – This includes information about transactions which is used to know
how cash was provided or used during the accounting period.
There are two ways of preparing the statement of cash flows, which are as follows:
1. Indirect method – In this method, the net income is adjusted for items that do not affect cash.
The majority of companies use this method for preparing the statement of cash flows because
it is easier to do so.
2. Direct method – In this method, cash receipts and payments are shown in the statement of
cash flows. Every item in the income statement is adjusted from the accrual basis to the cash
basis.
Format of the Statement of Cash Flows

Using the indirect method, a format of the statement of cash flows is as follows:
Name of the Business

Statement of Cash Flows – Indirect Method
For the Year Ended [Date of the End of the Accounting Period]
Cash Flows from Operating Activities
Net income ####
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense ###
Add: Loss on disposal of plant assets ###
Decrease in accounts receivable ###
Increase in accounts payable ###
Decrease in inventory ###
Decrease in prepaid expenses ###
Increase in income taxes payable ###
Less: Increase in inventory (###)
Increase in prepaid expenses (###)
Decrease in income taxes payable (###)
Gain on disposal of plant assets (###)
Increase in accounts receivable (###)
Decrease in accounts payable (###)
###
Net cash provided/used by operating activities ####
Cash Flows from Investing Activities
Sale of land ####
Add: Sale of building ###
Add: Sale of equipment ###
Less: Purchase of land (###)
Less: Purchase of building (###)
Less: Purchase of equipment (###)
Net cash provided/used by investing activities ####
80
Cash Flows from Financing Activities
Issuance of common stock ###
Add: Issuance of bond ###
Less: Payment of cash dividends (###)
Less: Repurchase of common stock (###)
Net cash provided/used by financing activities ####
Net increase/decrease in cash ###
Add: Cash at beginning of period ####
Cash at end of period ####
Example of a Statement of Cash Flows

The following are some information related to Computer Services Company for 2022.
Computer Services Company

Comparative Balance Sheets
December 31
Changes in
Account Balance
2022 2021 Increase/Decrease
Assets
Current assets:
Cash $55,000 $33,000 $22,000 Increase
Accounts receivable 20,000 30,000 10,000 Decrease
Inventory 15,000 10,000 5,000 Increase
Prepaid expenses 5,000 1,000 4,000 Increase
Property, plant, and equipment:
Land 130,000 20,000 110,000 Increase
Buildings 160,000 40,000 120,000 Increase
Accumulated depreciation – buildings (11,000) (5,000) 6,000 Increase
Equipment 27,000 10,000 17,000 Increase
Accumulated depreciation – equipment (3,000) (1,000) 2,000 Increase
Total assets $398,000 $138,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable $28,000 $12,000 $16,000 Increase
Income taxes payable 6,000 8,000 2,000 Decrease
Long-term liabilities:
Bonds payable 130,000 20,000 110,000 Increase
Stockholders’ equity:
Common stock 70,000 50,000 20,000 Increase
Retained earnings 164,000 48,000 116,000 Increase
Total liabilities and stockholders’ equity $398,000 $138,000
81
Income Statement
For the Year Ended December 31, 2022
Sales revenue $507,000
Less: Cost of goods sold (150,000)
Gross profit 357,000
Less: Operating expenses (excluding depreciation) ($111,000)
Depreciation expense (9,000)
Income from operations 237,000
Less: Other Expenses and Losses
Loss on disposal of plant assets 3,000
Interest expense 42,000
(45,000)
Income before income tax 192,000
Less: Income tax expense (47,000)
Net income $145,000
Additional information for 2022:
1. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.
2. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated
depreciation $1,000) for $4,000 cash.
3. Issued $110,000 of long-term bonds in direct exchange for land.
4. A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also
purchased for cash.
5. Issued common stock at par for $20,000 cash.
6. The company declared and paid a $29,000 cash dividend.
According to the indirect method, the statement of cash flows of Computer Services Company for
2022 is as follows:

