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1/21/2020Exercise 5-1

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 5 Assignment

*Exercise 5-1
This information relates to Cullumber Co..

1. On April 5, purchased merchandise from Oriole Company for $26,600, terms 4/10, n/30.

2. On April 6, paid freight costs of $630 on merchandise purchased from Oriole Company.

3. On April 7, purchased equipment on account for $33,900.

4. On April 8, returned $5,100 of April 5 merchandise to Oriole Company.

5. On April 15, paid the amount due to Oriole Company in full.

(a)

Prepare the journal entries to record the transactions listed above on Cullumber Co.’s books.
Cullumber Co. uses a perpetual inventory system. (If no entry is required, select “No Entry”
for the account titles and enter 0 for the amounts. Credit account titles are automatically
indented when amount is entered. Do not indent manually. Record journal entries in the
order presented in the problem.)

No.

Date Account Titles and Explanation Debit Credit

(b)

Assume that Cullumber Co. paid the balance due to Oriole Company on May 4 instead of April 15.
Prepare the journal entry to record this payment. (If no entry is required, select “No Entry” for
the account titles and enter 0 for the amounts. Credit account titles are automatically
indented when amount is entered. Do not indent manually. Record journal entries in the
order presented in the problem.)

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Date Account Titles and Explanation Debit Credit

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 4 Assignment

*Exercise 4-11
The unadjusted trial balance for Blue Spruce Corp. is shown below.

BLUE SPRUCE CORP.
Trial Balance

October 31, 2017

Debit Credit

Cash $15,450

Supplies 2,950

Prepaid Insurance 690

Equipment 4,570

Notes Payable $4,570

Accounts Payable 2,270

Unearned Service Revenue 1,750

Common Stock 11,290

Retained Earnings 0

Dividends 600

Service Revenue 13,490

Salaries and Wages Expense 4,000

Rent Expense 5,110

$33,370 $33,370

Assume the following adjustment data.

1. Supplies on hand at October 31 total $620.

2. Expired insurance for the month is $115.

3. Depreciation for the month is $60.

4. As of October 31, services worth $880 related to the previously recorded unearned revenue
had been performed.

5. Services performed but unbilled (and no receivable has been recorded) at October 31 are
$320.

6. Interest expense accrued at October 31 is $90.

7. Accrued salaries at October 31 are $1,540.

Prepare the adjusting entries for the items above. (If no entry is required, select “No Entry”
for the account titles and enter 0 for the amounts. Credit account titles are automatically
indented when the amount is entered. Do not indent manually.)

No. Date Account Titles and Explanation Debit Credit

1. Oct. 31

2. Oct. 31

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3. Oct. 31

4. Oct. 31

5. Oct. 31

6. Oct. 31

7. Oct. 31

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 5 Assignment

*Exercise 5-3
The following transactions are for Sheridan Company.

1. On December 3, Sheridan Company sold $519,300 of merchandise to Crane Co., terms 2/10,
n/30. The cost of the merchandise sold was $329,200.

2. On December 8, Crane Co. was granted an allowance of $24,100 for merchandise purchased
on December 3.

3. On December 13, Sheridan Company received the balance due from Crane Co.

(a)

Prepare the journal entries to record these transactions on the books of Sheridan Company.
Sheridan Company uses a perpetual inventory system. (If no entry is required, select “No
Entry” for the account titles and enter 0 for the amounts. Credit account titles are
automatically indented when amount is entered. Do not indent manually.)

No.

Date Account Titles and Explanation Debit Credit

(To record credit sale)

(To record cost of merchandise sold)

3. Dec. 13

(b)

Assume that Sheridan Company received the balance due from Crane Co. on January 2 of the
following year instead of December 13. Prepare the journal entry to record the receipt of payment
on January 2. (If no entry is required, select “No Entry” for the account titles and enter 0
for the amounts. Credit account titles are automatically indented when amount is
entered. Do not indent manually.)

Date Account Titles and Explanation Debit Credit

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1/21/2020 Exercise 4-20 (Part Level Submission)

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 4 Assignment

*Exercise 4-20 (Part Level Submission)
Selected year-end account balances from the adjusted trial balance as of December 31, 2017, for
Martinez Corp. is provided below.

Debit Credit

Accounts Receivable $75,500

Dividends 27,350

Depreciation Expense 13,730

Equipment 221,310

Salaries and Wages Expense 94,740

Accounts Payable $55,120

Accumulated Depreciation—Equipment 119,390

Unearned Rent Revenue 23,820

Service Revenue 191,150

Rent Revenue 6,450

Rent Expense 3,740

Retained Earnings 64,270

Supplies Expense 1,460

*(a)
Prepare closing entries. (Credit account titles are automatically indented when the amount
is entered. Do not indent manually. If no entry is required, select “No Entry” for the
account titles and enter 0 for the amounts.)

Date Account Titles and Explanation Debit Credit

Dec. 31

(To close revenue account)

Dec. 31

(To close expense accounts)

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Dec. 31

(To close net income to retained earnings)

Dec. 31

(To close dividends to retained earnings)

*(b)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

1/21/2020 Problem 3-6A (Part Level Submission)

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 3 Assignment

*Problem 3-6A (Part Level Submission)
This is the trial balance of Pharoah Company on September 30.

PHAROAH COMPANY
Trial Balance

September 30, 2017

Debit Credit

Cash $ 23,830

Accounts Receivable 7,230

Supplies 5,040

Equipment 10,940

Accounts Payable $ 9,430

Unearned Service Revenue 4,040

Common Stock 19,630

Retained Earnings 13,940

$47,040 $47,040

The October transactions were as follows.

Oct. 5 Received $1,440 in cash from customers for accounts receivable due.

