CHAPTER 3

THE ACCOUNTING PROCESS

1
 LEARNING CONTENTS
3.1. Overview of accounting process

3.2. The Identification

3.3. The Measurement

3.4. The Recording

3.5. The Communication

 Overview of accounting
3.1
process
The
Identification

The
Measurement
The recording

The
communication
3
 Accounting process

The activities of the accounting

process

Identification Measurement Recording Communication

Accounting
Recording reports
Transactions Quantification
classification Analysis &
in $ terms
summarisation interpretation

The accounting process includes

the bookkeeping function.
 Identification

◼ As a starting point to the accounting process, an

entity identifies the economic event (transactions)
relevant to its business.

◼ Identification: Observing events; identifying those

events that are economic events; measurement
economic events in financial terms.

◼ A transaction is recorded on a source document

5
 Identification

◼ A transaction is a business event that has a monetary

impact on an entity's financial statements, and is
recorded as an entry in its accounting records.
◼ Transactions are events that;
(i) cause an immediate change in the financial
resources or obligations of the business.
(ii) can be measured objectively in monetary terms.
 Measurement

✓ Process of expressing assets of one entity in

terms of money
✓ Reasons:
➢ Assets with differently physical forms
➢ Needs of useful information; inventories, fixed assets
✓ Unit of money: $ U.S, VND…
 Recording

◼ Once a entity identifies economic events, it records those

events in order to provide a history of its financial activities.
Recording consists of keeping a systematic, chronological
diary of events, measured in term of money.
◼ Recording: Recording measurements, classifying
measurements, summarizing measurements.
◼ To record transactions, entities use a set of procedures and
records. These include a ledger, T-account, debits and
credits, double-entry accounting, journalizing, and posting.
 Communication

◼ Finally, entity communicates the collected

information to interested users by means of
accounting reports. The most common of these
reports are called financial statements.
◼ Communication:
 Reporting economic events in financial statements
and other reports
 Analyzing and interpreting the reported
information.
 3.2 The Identification

Learning Objectives
Defining the source document for recording business
1 transactions

2 Types of source documents

3 Identifying basic information in source documents

4 Source document process and flowchat

 Defining the source document for
1 recording business transactions.

◼ Source document:
• A source document is the original record
containing the details to substantiate a transaction
entered in an accounting system.
• A source document describes all the basic
facts of the transaction, such as the amount of the
transaction, to whom the transaction was made,
the purpose of the transaction, and the transaction
date.
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 Credit sale Credit purchased

Receive sales Sales order

Order from (receive Purchase Send purchase
customer from Order to supplier
order
customer)

Prepare goods Goods Receive goods

And delivery Delivery received with suppliers’s
Note; deliver to Delivery note
note note
customer

Prepare sales Purchase Receive purchased

Invoice and send Sales invoice Invoice from
to customer (receive supplier
invoice
from
SOURCE SOURCE
DOCUMENT
customer) DOCUMENT
2 Some types of source documents
2 Some types of source documents

• Quotation
• Purchase Order
• Sales Order
• Delivery note
• Goods received note
• Credit Note
• Debit Note
• Invoice…
 2 Some types of source documents

◼ Quotation – This is an agreement, usually written, from a

producer to a potential customer to sell goods or services at
a particular price and quantity. The quotation may include
the cost to produce, deliver and finance the purchase
◼ Purchase Order – This is a written order giving the
authorization to purchase goods or services from a supplier
◼ Sales Order – A sales order (SO) is an internal document
that is generated from a customer's purchase order. This
document is generated to create an audit trail/control to be
used to monitor the entire sales process using the company’s
internal numbering system instead of relying on the
customer's purchase order, and the numbering system that it
is based on. 15
 2 Some types of source documents

◼ Credit Note – This document is sent by a supplier to a

customer to reduce the liability of the customer. In essence it
is a negative invoice that is issued when goods are returned,
when there was an overpayment, or when some other event
has occurred that has the effect of reducing the amount that
the customer owes to the supplier.
◼ Debit Note – This document is sent from a customer to a
supplier to request a credit note in respect to an overpayment
or return of goods.
◼ Invoice – This document is sent to request payment for
monies owed, for goods that were delivered, or services that
were rendered
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 2 Some types of source documents

◼ A supplier invoice is the bill issued by a vendor for goods

delivered or services rendered to a customer. It itemizes the
goods and services sold to a customer, as well as any sales
taxes and shipping charges incurred as part of the
transaction
◼ A bank reconciliation statement is a summary of banking
and business activity that reconciles an entity’s bank
account with its financial records. The statement outlines
the deposits, withdrawals, and other activities affecting a
bank account for a specific period
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 2 Some types of source documents

◼ Goods received note: Goods Received Note (GRN) is a

record of goods received from suppliers, and the record is
shown as a proof that ordered products had been received
◼ Goods dispatched note: The goods dispatch note is the
supplier's records of the same order. It is created every time
an order is delivered or shipped. One copy is given to the
dispatching department and another to the accounting
department. The accounting department uses this document
to create an invoice. Petty cash voucher:

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 2 Some types of source documents

◼ Cash receipt: is a printed acknowledgement of the

amount of cash received during a transaction involving
the transfer of cash or cash equivalent
◼ Cash payment invoice: is an invoice used to record a
payment made with physical cash.
◼ Check: is an order for a specific sum of money that a
bank can pay to whoever it's addressed to. Banks
typically distribute books of checks to customers who
open accounts with them, who can then write checks for
transactions like purchasing products and paying for
services.
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 2 Some types of source documents

Pay in slip: is a written record of a bank deposit.