Statement of Cash Flows – Indirect Method
For the Year Ended December 31, 2022
Cash Flows from Operating Activities
Net income $145000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense $9000
Add: Loss on disposal of plant assets 3000
Decrease in accounts receivable 10000
82
Increase in accounts payable 16000
Less: Increase in inventory (5000)
Less: Increase in prepaid expenses (4000)
Less: Decrease in income taxes payable (2000)
27000
Net cash provided by operating activities 172000
Cash Flows from Investing Activities
Sale of equipment 4000
Less: Purchase of building (120000)
Less: Purchase of equipment (25000)
Net cash used by investing activities (141000)
Cash Flows from Financing Activities
Issuance of common stock 20000
Less: Payment of cash dividends (29000)
Net cash used by financing activities (9000)
Net increase in cash 22000
Add: Cash at beginning of period 33000
Cash at end of period $55000
83

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BUS505 Course Notes

Course Name: Accounting Principles

Chapter 1: Accounting in Action ................................................................................................. 4

Accounting and Bookkeeping

Users of Accounting Data

3. International Accounting Standards Board (IASB) – This organization sets accounting

2. Usually offers small types 2. Usually involved in 2. It is a separate legal entity

The Accounting Equation

 Assets = Liabilities + Owner’s Equity

 Assets = Liabilities + (Owner’s Capital + Revenues – Expenses – Owner’s Drawings)

Effect of Transactions on the Accounting Equation

2. Softbyte purchases computer equipment for $7,000 cash.

Here, total assets = $(8050+1400+1600+7000) = $18050,

total liabilities and equity = $(1600+16450) = $18050.

 Assets = Liabilities + Owner’s Equity = $18050.

• A single line is placed below the last item in a column of values.

The owner’s equity statement of Softbyte is shown in the next page:

The balance sheet of Softbyte is shown in the next page:

1. Joan invested $11,000 in cash in the law practice.

2. Paid $800 for July rent on office space.

3. Purchased equipment on account $3,000.

4. Performed legal services to clients for cash $1,500.

5. Borrowed $700 cash from a bank on a note payable.

6. Performed legal services for client on account $2,000.

8. Joan withdrew $1,000 cash for personal use.

a. Prepare a tabular summary of the transactions.

Here, total assets = $(10500+2000+3000) = $15500,

total liabilities and equity = $(3700+11800) = $15500.

 Assets = Liabilities + Owner’s Equity = $15500.

Service revenue = $(1500+2000) = $3500

Debits and Credits

1. a) If an asset account increases, then it is debited.

b) If an asset account decreases, then it is credited.

2. a) If a liability account increases, then it is credited.

b) If a liability account decreases, then it is debited.

3. a) If the owner’s capital account increases, then it is credited.

b) If the owner’s capital account decreases, then it is debited.

4. a) If the owner’s drawings account increases, then it is debited.

b) If the owner’s drawings account decreases, then it is credited.

5. a) If an expense account increases, then it is debited.

b) If an expense account decreases, then it is credited.

6. a) If a revenue account increases, then it is credited.

b) If a revenue account decreases, then it is debited.

The advantages of using a journal are as follows:

1. It shows the complete effects of a transaction.

2. It provides a record of a business’s transactions in chronological order.

Asset Accounts Liability Accounts Owner’s Equity Accounts

Land Accounts payable Owner’s capital

Equipment Interest payable Owner’s drawings

Buildings Salaries and Salaries and

Name of the Account

➢ This format is called the “three-column form of account.”

The format of a trial balance is as follows:

Name of the Owner/Business

1. A transaction is not journalized.

2. A correct journal entry is not posted.

3. A journal entry is posted twice.

4. Wrong accounts are used in journalizing or posting.

5. Offsetting errors are made when the amount of a transaction is recorded.

Oct. 1 The owner invests $10,000 cash into the business.