10 Billed customers for services performed $5,470.

15 Paid employee salaries $1,260.

17 Performed $590 of services in exchange for cash.

20 Paid $1,970 to creditors for accounts payable due.

29 Paid a $250 cash dividend.

31 Paid utilities $350.

*(a)
Prepare a general ledger using T-accounts. Enter the opening balances in the ledger accounts as of
October 1.

Cash

Accounts Receivable

Supplies

Equipment

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Accounts Payable

Unearned Service Revenue

Common Stock

Retained Earnings

*(b)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(c)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(d)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 3 Assignment

*Problem 3-2A (Part Level Submission)
Nona Curry started her own consulting firm, Shamrock, Inc., on May 1, 2017. The following transactions occurred during the month of May.

May 1 Stockholders invested $21,375 cash in the business in exchange for common stock.

2 Paid $855 for office rent for the month.

3 Purchased $712 of supplies on account.

5 Paid $214 to advertise in the County News.

9 Received $1,995 cash for services performed.

12 Paid $285 cash dividend.

15 Performed $5,985 of services on account.

17 Paid $3,562 for employee salaries.

20 Paid for the supplies purchased on account on May 3.

23 Received a cash payment of $1,710 for services performed on account on May 15.

26 Borrowed $7,125 from the bank on a note payable.

29 Purchased office equipment for $2,850 paying $285 in cash and the balance on account.

30 Paid $256 for utilities.

*(a)
Show the effects of the above transactions on the accounting equation using the following format. Assume the note payable is to be repaid within the year. (
decrease in Assets, Liabilities or Stockholders’ Equity, place a negative sign (or parentheses) in front of the amount entered for the particula
that was reduced. See Illustration 3-3 for example.)

SHAMROCK, INC.

Assets = Liabilities + Stockholde

Date Cash + AccountsReceivable + Supplies +
Equipment = NotesPayable +

Accounts
Payable +

Common
Stock + R

Revenues

May 1 $ $ $ $ $ $ $ $

May 2

May 3

May 5

May 9

May 12

May 15

May 17

May 20

May 23

May 26

May 29

May 30

$ $ $ $ = $ $ $ $

*(b)
The parts of this question must be completed in order. This part will be available when you complete the part above.

*(c)
The parts of this question must be completed in order. This part will be available when you complete the part above.

1/21/2020 Problem 4-7A (Part Level Submission)

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 4 Assignment

*Problem 4-7A (Part Level Submission)
On November 1, 2017, the following were the account balances of Soho Equipment Repair.

Debit Credit

Cash $ 3,230 Accumulated Depreciation—Equipment $ 500

Accounts Receivable 3,030 Accounts Payable 2,740

Supplies 1,560 Unearned Service Revenue 400

Equipment 10,440 Salaries and Wages Payable 740

Common Stock 10,440

Retained Earnings 3,440

$18,260 $18,260

During November, the following summary transactions were completed.

Nov.
8

Paid $1,220 for salaries due employees, of which $480 is for November and $740 is for
October salaries payable.

10 Received $1,820 cash from customers in payment of account.

12 Received $3,770 cash for services performed in November.

15 Purchased store equipment on account $3,850.

17 Purchased supplies on account $1,370.

20 Paid creditors $2,580 of accounts payable due.

22 Paid November rent $520.

25 Paid salaries $1,040.

27 Performed services on account worth $980 and billed customers.

29 Received $820 from customers for services to be performed in the future.

*(a)
Enter the November 1 balances in the ledger accounts.

Cash

Accounts Receivable

Supplies

Equipment

Accumulated Depreciation—Equipment

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Accounts Payable

Unearned Service Revenue

Salaries and Wages Payable

Common Stock

Retained Earnings

*(b)

The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(c)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(d)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(e1)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(e2)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(f)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(g1)

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The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(g2)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(g3)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

1/21/2020Problem 3-4A

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Date Account Titles and Explanation Debit Credit

Mar. 3

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 3 Assignment

*Problem 3-4A
Bradley’s Miniature Golf and Driving Range Inc. was opened on March 1 by Bob Dean. These
selected events and transactions occurred during March.

Mar. 1 Stockholders invested $58,500 cash in the business in exchange for common stock of the
corporation.

3 Purchased Snead’s Golf Land for $42,800 cash. The price consists of land $24,400,
building $9,780, and equipment $8,620. (Record this in a single entry.)

5 Advertised the opening of the driving range and miniature golf course, paying advertising
expenses of $2,700 cash.

6 Paid cash $3,600 for a 1-year insurance policy.

10 Purchased golf clubs and other equipment for $5,850 from Tahoe Company, payable in 30
days.

18 Received golf fees of $1,550 in cash from customers for golf services performed.

19 Sold 105 coupon books for $20 each in cash. Each book contains 10 coupons that enable
the holder to play one round of miniature golf or to hit one bucket of golf balls. (Hint: The
revenue should not be recognized until the customers use the coupons.)

25 Paid a $540 cash dividend.

30 Paid salaries of $760.

30 Paid Tahoe Company in full for equipment purchased on March 10.

31 Received $930 in cash from customers for golf services performed.

Journalize the March transactions. Bradley’s records golf fees as service revenue. (If no entry is
required, select “No Entry” for the account titles and enter 0 for the amounts. Credit
account titles are automatically indented when amount is entered. Do not indent
manually. Record journal entries in the order presented in the problem.)

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(Paid salaries expense)

(Paid creditor on account)

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WOLFORD DEPARTMENT STORE
Income Statement

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 5 Assignment

*Problem 5-4A (Part Level Submission)
Wolford Department Store is located in midtown Metropolis. During the past several years, net
income has been declining because suburban shopping centers have been attracting business away
from city areas. At the end of the company’s fiscal year on November 30, 2017, these accounts
appeared in its adjusted trial balance.