Accountants can use pay in slips to record the date when a
deposit is made, who made the deposit and the amount the
deposit is for. When using a pay in slip, someone can fill out
the form with the necessary information and bring it to their
bank with the cash deposit. Then, a bank teller can sign and
stamp the pay in slip and return it to the person making the
deposit, who can pass it on to their accountant to be included
in their financial records.

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22
23
Types of Source Documents
 Identifying basic information
3 in source documents

Name of source document

Date and reference number of the transaction

Description of a business transaction

The amount (Money, quantity, labor hour…)

Name, address, signature, seal (if any)

Of business (people) related to accounting transaction
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4 Source documents process and flowchart

Transfer

Completion

Source
Documents process
and flowchart
Storage
Inspection

Preparation

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 Responsibility Function parts
Specific work Payer Payment Chief Cashier Director
accountant accountant

1. Application
for payment 1
2. Preparing
Cash receipt 2
invoice
3. Sign in Cash
receipt invoice
3a 3b
4. Receive cash 4
5. Recording in
accounting book
5
6. Storage
6
 Responsibility Fuction parts

Specific works Payment Payment Chief Cashier Director

requester Accountant Accountant

1. Application for
payment 1
2. Preparing Cash
payment invoice
2
3 Sign in Cash
payment invoice
3a 3b
4. Pay cash 5
5. Recording in
accounting book
4
6. Storage
6
 3.2 The Measurement

A. Which elements are measured?

B. Prices (based) used for measurement?
C. Time of measurement?
D. Measurement of Inventory
E. Measurement of Fixed Asset

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 A. Which elements are measured?

1. Asset
2. Liability
3. Equity
4. Income
5. Expense

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 B. Prices used for measurement?
(Or measurement bases)

1. Historical cost
2. Current cost
3. Market value (Selling price)
4. Relizable value
5. Present value
6. Fair value

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 Historical cost

◼ Historical cost is a term used instead of the

term cost. Cost and historical cost usually
mean the original cost at the time of a
transaction.
◼ The amount of money that was originally used
to pay for an asset.
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 Current cost

◼ Current cost are amount of cash or cash

equivalent that would be paid if assets were
acquired currently

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 Market value
◼ Market value refers to the current or most recently-
quoted price for a market-traded security. It can also
refer to the most probable price an asset, like a house,
would fetch on the open market
◼ The market value of an asset is determined by
fluctuations in supply and demand. It should be noted
that market value represents what someone is willing
to pay for an asset -- not the value it is offered for or
intrinsically worth
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 Realizable value
Realizable Value = Selling Price – Costs to sales

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 Present value

◼ Current worth of future sum of money

◼ Present value likely refers to the amount that
remains after future cash amounts have been
discounted to an earlier time
◼ The discounting process involves removing
the time value of money, future interest, etc.
which is contained within the future cash
amounts.
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 Fair value
Fair value is the price that two parties are
willing to pay for an asset or liability,
preferably in an active market. A less accurate
measure of fair value is when there is an active
market for a similar item, while the least
accurate measurement method is to use the
discounted cash flows associated with the
future performance of an item.
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 Example
◼ ABC Business bought a car costing VND 600,000,000 on 1 January X1. A
car could be used for five years with no scrap value at the end of its useful
life.
◼ At the end of year 2, the net book value of the car will be VND
360,000,000. This is carrying value of the car using historical cost basic.
◼ Suppose ABC Business lost its car and it needs a replacement. If a
similar car will cost VND 408,000,000, then the replacement or current
cost is VND 408,000,000.
◼ Let’s us say, that ABC Business wants to dispose of its car and it could
get VND 336,000,000 for it. VND 336,000,000 is realizable value.
◼ Suppose ABC Business uses the car for rent and earns VND 108,000,000
per annum. Assuming that the car can be used for rent for three more years
then the cash flow from the asset is VND 324,000,000. If present value of
the VND 324,000,000 VND were to be VND 294,000,000 then present
value of the car is VND 294,000,000

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 C. Time of measurement?

◼ Measurement at initial recognition

◼ Measurement subsequent to initial recognition
◼ Measurement at the end of accounting period

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 D. Measurement of inventory

◼ Measurement at initial recognition

❖ General principle: (AT COST) the cost of bringing items
of inventory to their present location and condition
❖ Cost of purchases: purchase price including import
duties, transport and handling costs any other directly
attributable costs, less trade discounts, purchase returns &
allowances (cash discount; purchase discount)
❖ Cost of self-produced inventory: cost of direct materials
+ conversion costs (direct labor costs + manufacturing
overhead)

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 D. Measurement of inventory

◼ Measurement at subsequent to initial recognition

o FIFO (First-in, first-out)
o LIFO (Last-in, first-out)
o Average
o Specific identification

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 D. Measurement of inventory

◼ Measurement at subsequent to initial recognition

Some items are charged as expense:
• Abnormal waste
• Storage costs (except inventory need to
produce further for sale)
• Administrative costs
• Selling costs.