Accounts Payable $ 35,376

Accounts Receivable 22,704

Accumulated Depreciation—Equipment 89,760

Cash 10,560

Common Stock 46,200

Cost of Goods Sold 810,876

Freight-Out 8,184

Equipment 207,240

Depreciation Expense 17,820

Dividends 15,840

Gain on Disposal of Plant Assets 2,640

Income Tax Expense 13,200

Insurance Expense 11,880

Interest Expense 6,600

Inventory 34,584

Notes Payable 57,420

Prepaid Insurance 7,920

Advertising Expense 44,220

Rent Expense 44,880

Retained Earnings 18,744

Salaries and Wages Expense 154,440

Sales Revenue 1,193,280

Salaries and Wages Payable 7,920

Sales Returns and Allowances 26,400

Utilities Expense 13,992

Additional data: Notes payable are due in 2021.

*(a1)
Prepare a multiple-step income statement. (List other revenues before other expenses.)

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$
$

Attempts: 0 of 3 used

*(a2)

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The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(a3)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(b)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

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Date Account Titles and Explanation Debit Credit

(To record credit sale)

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AC201:AC201MNS1A2020 Principles Financial Accounting / AC201 – Chapter 5 Assignment

*Problem 5-1A (Part Level Submission)
Winters Hardware Store completed the following merchandising transactions in the month of May.
At the beginning of May, Winters’ ledger showed Cash of $10,400 and Common Stock of $10,400.

May
1

Purchased merchandise on account from Black Wholesale Supply for $8,050, terms 1/10,
n/30.

2 Sold merchandise on account for $4,400, terms 2/10, n/30. The cost of the merchandise
sold was $3,300.

5 Received credit from Black Wholesale Supply for merchandise returned $350.

9 Received collections in full, less discounts, from customers billed on May 2.

10 Paid Black Wholesale Supply in full, less discount.

11 Purchased supplies for cash $1,170.

12 Purchased merchandise for cash $4,030.

15 Received $299 refund for return of poor-quality merchandise from supplier on cash
purchase.

17 Purchased merchandise from Wilhelm Distributors for $2,350, terms 2/10, n/30.

19 Paid freight on May 17 purchase $325.

24 Sold merchandise for cash $7,150. The cost of the merchandise sold was $5,330.

25 Purchased merchandise from Clasps Inc. for $1,040, terms 3/10, n/30.

27 Paid Wilhelm Distributors in full, less discount.

29 Made refunds to cash customers for returned merchandise $135. The returned
merchandise had cost $91.

31 Sold merchandise on account for $1,664, terms n/30. The cost of the merchandise sold
was $1,079.

*(a)
Journalize the transactions using a perpetual inventory system. (If no entry is required, select
“No Entry” for the account titles and enter 0 for the amounts. Credit account titles are
automatically indented when amount is entered. Do not indent manually. Record journal
entries in the order presented in the problem.)

1/21/2020 Problem 5-1A (Part Level Submission)

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(To record cost of merchandise sold)

May 9

(To record sales)

(To record cost of merchandise sold)

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(To record payment for returned merchandise)

(To record cost of goods returned)

(To record credit sale)

(To record cost of goods sold on account)

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*(b)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(c)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

*(d)
The parts of this question must be completed in order. This part will be available when you
complete the part above.

Merchandising Operations and the Multiple-Step Income Statement

Kimmel ● Weygandt ● Kieso

Accounting, Sixth Edition

5-‹#›

CHAPTER OUTLINE
Describe merchandising operations and inventory systems.
1
LEARNING OBJECTIVES
Record purchases under a perpetual inventory system.
2
Record sales under a perpetual inventory system.
3
Prepare a multiple-step income statement and a comprehensive income statement.
4
Determine cost of goods sold under a periodic inventory system.
5
Compute and analyze gross profit rate and profit margin.
6

5-‹#›

Merchandising Companies
Buy and Sell Goods
Wholesaler
Consumer

The primary source of revenues is referred to as sales revenue or sales.

Retailer

LEARNING OBJECTIVE
Describe merchandising operations and inventory systems.
1
LO 1

5-‹#›

Income Measurement
Cost of goods sold is the total cost of merchandise sold during the period.
Not used in a Service business.

Net
Income
(Loss)
Less
Less
Equals
Equals
Sales
Revenue
Cost of
Goods Sold
Gross
Profit
Operating
Expenses
ILLUSTRATION 5-1
Income measurement process for a merchandising company
Merchandising Company
LO 1

5-‹#›

OPERATING CYCLES
ILLUSTRATION 5-2
Operating cycles for a service company and a merchandising company
LO 1

5-‹#›

Companies use either a perpetual inventory system or a periodic inventory system to account for inventory.
FLOW OF COSTS
ILLUSTRATION 5-3
Flow of costs
LO 1

5-‹#›

Perpetual System
Maintain detailed records of the cost of each inventory purchase and sale.
Records continuously show inventory that should be on hand for every item.
Company determines cost of goods sold each time a sale occurs.
FLOW OF COSTS
LO 1

5-‹#›

Do not keep detailed records of the goods on hand.
Cost of goods sold determined by count at the end of the accounting period.
Calculation of Cost of Goods Sold:
Beginning inventory $ 100,000
Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000

Periodic System
FLOW OF COSTS
LO 1

5-‹#›

Traditionally used for merchandise with high unit values.
Shows the quantity and cost of the inventory that should be on hand at any time.
Provides better control over inventories than a periodic system.
Advantages of the Perpetual System
FLOW OF COSTS
LO 1

5-‹#›

INVESTOR INSIGHT
Improve Stock Appeal
Investors are often eager to invest in a company that has a hot new product. However, when snowboard maker Morrow Snowboards, Inc. issued shares of stock to the public for the first time, some investors expressed reluctance to invest in Morrow because of a number of accounting control problems. To reduce investor concerns, Morrow implemented a perpetual inventory system to improve its control over inventory. In addition, it stated that it would perform a physical inventory count every quarter until it felt that its perpetual inventory system was reliable.
LO 1
Morrow Snowboards, Inc.