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 D. Measurement of inventory
◼ Perpeptual system: provides a continuous record of the
balance in both the Inventory and Cost of Goods Sold
accounts. (Only perpetual inventory introduced in this
subject)
1. Purchases of merchandise are debited to Inventory.
2. Freight-in is debited to Inventory. Purchase returns and
allowances and purchase discounts are credited to
Inventory.
3. Cost of goods sold is debited and Inventory is credited for
each sale.
4. Subsidiary records show quantity and cost of each type of
inventory on hand.
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 D. Measurement of inventory
Periodic system:
1. Purchases of merchandise are debited to Purchases.
2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:
Beginning inventory $ 100,000
Purchases, net + 800,000
Goods available for sale 900,000
Ending inventory - 125,000
Cost of goods sold $ 775,000
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 D. Measurement of inventory
◼ Measurement at subsequent to initial recognition
❖ FIFO:
Oldest cost => Cost of good sold
Recent cost => Ending inventory
❖ LIFO
Recent cost => Cost of good sold
Oldest cost => Ending inventory
❖ SPECIFIC UNIT COST
When units are sold, the specific cost of the unit sold is added to
cost of goods sold
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 D. Measurement of inventory

◼ Measurement at subsequent to initial recognition

❖ AVERAGE COST

The average cost of each unit in inventory is assigned to

cost of goods sold.
Average cost = Cost of inventory on hand / Number of
units on hand

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 D. Measurement of inventory

◼ Measurement at the end of accounting period

End inventory = Beg inventory + inventory increased –
inventory decreased

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 E. Measurement of Fixed Asset

◼ Measurement at initial recognition

The cost of an item of property, plant and equipment comprises:
✓ Purchase price, less any trade discount or rebate
✓ Directly attributable costs of bringing the asset to working
condition for its intended use:
▪ Initial delivery and handling costs
▪ Installation costs
▪ Professional fees (architects, engineers)
▪ Test costs
▪ ……..
❖ Example
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 E. Measurement of Fixed Asset

◼ Measurement at subsequent to initial recognition

❖ Repair:
❖ Depreciation: Systematic allocation of cost of tangiable
asset over its useful life
Depreciation amount = cost – residual value (Scrap value)
Residual value = Proceed form disposal – cost to dispose
Annual dep expense = (cost – residual value)/useful life
(Straight line method)
❖ Disposal:
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 E. Measurement of Fixed Asset

◼ Measurement at the end of accounting period

❖ CA (Carrying amount) = Initial cost – Accumulated
depreciation

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 3.4 The Recording

Learning Contents

3.4.1 The recording process.

3.4.2 Adjusting the accounts.

3.4.3 Completing the accounting cycle.

 3.4.1 The Recording Process

Learning Objectives

1 Account and form of account

Describe how accounts, debits and credits are used to record

2
business transactions

3 Indicate how a journal is used in the recording process.

Explain how a ledger and posting help in the recording

4
process.
 3.4.2 Adjusting The Accounts

Learning Objectives
Explain the accrual basis of accounting and the
1 reasons for adjusting entries.

2 Prepare adjusting entries for deferrals.

3 Prepare adjusting entries for accruals.

 Completing the
3.4.3 Accounting Cycle
Learning Objectives

1 Prepare closing entries.

2 Explain how to prepare entries for correcting errors

3 Prepare a trial balance.

 1 Accounts and form of account

A part of the accounting system

used to classify and summarize the
The
Account increases, decreases, and balances
of each asset, liability,
stockholders' equity item, revenue,
and expense.

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 How to open accounts

The chart of accounts is a complete listing of the titles

and numbers of all the accounts in the ledger. The
chart of accounts can be compared to a table of
contents. The groups of accounts usually appear in
this order: assets, liabilities, stockholders' equity,
dividends, revenues, and expenses.
 Types of Accounts
Assets

BS Account: real
Liabilities
(permanent) accounts

Relationship to Equity
FS
I/CS Account: Income
nominal (temporary)
accounts Expenses
Control accounts
Accounts Detailed
information level
Subsidiary accounts

Real accounts

Function Contra accounts

Nominal accounts
Structure of accounts

General Structure

Structure of Asset account

Structure of Equity account

Structure of operation process

account (nominal account)

Structure of some special

accounts

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 General Structure of accounts

An account can
be illustrated in a
T-account form.

Three parts:
(1) A title/name
(2) A left or debit side
(3) A right or credit side.

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 General Structure of accounts

• Do NOT think of the way others use these terms

(such as your banks)!
• Do NOT be thinking of your plastic “debit cards” and
“credit cards”!
• Do NOT mistakenly think of Debit as “debt” and
Credit as “credit” (as the world defines them)!
• Do NOT mistakenly think of Debit as “good things”
and credits as “bad things”
• “Debit” means LEFT; “Credit” means RIGHT!!!!
 General Structure of accounts

Beginning balance + Increase

= Decrease + Ending balance
 Structure of asset account

Assets
Debit / Dr. Credit / Cr.

Normal Balance

Chapter
3-23

63
 Structure of Liability account

Liabilities
Debit / Dr. Credit / Cr.

Normal Balance

Chapter
3-24

64
 Structure of Owner’s Equity account

Owner’s Equity
Debit / Dr. Credit / Cr.

Normal Balance

Chapter
3-25

65
 Structure of Expense account

Expense
Debit / Dr. Credit / Cr.

Chapter
3-27

66
 Structure of Income account

Revenue
Debit / Dr. Credit / Cr.

Chapter
3-26

67
 Structure of Income summary account

Debit Income summary Credit

- Expense brought forward Income brought forward

- Profit in term - Loss in term

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Structure of some special accounts

Depreciation of fix asset/Accumulated

depreciation
Advance payment by customers

Advanced payment to suppliers

Deferred revenue

Prepaid expense

Provision for payable expenses

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Structure: opposite with asset account

Debit Accumulated depreciation Credit

Beginning balance: Accumulated

depreciation at beginning of
accounting period
Debiting: Decreased Crediting: Increased
depreciation value of fixed depreciation value of fixed
asset in accounting period asset in accounting period

Ending balance: Accumulated

depreciation at end of accounting period

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Structure: as equity account structure

Advanced payment by customers

Beginning balance: Advanced
payment remained at beginning of
accounting period

Debiting: Advanced payment Crediting: Advanced payment

decreased in accounting period increased in accounting period

Ending balance: Advance

payment remained at the end of
accounting period

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Structure: as asset account structure

Advanced payment to suppliers

Beginning balance: Prepaid to

sellers at beginning of
accounting period

Debiting: Advanced payment Crediting: Advanced payment

to suppliers increased in to suppliers decreased in
accounting period accounting period

Ending balance: Prepaid to sellers

at the end of accounting period
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Structure: as equity account structure

Deferred revenue
Beginning balance: Unallocated
deferred revenue at beginning of
accounting period

Debiting: Deferred revenue Crediting: Deferred revenue

allocated into income in increased in accounting period
accounting period

Ending balance:Unallocated
deferred revenue at end of
accounting period

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Structure: as asset account structure
Prepaid expense

Beginning balance: Unallocated

prepaid expense at beginning of
accounting period

Debiting: Actual prepaid cost Crediting: Prepaid expense

arising in accounting period allocated in accounting period

Ending balance: Unallocated

prepaid expense at end of
accounting period

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Structure: as equity account structure

Provision for payable expenses

Beginning balance: Provision for
payable expenses accumulated at
beginning of accounting period

Debiting: Actual payable Crediting: Deduction of

expenses arising in accounting provision for payable expense
period accounted into expense in
accounting period

Ending balance: Accumulated

provision for payable expenses at
the end of accounting period
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 Debits/Credits Rules

Balance Sheet Income Statement

Asset = Liability + Equity Revenue - Expense

Debit

Credit
 Summary of Debits/Credits Rules

Relationship among the assets, liabilities and owner’s equity

of a business:
Illustration 2-11
Basic
Equation Assets = Liabilities + Owner’s Equity

Expanded
Equation
Debit/Credit
Effects

The equation must be in balance after every transaction. Total

Debits must equal total Credits.
 Debits/Credits Rules

Question
Debits:

a. Increase both assets and liabilities.

b. Decrease both assets and liabilities.

c. Increase assets and decrease liabilities.

d. Decrease assets and increase liabilities.

 Debits/Credits Rules

Question
Accounts that normally have debit balances are:

a. Assets, expenses, and revenues.

b. Assets, expenses, and equity.

c. Assets, liabilities, and owner’s drawing.

d. Assets
 2 Recording financial transaction in accounts

◼ Double entry bookkeeping:

◆ Each transaction must affect two or more accounts

to keep the basic accounting equation in balance.

◆ Recording done by debiting at least one account

and crediting at least one other account.

◆ DEBITS must equal CREDITS.

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 2 Recording financial transaction in accounts

◼ The rules of double entry bookkeeping:

A debit entry will

• Increase an asset • Decrease a liability
• Increase an expense • Decrease capital
• Decrease income
A credit entry will
• Decrease an asset • Increase a liability
• Increase capital
• Decrease an expense
• Increase income

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 2 Recording financial transaction in accounts

◼ Steps in Recording in Accounts:

Step 1: Identify that items are

affected and consider
whether they are being increased or
decreased and by how much.