5-‹#›

Merchandising Operations and Inventory Systems
Indicate whether the following statements are true or false. If false, indicate how to correct the statement.
DO IT!
1
LO 1
False
(service company)
The primary source of revenue for a merchandising company results from performing services for customers.
The operating cycle of a service company is usually shorter than that of a merchandising company.
Sales revenue less cost of goods sold equals gross profit.
Ending inventory plus the cost of goods purchased equals cost of goods available for sale.
True
True
False
(Beg. Inventory + COGS)

5-‹#›

ILLUSTRATION 5-5
Sales invoice used as
Purchase invoice by Sauk Stereo
Made using cash or credit (on account).
Normally record when goods are received from the seller.
Purchase invoice should support each credit purchase.
LEARNING OBJECTIVE
Record purchases under a perpetual inventory system.
2
LO 2

5-‹#›

Illustration: Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal entry for Sauk Stereo for the invoice from PW Audio Supply.
Inventory 3,800
May 4
Accounts Payable 3,800
Record Purchase of Merchandise

ILLUSTRATION 5-5
LO 2

5-‹#›

Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller.
Ownership of the goods remains with the seller until the goods reach the buyer.
Freight costs incurred by the seller are an operating expense.
LO 2
FREIGHT COSTS

ILLUSTRATION 5-6
Shipping terms

5-‹#›
Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Public Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is:
Inventory 150
May 6
Cash 150
Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would be:
Freight-out 150
May 4
Cash 150
FREIGHT COSTS
LO 2

5-‹#›

Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications.
Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash.
May choose to keep the merchandise if the seller will grant a reduction of the purchase price.
Purchase Return
Purchase Allowance
PURCHASE RETURNS AND ALLOWANCES
LO 2

5-‹#›

Illustration: Assume Sauk Stereo returned goods costing $300 to PW Audio Supply on May 8.
Accounts Payable 300
May 8
Inventory 300
PURCHASE RETURNS AND ALLOWANCES
LO 2

5-‹#›

PURCHASE RETURNS AND ALLOWANCES
Review Question
In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting:
Purchases
Purchase Returns
Purchase Allowance
Inventory
LO 2

5-‹#›

Credit terms may permit buyer to claim a cash discount for prompt payment.
Advantages:
Purchaser saves money.
Seller shortens the operating cycle by converting the accounts receivable into cash earlier.
Example: Credit terms may read 2/10, n/30.
PURCHASE DISCOUNTS
LO 2

5-‹#›

2% discount if paid within 10 days, otherwise net amount due within 30 days.
1% discount if paid within first 10 days of next month.
2/10, n/30
1/10 EOM
Net amount due within the first 10 days of the next month.
n/10 EOM
PURCHASE DISCOUNTS
LO 2

5-‹#›

Accounts Payable 3,500
May 14
Cash 3,430
Inventory 70
(Discount = $3,500 x 2% = $70)
Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry Sauk Stereo makes on May 14 to record the payment.
PURCHASE DISCOUNTS
LO 2

5-‹#›

Accounts Payable 3,500
June 3
Cash 3,500
Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of $3,500 on June 3, the journal entry would be:
PURCHASE DISCOUNTS
LO 2

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Should discounts be taken when offered?

Example: 2% for 20 days = Annual rate of 36.5%
($3,500 x 36.5% x 20) ÷ 365 = $70
PURCHASE DISCOUNTS
LO 2

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$3,800
8th – Return
$300
Balance
4th – Purchase
$3,580
70
14th – Discount
150
6th – Freight-in
PURCHASING TRANSACTIONS
LO 2

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Purchase Transactions
On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The purchase price of the goods paid by De La Hoya is $1,500. On September 8, De La Hoya returns defective goods with a selling price of $200. Record the transactions on the books of De La Hoya Company.
SOLUTION
DO IT!
2
Inventory 1,500
Accounts Payable 1,500
LO 2
Sept. 5
Accounts Payable 200
Inventory 200
Sept. 8

5-‹#›

Sales may be made on credit or for cash.
Sales revenue, like service revenue, is recorded when the performance obligation is satisfied.
Performance obligation is satisfied when the goods are transferred from the seller to the buyer.
Sales invoice should support each credit sale.
ILLUSTRATION 5-5
LEARNING OBJECTIVE
Record sales under a perpetual inventory system.
3
LO 3

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Journal Entries to Record a Sale
Accounts Receivable or Cash XXX
Sales Revenue XXX
#1
Cost of Goods Sold XXX
Inventory XXX
#2
Selling Price
Cost
Recording Sales
LO 3

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Accounts Receivable 3,800
May 4
Sales Revenue 3,800
Illustration: PW Audio Supply records the sale of $3,800 on May 4 to Sauk Stereo on account (Illustration 5-5) as follows (assume the merchandise cost PW Audio Supply $2,400).
Cost of Goods Sold 2,400
4
Inventory 2,400
Recording Sales
LO 3

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LO 3

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“Flip side” of purchase returns and allowances.
Contra revenue account to Sales Revenue (debit).
Sales not reduced (debited) because:
Would obscure importance of sales returns and allowances as a percentage of sales.
Could distort comparisons.
SALES RETURNS AND ALLOWANCES
LO 3