Step 2: Determine what type of

account is involved

Step 3: Translate the increases and

decreases into debits and credits.
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 Recording the following financial transactions in accounts
1. Ray Neal decides to start a smartphone app development company which he names
Softbyte. On September 1, 2017, he invests $15,000 cash in the business.
2. Softbyte Inc. purchases computer equipment for $7,000 cash.
3. Softbyte Inc. purchases for $1,600 headsets and other accessories expected to last
several months
4. Softbyte Inc. receives $1,200 cash from customers for app development services it has
performed.
5. Softbyte Inc. 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 services. The company receives cash of $1,500 from
customers, and it bills the balance of $2,000 on account
7. Softbyte Inc. pays the following expenses in cash for September: office rent $600,
salaries and wages of employees $900, and utilities $200.
8. Softbyte Inc. pays its $250 Daily News bill in cash. The company previously (in
Transaction 5) recorded the bill as an increase in Accounts Payable
9. Softbyte Inc. receives $600 in cash from customers who had been billed for services (in
Transaction 6).
10. Ray Neal withdraws $1,300 in cash in cash from the business for his personal use
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Recording the following financial transactions in accounts
1. Purchase a van (using for delivery of goods), which is payable to supplier
X: 420
2. Pay salary to employees (cash on hand): 50
3. Receipts from customer A for due amount of previous period (cash at
bank): 50
4. Owner contributes additional capital in cash (cash on hand): 500
5. Retained earnings used to increase capital: 200
6. Advances to employees for business trip (cash on hand): 15
7. Retained earnings is allocated to Bonus and Welfare Fund: 10
8. Merchandise is purchased and received, paid by cash at bank: 50
9. Purchase tangible fixed assets financed by long-term loan: 300
10. Payment to settle short-term loan(cash at bank):100;payment to State
Treasury: 30
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 Indicate how a journal is used
3 in the recording process.

The JOURNAL
◆ Book of original entry.
◆ Transactions recorded in chronological order.
◆ Contributions to the recording process:
1. Discloses the complete effects of a transaction.
2. Provides a chronological record of transactions.
3. Helps to prevent or locate errors because the
debit and credit amounts can be easily compared.

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JOURNALIZING - Entering transaction data in the journal.
Name:...........
GENERAL JOURNAL
Year:..................
(Unit:..........)
Voucher Amount
Explanation Ref Account
No Date Deb Cre
Opened a bank v Cash 20.000
account in the name of
1 Owner’’s
Hair It Is and deposited 20.000
capital
cash
Purchased equipment Equipment 4.800
2
on account A/P 4.800

Total 24.800 24.800

86
 Indicate how a journal is used
3 in the recording process.

SIMPLE AND COMPOUND ENTRIES

Illustration: On July 1, Butler Company purchases a delivery truck
costing $14,000. It pays $8,000 cash now and agrees to pay the remaining
$6,000 on account.

Voucher Amount
Explanation Ref Account
No Date Deb Cre
Fixed asset 14.000
1/7/N Purchases a delivery truck
Cash 8.000
Account payable 6.000

Total
 DO IT!
Kate Browne engaged in the following activities in establishing
her salon, Hair It Is:

1. Opened a bank account in the name of Hair It Is and

deposited $20,000 of her own money in this account as her
initial investment.

2. Purchased equipment on account (to be paid in 30 days)

for a total cost of $4,800.

3. Interviewed three persons for the position of hair stylist.

Prepare the entries to record the transactions.

 DO IT!
Prepare the entries to record the transactions.

1. Opened a bank account and deposited $20,000.

Dr Cash 20,000
Cr Owner’s Capital 20,000

2. Purchased equipment on account (to be paid in 30 days)

for a total cost of $4,800.
Dr Equipment 4,800
Cr Accounts Payable 4,800

3. Interviewed three persons for the position of hair stylist.

No entry
 Explain how a ledger and posting
4 help in the recording process.

The Ledger
◆ General Ledger contains all the asset, liability, and owner’s
equity accounts.
Illustration 2-15
 The Ledger

STANDARD FORM OF ACCOUNT

CASH NO.111
Source
Amount
Date doccument Explaination Ref.
N D Debit Credit

Sept.1 Beginning balance

Sum

Ending balance
 Ledger

POSTING
Transferring
journal entries
to the ledger
accounts.
Posting

Question
Posting:

a. Normally occurs before journalizing.

b. Transfers ledger transaction data to the journal.

c. Is an optional step in the recording process.

d. Transfers journal entries to ledger accounts.

 DO IT! Posting
Kate Brown recorded the following transactions in a general journal
during the month of March. Post these entries to the Cash account.

Mar. 4 Cash 2,280

Service Revenue 2,280
Mar. 15 Salaries and Wages Expense 400
Cash 400
Mar. 19 Utilities Expense 92
Cash 92
Draft financial information shown below has been prepared for Z,
a joint stock company, as at 01/01/N (unit: million VND)

Cash on hand 1.500 A/P 1.700

Cash at bank 3.000 Salaries Payable 800
Merchandise 2.130 Owner’s Capital 18.000
Accounts receivable 50 Taxes payable 30
Tangible fixed assets 15.000 Short term loan 100
Retain earnings 1.050

95
1. Purchase a van (using for delivery of goods), which is payable to supplier X: 420
2. Pay salary to employees (cash on hand): 50
3. Receipts from customer A for due amount of previous period (cash at bank): 50
4. Owner contributes additional capital in cash (cash on hand): 500
5. Retained earnings used to increase capital: 200
6. Advances to employees for business trip (cash on hand): 15
7. Retained earnings is allocated to Bonus and Welfare Fund: 10
8. Merchandise is purchased and received, paid by cash at bank: 50
9. Purchase tangible fixed assets financed by long-term loan: 300
10. Payment to settle short - term loan (cash at bank):100; payment to State
Treasury: 30
Required:
1. Prepare the General Journal
2. Prepare the General ledger of cash on hand, payable to employees, retain
earnings.
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 3.4.2 Adjusting The Accounts

Learning Objectives
Explain the accrual basis of accounting and the reasons for
1 adjusting entries.

2 Prepare adjusting entries for deferrals.

3 Prepare adjusting entries for accruals.

 Explain the accrual basis of accounting
1 and the reasons for adjusting entries.

REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
 Explain the accrual basis of accounting
1 and the reasons for adjusting entries.

EXPENSE RECOGNITION PRINCIPLE

Match expenses with revenues
in the period when the company
makes efforts that generate
those revenues.

“Let the expenses

follow the revenues.”
 Explain the accrual basis of accounting
1 and the reasons for adjusting entries.

The Needs for Adjusting Entries

◆ Ensure that the revenue recognition and expense
recognition principles are followed.

◆ Necessary because the trial balance may not contain

up-to-date and complete data.

◆ Required every time a company prepares financial

statements.

◆ Will include one income statement account and one

balance sheet account.
The Needs for Adjusting Entries

Question:
Adjusting entries are made to ensure that:
a. Expenses are recognized in the period in which
they are incurred.
b. Revenues are recorded in the period in which
services are performed.
c. Balance sheet and income statement accounts
have correct balances at the end of an accounting
period.
d. All of the above.
Types of Adjusting Entries
Illustration 3-2
Categories of adjusting entries

Deferrals Accruals

1. Prepaid Expenses. 1. Accrued Revenues.

Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet
received in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.
 DO IT! Timing Concepts
A list of concepts is provided in the left column below, with a description of the
concept in the right column below. There are more descriptions provided than
concepts. Match the description of the concept to the concept.

f Accrual-basis accounting.
1. ___ (a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be matched
e Calendar year.
2. ___
with results (revenues).
c Time period assumption.
3. ___ (c) Accountants divide the economic life of
b Expense recognition
4. ___ a business into artificial time periods.
principle. (d) Companies record revenues when they
receive cash and record expenses
when they pay out cash.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the
period in which the events occur.
2 Prepare adjusting entries for deferrals.

Deferrals are expenses or revenues that are recognized

at a date later than the point when cash was originally
exchanged. There are two types:

◆ Prepaid expenses

◆ Unearned revenues
Prepaid Expenses

Payment of cash, that is recorded as an asset to show the

service or benefit the company will receive in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

◆ Insurance ◆ Rent
◆ Supplies ◆ Equipment
◆ Advertising ◆ Buildings
Prepaid Expenses

◆ Expire either with the passage of time or through use.

◆ Adjusting entry:
► Increase (debit) to an expense account and

► Decrease (credit) to an asset account.

Illustration 3-4
Depreciation

◆ Buildings, equipment, and motor vehicles

(assets that provide service for many years) are
recorded as assets, rather than an expense, on
the date acquired.

◆ Depreciation is the process of allocating the cost

of an asset to expense over its useful life.

◆ Depreciation does not attempt to report the actual

change in the value of the asset.

► Allocation concept, not a valuation concept.

Depreciation

Illustration: For Pioneer Advertising, assume

that depreciation on the equipment is $480 a
year, or $40 per month.

Oct. 31

Depreciation expense 40
Accumulated depreciation 40

Accumulated Depreciation is called

a contra asset account.
Illustration 3-7
Depreciation

STATEMENT PRESENTATION
◆ Accumulated Depreciation is a contra asset account
(credit).
◆ Offsets related asset account on the balance sheet.
◆ Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Illustration 3-8
Prepaid Expenses

Summary of the accounting for prepaid expenses.

Unearned Revenues

Receipt of cash that is recorded as a liability because the

service has not been performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

◆ Rent ◆ Magazine subscriptions

◆ Airline tickets ◆ Customer deposits
Unearned Revenues

◆ Adjusting entry is made to record the revenue for

services performed during the period and to show the
liability that remains at the end of the period.

◆ Results in a decrease (debit) to a liability account

and an increase (credit) to a revenue account.
 Unearned Revenues

Illustration: Pioneer Advertising received

$1,200 on October 2 from R. Knox for
advertising services expected to be
completed by December 31. Unearned
Service Revenue shows a balance of $1,200
in the October 31 trial balance. Analysis
reveals that the company performed $400 of
services in October.

Oct. 31
Unearned Service Revenue 400
Service Revenue 400
Unearned Revenues
Illustration 3-11
Unearned Revenues

Summary of the accounting for unearned revenues.

Illustration 3-12
3 Prepare adjusting entries for accruals.

Accruals are made to record

◆ Revenues for services performed but not yet

recorded at the statement date.

◆ Expenses incurred but not yet paid or recorded at

the statement date.
 Accrued Revenues

Revenues for services performed but not yet received in

cash or recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

◆ Rent
◆ Interest
◆ Services
Accrued Revenues

◆ Adjusting entry shows the receivable that exists and

records the revenues for services performed.