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Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a $300 selling price (assume a $140 cost). Assume the goods were not defective.
Sales Returns and Allowances 300
May 8
Accounts Receivable 300
Inventory 140
8
Cost of Goods Sold 140
SALES RETURNS AND ALLOWANCES
LO 3

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Sales Returns and Allowances 300
Accounts Receivable 300
Inventory 50
Cost of Goods Sold 50
Illustration: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries:
May 8
8
SALES RETURNS AND ALLOWANCES
LO 3

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Review Question
The cost of goods sold is determined and recorded each time a sale occurs in:
periodic inventory system only.
a perpetual inventory system only.
both a periodic and perpetual inventory system.
neither a periodic nor perpetual inventory system.
SALES RETURNS AND ALLOWANCES
LO 3

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ACCOUNTING ACROSS THE ORGANIZATION
The Point of No Returns?
In most industries, sales returns are relatively minor. But returns of consumer electronics can really take a bite out of profits. Recently, the marketing executives at Costco Wholesale Corp. faced a difficult decision. Costco has always prided itself on its generous return policy. Most goods have had an unlimited grace period for returns. A new policy will require that certain electronics must be returned within 90 days of their purchase. The reason? The cost of returned products such as high-definition TVs, computers, and iPods cut an estimated 8¢ per share off Costco’s earnings per share, which was $2.30.
Source: Kris Hudson, “Costco Tightens Policy on Returning Electronics,” Wall Street Journal (February 27, 2007), p. B4.
LO 3

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Offered to customers to promote prompt payment of the balance due.
Contra revenue account (debit) to Sales Revenue.
SALES DISCOUNTS
LO 3

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Cash 3,430
May 14
Accounts Receivable 3,500
Sales Discounts 70
* [($3,800 – $300) X 2%]
*
Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14.
SALES DISCOUNTS
LO 3

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On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The selling price of the goods is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns goods with a selling price of $200 and a cost of $105. Record the sale on the books of Junot Diaz Company.
SOLUTION
Accounts Receivable 1,500
Sales Revenue 1,500
Sept. 5
Cost of Goods Sold 800
Inventory 800
Sept. 5
Sales Transactions
DO IT!
3
LO 3

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On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The selling price of the goods is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns goods with a selling price of $200 and a cost of $105. Record the return on the books of Junot Diaz Company.
SOLUTION
Sales Returns and Allowances 200
Accounts Receivable 200
Sept. 8
Inventory 105
Cost of Goods Sold 105
Sept. 8
Sales Transactions
DO IT!
3
LO 3

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Subtract total expenses from total revenues
Two reasons for using the single-step format:
Company does not realize any type of profit or income until total revenues exceed total expenses.
Form is simple and easy to read.
SINGLE-STEP INCOME STATEMENT
LEARNING OBJECTIVE
Prepare a multiple-step income statement and a comprehensive income statement.
4
LO 4

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Illustration 5-7

SINGLE-STEP INCOME STATEMENT
ILLUSTRATION 5-7
Single-step income statements
LO 4

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Highlights the components of net income.
Three important line items:
gross profit,
income from operations, and
net income.

MULTIPLE-STEP INCOME STATEMENT
LO 4

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Key Line Items

MULTIPLE-STEP INCOME STATEMENT
ILLUSTRATION 5-8
Multiple-step income statements
LO 4

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Key Items:
Sales
ILLUSTRATION 5-11
MULTIPLE-STEP

LO 4

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Key Items:
Sales
Gross Profit
ILLUSTRATION 5-11

MULTIPLE-STEP
LO 4

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Key Items:
Sales
Gross Profit
Operating Expenses
ILLUSTRATION 5-11

MULTIPLE-STEP
LO 4

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Key Items:
Sales
Gross Profit
Operating Expenses
Nonoperating Activities
ILLUSTRATION 5-11

MULTIPLE-STEP
LO 4

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Key Items:
Sales
Gross Profit
Operating Expenses
Nonoperating Activities
ILLUSTRATION 5-11

MULTIPLE-STEP

LO 4

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Key Items:
Sales
Gross Profit
Operating Expenses
Nonoperating Activities
Net Income
ILLUSTRATION 5-11

MULTIPLE-STEP
LO 4

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Review Question
The multiple-step income statement for a merchandiser shows each of the following features except:
gross profit.
cost of goods sold.
a sales revenue section.
investing activities section.
MULTIPLE-STEP INCOME STATEMENT
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ETHICS INSIGHT
Disclosing More Details
After Enron, increased investor criticism and regulator scrutiny forced many companies to improve the clarity of their financial disclosures. For example, IBM began providing more detail regarding its “Other gains and losses.” It had previously included these items in its selling, general, and administrative expenses, with little disclosure. For example, previously if IBM sold off one of its buildings at a gain, it included this gain in the selling, general, and administrative expense line item, thus reducing that expense. This made it appear that the company had done a better job of controlling operating expenses than it actually had. As another example, when eBay recently sold the remainder of its investment in Skype to Microsoft, it reported a gain in “Other revenues and gains” of $1.7 billion. Since eBay’s total income from operations was $2.4 billion, it was very important that the gain from the Skype sale not be buried in operating income.
IBM
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Comprehensive income statement presents items that are not included in the determination of net income.
Items excluded from net income but included in comprehensive income are either reported in a combined statement of net income and comprehensive income, or in a separate comprehensive income statement.
COMPREHENSIVE INCOME STATEMENT

ILLUSTRATION 5-12
Combined statement of net
income and comprehensive
income
LO 4

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The following information is available for Art Center Corp. for the year ended December 31, 2017.
Other revenues and gains $ 8,000 Sales revenue $462,000
Other expenses and losses 3,000 Operating expenses 187,000
Cost of goods sold 147,000 Sales discounts 20,000
Other comprehensive
income 10,000
Prepare a multiple-step income statement and comprehensive income statement for Art Center Corp. The company has a tax rate of 25%. This rate also applies to other comprehensive income.
Multiple-Step Income Statement
DO IT!
4
LO 4

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LO 4
Prepare a multiple-step income statement and comprehensive income statement for Art Center Corp. (statement heading omitted).