◆ Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
Illustration 3-13
Accrued Revenues

Illustration: In October Pioneer Advertising

performed services worth $200 that were not
billed to clients on or before October 31.

Oct. 31

Accounts Receivable 200

Service Revenue 200

On November 10, Pioneer receives cash of $200 for the services

performed.

Nov. 10 Cash 200

Accounts Receivable 200
Accrued Revenues
Illustration 3-14
Accrued Revenues

Summary of the accounting for accrued revenues.

Illustration 3-15
Accrued Expenses

Expenses incurred but not yet paid in cash or recorded.

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

◆ Rent ◆ Taxes
◆ Interest ◆ Salaries
Accrued Expenses

◆ Adjusting entry records the obligation and recognizes

the expense.

◆ Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Illustration 3-16
Accrued Expenses

ACCRUED INTEREST
Illustration: Pioneer Advertising signed a three-month note
payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.
Illustration 3-17

Oct. 31 Interest expense 50

Interest payable 50
Accrued Expenses
Illustration 3-18
Accrued Expenses

ACCRUED INTEREST
Illustration: Pioneer Advertising paid salaries and wages on
October 26; the next payment of salaries will not occur until
November 9. The employees receive total salaries of $2,000 for a
five-day work week, or $400 per day.
Illustration 3-19
Accrued Expenses
Illustration 3-20
Accrued Expenses

Summary of the accounting for accrued expenses.

Illustration 3-21
Summary of Basic Relationships
Illustration 3-22
 DO IT! Adjusting Entries for
Accruals
Micro Computer Services began operations on August 1, 2017.
At the end of August 2017, management prepares monthly
financial statements. The following information relates to
August.
1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a
local bank on a 15-year mortgage. The annual interest
rate is 10%.
3. Revenue for services performed but unrecorded for
August totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.
 DO IT! Adjusting Entries for
Accruals
Prepare the adjusting entries needed at August 31, 2017.
1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
Salaries and Wages Expense 800
Salaries and Wages Payable 800
2. On August 1, the company borrowed $30,000 from a local bank
on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 250
Interest Payable 250

3. Revenue for services performed but unrecorded for August

totaled $1,100.
Accounts Receivable 1,100
Service Revenue 1,100
 3.4.3
Completing the
Accounting Cycle
Learning Objectives

1 Prepare closing entries.

2 Prepare entries for Correcting errors

3 Prepare a trial balance.

 1 Prepare closing entries.

At the end of the accounting period, the company makes

the accounts ready for the next period.
Preparing Closing Entries

Closing entries formally recognize in the ledger the transfer of

◆ Net income (or net loss) and
◆ Owner’s drawings

to owner’s capital.

Companies generally journalize and post closing entries only at

the end of the annual accounting period.
Closing entries produce a zero balance in each temporary
account.
Preparing Closing Entries

Illustration 4-9
Diagram of closing
process—proprietorship

Owner’s Capital is a
permanent account.
All other accounts are
temporary accounts.
 Preparing Closing Entries
CLOSING
ENTRIES
ILLUSTRATED
Posting
Closing
Entries
 2 Correction of errors

Types of errors in Accounting:

➢ Transposition errors: When two digits in an amount are
accidentally recorded the wrong way round.
➢ Errors of omission: Failing to record a transaction at all, or making
a debit or credit entry, but not the corresponding double entry
➢ Errors of principle: Making a double entry in the belief that the
transaction is being entered in the correct accounts, but
subsequently finding out that the accounting entry breaks the 'rules'
of an accounting principle or concept
➢ Errors of Commission: Where the bookkeeper makes a mistake in
carrying out his or her task of recording transactions in the accounts.
Two examples are: - putting a debit/credit entry in the wrong
account; errors of casting (adding up)
➢ Compensating errors: Errors which are, coincidentally, equal and
opposite to one another
◼ Errors of Dr or Cr:
◼ Amount, transposition:
◼ Detail objects: true A, fasle B
◼ Increase, decrease

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 2 Correction of errors

◼ Errors which have not caused an imbalance are corrected via

journals
◼ Errors which have broken the rules of double entry bookkeeping
and result in the trial balance failing to balance can be corrected
by:
1. Setting up a suspense account
2. Clearing it with correcting journal
◼ A suspense account may also be deliberately set up when a book
keeper doesnot know where to put one side of an entry
◼ Suspense accounts are always temporary and should never appear
in FS. These should not be prepared until the errors have been
corrected and the suspense account has been cleared.
◼ Some corrections of errors will result in adjustment to a draft
profit calculated while there were still errors in the account.
141
 2 Correction of errors

◼ Journal entries:
1. Work out first what the original entry was
2. Then what the original entry should have been
3. And finally what the correcting entry should be

142
 2 Correction of errors

◼ Suspense account: An account showing a balance equal

to the difference in a trial balance.
◼ Using a suspense account when the trial balance does
not balance:
+ Open a suspense account with the amount of the
imbalance.
+ Use a journal entry to clear the suspense account and
correct the error.
◼ Using a suspense account to complete the double entry
When bookkeeper does not know where to post one side
of a transaction.
143
 3 Prepare a trial balance.