5-‹#›

Prepare a multiple-step income statement and comprehensive income statement for Art Center Corp.

LO 4

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Periodic Inventory System
No running account of changes in inventory.
Ending inventory determined by physical count.
Cost of goods sold not determined until the end of the period.
LEARNING OBJECTIVE
Determine cost of goods sold under a periodic inventory system.
5
ILLUSTRATION 5-13
Basic formula for cost of goods
sold using the periodic system
LO 5

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Periodic Inventory System
ILLUSTRATION 5-14
Cost of goods sold for a merchandiser using a periodic inventory system
LO 5

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Beginning Inventory $ 18,000
Purchases $ 162,500
Purchase Returns and Allowances – 5,200
Purchase Discounts – 3,400
Freight-In + 6,100 160,000 (a)
Goods Available for Sale 178,000
Ending Inventory – 20,000
Cost of Goods Sold $ 158,000 (b)
Aerosmith Company’s accounting records show the following at the yearend December 31, 2017.
Purchase Discounts $ 3,400 Freight-In 6,100
Purchases 162,500 Beginning Inventory 18,000
Ending Inventory 20,000 Purchase Returns and Allowances 5,200
Assuming that Aerosmith Company uses the periodic system, compute (a) cost of goods purchased and (b) cost of goods sold.

SOLUTION
COGS—Periodic System
DO IT!
5
LO 5

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May be expressed as a percentage by dividing the amount of gross profit by net sales.
GROSS PROFIT RATE
A decline in the gross profit rate might have several causes.
Selling products with a lower “markup.”
Increased competition may result in a lower selling price.
Company forced to pay higher prices to its suppliers without being able to pass these costs on to its customers.
LEARNING OBJECTIVE
Compute and analyze gross profit rate and profit margin.
6
LO 6

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Why does REI’s gross profit rate differ so much from that of Dick’s Sporting Goods and the industry average?
GROSS PROFIT RATE

ILLUSTRATION 5-16
Gross profit rate
LO 6

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The profit margin measures the percentage of each dollar of sales that results in net income.
How do the gross profit rate and profit margin ratio differ?
Gross profit rate measures the margin by which selling price exceeds cost of goods sold.
Profit margin ratio measures the extent by which selling price covers all expenses (including cost of goods sold).
PROFIT MARGIN
LO 6

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How does REI compare to its competitors? Its profit margin was lower than Dick’s in 2014 and was less than the industry average. Thus, its profit margin does not suggest exceptional profitability.
PROFIT MARGIN

ILLUSTRATION 5-18
Profit margin
LO 6

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PEOPLE, PLANET, AND PROFIT INSIGHT
Selling Green
Here is a question an executive of PepsiCo Inc. was asked: Should PepsiCo market green? The executive indicated that the company should, as he believes it’s the No. 1 thing consumers all over the world care about. Here are some of his thoughts on this issue:
“Sun Chips are part of the food business I run. It’s a ’healthy snack.’ We decided that Sun Chips, if it’s a healthy snack, should be made in facilities that have a net-zero footprint. In other words, I want off the electric grid everywhere we make Sun Chips. We did that. Sun Chips should be made in a facility that puts back more water than it uses. It does that. And we partnered with our suppliers and came out with the world’s first compostable chip package.
Now, there was an issue with this package: It was louder than the
(continued)
LO 6

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PEOPLE, PLANET, AND PROFIT INSIGHT
Selling Green
New York subway, louder than jet engines taking off. What would a company that’s committed to green do: walk away or stay committed? If your people are passionate, they’re going to fix it for you as long as you stay committed. Six months later, the compostable bag has half the noise of our current package.
So the view today is: we should market green, we should be proud to do it . . . it has to be a 360 process, both internal and external. And if you do that, you can monetize environmental sustainability for the shareholders.”
Source: “Four Problems—and Solutions,” Wall Street Journal (March 7, 2011), p. R2.
LO 6

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Earnings have high quality if they provide a full and transparent depiction of how a company performed.
A measure significantly less than 1 suggests that a company may be using more aggressive accounting techniques in order to accelerate income recognition.
A measure significantly greater than 1 suggests that a company is using conservative accounting techniques which cause it to delay the recognition of income.
KEEPING AN EYE ON CASH
LO 6

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Rachel Rose, Inc. reported the following in its 2017 and 2016 income statements.
2017 2016
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000
Operating expenses 14,000 28,000
Income tax expense 8,000 12,000
Net income $18,000 $ 20,000
Determine the company’s gross profit rate and profit margin.
Gross Profit Rate and Profit Margin
DO IT!

($80,000 − $40,000)
$80,000
= 50%
($120,000 − $60,000)
$120,000
= 50%
2017
2016
6
LO 6

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$18,000 ÷ $80,000 = 22.5%
$20,000 ÷ $120,000 = 16.7%
2017
2016
6
LO 6

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Record revenues when sales are made.
Do not record cost of merchandise sold on the date of sale.
Physical inventory count determines:
Cost of merchandise on hand and
Cost of merchandise sold during the period.
Record purchases in Purchases account.
Purchase returns and allowances, Purchase discounts, and Freight costs are recorded in separate accounts.
RECORDING MERCHANDISE TRANSACTIONS
LEARNING OBJECTIVE
APPENDIX 5A: Record purchases and sales of inventory under a periodic inventory system.
*7
LO 7

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Illustration: On the basis of the sales invoice (Illustration 5-5) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the $3,800 purchase as follows.
Purchases 3,800
May 4
Accounts Payable 3,800
RECORDING PURCHASE OF MERCHANDISE
LO 7

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Illustration: If Sauk pays Public Freight Company $150
for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is:
Freight-in (Transportation-in) 150
May 6
Cash 150
FREIGHT COSTS
LO 7

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Accounts Payable 300
May 8
Purchase Returns and Allowances 300
Illustration: Sauk Stereo returns $300 of goods to PW Audio Supply and prepares the following entry to recognize the return.
Purchase Returns and Allowances
LO 7

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Accounts Payable 3,500
May 14
Purchase Discounts 70
Cash 3,430
Illustration: On May 14 Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio for payment within 10 days. Sauk Stereo records the payment and discount as follows.
Purchase Discounts
LO 7

5-‹#›

No entry is recorded for cost of goods sold at the time of the sale under a periodic system.
Illustration: PW Audio Supply, records the sale of $3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-5) as follows.
Accounts Receivable 3,800
May 4
Sales Revenue 3,800
RECORDING SALES OF MERCHANDISE
LO 7

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Illustration: To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the $300 sales return as follows.
Sales Returns and Allowances 300
May 8
Accounts Receivable 300
Sales Returns and Allowances
LO 7

5-‹#›

Cash 3,430
May 14
Accounts Receivable 3,500
Sales Discounts 70
Illustration: On May 14, PW Audio Supply receives payment of $3,430 on account from Sauk Stereo. PW Audio honors the 2% cash discount and records the payment of Sauk’s account receivable in full as follows.
Sales Discounts
LO 7

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COMPARISON OF ENTRIES—PERPETUAL VS. PERIODIC

LO 7

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COMPARISON OF ENTRIES—PERPETUAL VS. PERIODIC

LO 7

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KEY POINTS
A Look at IFRS
LEARNING OBJECTIVE
Compare the accounting for merchandising under GAAP and IFRS.
8
Similarities
Under both GAAP and IFRS, a company can choose to use either a perpetual or a periodic inventory system.
The definition of inventories is basically the same under GAAP and IFRS.
LO 8

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A Look at IFRS
KEY POINTS
Similarities
As indicated above, the basic accounting entries for merchandising are the same under both GAAP and IFRS.
Both GAAP and IFRS require that income statement information be presented for multiple years. For example, IFRS requires that 2 years of income statement information be presented, whereas GAAP requires 3 years.
LO 8

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A Look at IFRS
KEY POINTS
Differences
Under GAAP, companies generally classify income statement items by function. Classification by function leads to descriptions like administration, distribution, and manufacturing. Under IFRS, companies must classify expenses either by nature or by function. Classification by nature leads to descriptions such as the following: salaries, depreciation expense, and utilities expense. If a company uses the functional-expense method on the income statement, disclosure by nature is required in the notes to the financial statements.
LO 8

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A Look at IFRS
KEY POINTS
Differences
Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multiple-step approach.
Under IFRS, revaluation of land, buildings, and intangible assets is permitted. The initial gains and losses resulting from this revaluation are reported as adjustments to equity, often referred to as other comprehensive income. The effect of this difference is that the use of IFRS result in more transactions affecting equity (other comprehensive income) but not net income.
LO 8

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A Look at IFRS
LOOKING TO THE FUTURE
The IASB and FASB are working on a project that would rework the structure of financial statements. A main goal of this new approach is to provide information that better represents how businesses are run. This approach draws attention away from just one number—net income. It will adopt major groupings similar to those currently used by the statement of cash flows (operating, investing, and financing), so that numbers can be more readily traced across statements. For example, the amount of income that is generated by operations would be traceable to the assets and liabilities used to generate the income. Finally, this approach would also provide detail, beyond that currently seen in most statements (either GAAP or IFRS), by requiring that line items be presented both by function and by nature.
LO 8

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IFRS Practice
Which of the following would not be included in the definition of inventory under IFRS?
Photocopy paper held for sale by an office-supply store.
Stereo equipment held for sale by an electronics store.
Used office equipment held for sale by the human relations department of a plastics company.
All of the above would meet the definition.

A Look at IFRS

LO 8

5-‹#›

IFRS Practice
Which of the following would not be a line item of a company reporting costs by nature?
Depreciation expense.
Salaries expense.
Interest expense.
Manufacturing expense.

A Look at IFRS

LO 8

5-‹#›

IFRS Practice
Which of the following would not be a line item of a company reporting costs by function?
Administration.
Manufacturing.
Utilities expense.
Distribution.

A Look at IFRS

LO 8

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“Copyright © 2016 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.”
COPYRIGHT

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Discount of 2% on $3,50070.00$
$3,500 invested at 10% for 20 days19.18
Savings by taking the discount50.82$
Trial Balance

Discount of 2% on $3,500 $ 70.00
$3,500 invested at 10% for 20 days 19.18
Savings by taking the discount $ 50.82

Inventory
Debit
Credit

The Accounting Information System

Kimmel ● Weygandt ● Kieso

Accounting, Sixth Edition

3-‹#›

Explain how accounts, debits, and credits are used to record business transactions.
CHAPTER OUTLINE
Analyze the effect of business transactions on the basic accounting equation.
1
2
LEARNING OBJECTIVES
Indicate how a journal is used in the recording process.
3
Explain how a ledger and posting help in the recording process.
4
Prepare a trial balance.
5

3-‹#›

Accounting Information System
System of
collecting and
processing transaction data and
communicating financial information to decision-makers.
LEARNING OBJECTIVE
Analyze the effect of business transactions on the basic accounting equation.
1
LO 1