Trial balance

Name of Openning balance Incurred Ending balance

account
Debit Credit Debiting Crediting Debit Credit

Total

144
 3 Prepare a trial balance.

◼ Trial balance: is a list of nominal ledger balance

shown in debit and credit columns, as a method of
testing the accuracy of double entry bookkeeping.
The trial balance is not part of the double entry
system.
◼ The balance at the end of a period on all the nominal
ledgers are listed on a trial balance, debit balances
appear in the debit column and credit balances in the
credit column. When added up, the two columns
should be equal.

145
 3 Prepare a trial balance.

◼ Limitations of trial balance: Even if the trial

balance balances, the following error types may still
have arisen in the ledger accounts:
+ Omission errors
+ Commission errors
+ Compensating errors
+ Errors of principle
▪ Two types of trial balance:
✓ Initial trial balance
✓ Extended trial balance
146
 3.5 The communication

Learning Contents

1 Steps to prepare Financial statements

2 Statement of Profit or Loss (Income statement

3 Statement of Financial position(Balance sheet)

 1 Steps to prepare Financial statements.

◼ To prepare the statement of profit or loss and statement of

financial position, you need to follow through methodically the
steps involved:
✓ Calculate balances on all nominal ledger accounts
✓ Prepare the trial balance
✓ Transfer income and expense balances to the profit and loss
ledger account and calculate profit (or loss) for the period
✓ Prepare statement of profit or loss
✓ Transfer profit or loss ledger account and drawings balance to
capital account
✓ Prepare statement of financial position

148
 2 Statement of Profit or Loss (Income statement).
◼ The statement of profit or loss, is a name that is often used for
what today is the income statement which reports a company's
revenues, expenses, and most of the gains and losses which
occurred during the period of time specified in its heading.
◼ The statement of profit or loss’ period of time could be a year,
a year-to-date period such as nine months, a quarter of a year,
one month, four weeks, 52 weeks, etc.
◼ Under the accrual basis (or method) of accounting the
revenues and expenses reported on the profit and loss
statement should be: the revenues (sales, service fees) that
were earned during the accounting period, and
◼ the expenses (cost of goods sold, salaries, rent, advertising,
etc.) that match the revenues being reported or have
expired during the accounting period.
149
 2 Statement of Profit or Loss (Income statement).

Single-Step Format
The single-step statement Income Statement (in thousands)
Revenues:
consists of just two Sales $ 285,000
groupings: Interest revenue 17,000
Total revenue 302,000
Expenses:
Revenues Single- Cost of goods sold 149,000
Selling expense 10,000
Expenses Step
Administrative expense 43,000

Net Income Interest expense 21,000

Income tax expense 24,000
Total expenses 247,000
Net income $ 55,000
No distinction between
Operating and Non-
Earnings per share $ 0.75
operating categories.

LO 2 Prepare a single-step income statement.

150
 2 Statement of Profit or Loss (Income statement).

Multiple-Step Format
Income Statement (in thousands)
The presentation Sales $ 285,000
divides information Cost of goods sold 149,000
Gross profit 136,000
into major sections. Operating expenses:
Selling expenses 10,000
1. Operating Administrative expenses 43,000
Total operating expense 53,000
Section
Income from operations 83,000
2. Nonoperating Other revenue (expense):
Section Interest revenue 17,000
Interest expense (21,000)
Total other (4,000)
Income before taxes 79,000
3. Income tax Income tax expense 24,000
Net income $ 55,000

Earnings per share $ 0.75

LO 3 Prepare a multiple-step income statement.

151
 2 Statement of Profit or Loss (Income statement).

Item Code Notes Current year Previous year

Revenue from sales of merchandises and
services rendered
Revenue deductions
Net revenue from sales of merchandises
and services rendered
Costs of goods sold
Gross profit from sales of merchandises
and services rendered
Revenue from financing activity
Financial expenses
Selling expenses
General administration expenses
Net profit from operating activity
Other income
Other expenses
Other profit (40 = 31 – 32)
Total accounting profit before tax
Current corporate income tax expense

152
3 Statement of Financial position (Balance sheet)
◼ The statement of financial position is another name for the balance
sheet. It is one of the main financial statements and it reports an entity's
assets, liabilities, and the difference in their totals. The amounts reported
on the statement of financial position are the amounts as of the final
moment of an accounting period.
◼The structure of the statement of financial position is similar to the basic
accounting equation. For instance, a corporation will report amounts in the
following format: Assets = Liabilities + Stockholders' Equity. A nonprofit
organization's format will be: Assets = Liabilities + Net Assets.
◼The statement of financial position must reflect the basic accounting
principles and guidelines such as the cost, matching, and full disclosure
principle. Accordingly, the statement of financial position is more

meaningful when it is prepared under the accrual method of accounting.

153
 3 Statement of Financial position (Balance sheet)

Balance Sheet - Format

Account Form Illustration 5-
16

LO 3 Prepare a classified balance sheet using the report and account formats.

154
 3 Statement of Financial position (Balance sheet)
Illustration 5-
16

Balance Sheet -
Format

Report Form

LO 3

155
3 Statement of Financial position (Balance sheet)
157