3-‹#›

Accounting information systems rely on a process referred to as the accounting cycle.
Accounting Information System
Analyze business transactions
Journalize
Post
Trial Balance
Adjusting Entries
Adjusted Trial Balance
Financial Statements
Closing Entries
Post-Closing Trial Balance
Most businesses use computerized accounting systems.
LO 1

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Transactions are economic events that require recording in the financial statements.
Not all activities represent transactions.
Assets, liabilities, or stockholders’ equity items change as a result of some economic event.
Dual effect on the accounting equation.
ACCOUNTING TRANSACTIONS
LO 1

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Question: Are the following events recorded in the accounting records?
Event
Purchase computer
Criterion

Pay rent
Record/ Don’t Record
Discuss guided trip options with potential customer
Illustration 3-1
Transaction identification process
ACCOUNTING TRANSACTIONS
Is the financial position (assets, liabilities, or stockholders’ equity) of the company changed?
LO 1

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Assets
Liabilities
Stockholders’ Equity
=
+
Basic Accounting Equation
The process of identifying the specific effects of economic events on the accounting equation.
ANALYZING TRANSACTIONS
LO 1

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Illustration 3-2
Expanded accounting equation
ANALYZING TRANSACTIONS
LO 1

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Event (1). On October 1, cash of $10,000 is invested in Sierra Corporation by investors in exchange for $10,000 of common stock.
1. +10,000 +10,000

ANALYZING TRANSACTIONS
LO 1

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Event (2). On October 1, Sierra borrowed $5,000 from Castle Bank by signing a 3-month, 12%, $5,000 note payable.
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

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Event (3). On October 2, Sierra purchased equipment by paying $5,000 cash to Superior Equipment Sales Co.
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

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Event (4). On October 2, Sierra received a $1,200 cash advance from R. Knox, a client.
4. +1,200 +1,200
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

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Event (5). On October 3, Sierra received $10,000 in cash from Copa Company for guide services performed.
4. +1,200 +1,200
5. +10,000 +10,000
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

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Event (6). On October 3, Sierra Corporation paid its office rent for the month of October in cash, $900.
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

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Event (7). On October 4, Sierra paid $600 for a one-year insurance policy that will expire next year on September 30.
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

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Event (8). On October 5, Sierra purchased an estimated three months of supplies on account from Aero Supply for $2,500.
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
8. +2,500 +2,500
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

3-‹#›

Event (9). On October 9, Sierra hired four new employees to begin work on October 15.
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
8. +2,500 +2,500
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
An accounting transaction has not occurred.
ANALYZING TRANSACTIONS
LO 1

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Event (10). On October 20, Sierra paid a $500 dividend.
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
8. +2,500 +2,500
10. -500 -500
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

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Event (11). Employees have worked two weeks, earning $4,000 in salaries, which were paid on October 26.
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
8. +2,500 +2,500
10. -500 -500
11. -4,000 -4,000
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000

ANALYZING TRANSACTIONS
LO 1

3-‹#›

INVESTOR INSIGHT
Why Accuracy Matters
While most companies record transactions very carefully, the reality is that mistakes still happen. For example, bank regulators fi ned Bank One Corporation (now JPMorgan Chase) $1.8 million because they felt that the unreliability of the bank’s accounting system caused it to violate regulatory requirements. Also, in recent years Fannie Mae, the government chartered mortgage association, announced a series of large accounting errors. These announcements caused alarm among investors, regulators, and politicians because they feared that the errors might suggest larger, undetected problems. This was important because the home-mortgage market depends on Fannie Mae to buy hundreds of billions of dollars of mortgages each year from banks, thus enabling the banks to issue new mortgages. Finally, before a major overhaul of its accounting system, the financial records of Waste Management Company were in such disarray that of the company’s 57,000 employees, 10,000 were receiving pay slips that were in error. The Sarbanes-Oxley Act was created to minimize the occurrence of errors like these by increasing every employee’s responsibility for accurate financial reporting.
LO 1

3-‹#›

Transaction Analysis
A tabular analysis of the transactions for the month of August is shown below. Describe each transaction.
DO IT!
1
LO 1
1. Company issued shares of stock for $25,000 cash.
2. Company purchased $7,000 of equipment on account.
3. Company received $8,000 cash in exchange for services performed.
4. Company paid $850 for this month’s rent.

3-‹#›

Double-entry system
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 another.
DEBITS must equal CREDITS.
Debit and Credit Procedures
LEARNING OBJECTIVE
Explain how accounts, debits, and credits are used to record business transactions.
2
LO 2

3-‹#›

If Debits are greater than Credits, the account will have a debit balance.
$10,000
Transaction #2
$3,000
$15,000
8,000
Transaction #3
Balance
Transaction #1
DEBIT AND CREDIT PROCEDURES
LO 2

3-‹#›

$10,000
Transaction #2
$3,000
Balance
Transaction #1
$1,000
8,000
Transaction #3
DEBIT AND CREDIT PROCEDURES
If Debits are greater than Credits, the account will have a debit balance.
LO 2

3-‹#›

Assets – Debits should exceed credits.
Liabilities – Credits should exceed debits.

Procedures for Assets and Liabilities
▼ HELPFUL HINT
The normal balance is the side where increases in the account are recorded.
LO 2

3-‹#›

Investments by stockholders and revenues increase stockholders’ equity (credit).
Dividends and expenses decrease stockholder’s equity (debit).

Procedures for Stockholders’ Equity
LO 2

3-‹#›

Revenues increase stockholder’s equity.
Expenses have the opposite effect: expenses decrease stockholders’ equity.
The effect of debits and credits on revenue and expense accounts is the same as their effect on stockholders’ equity.

Procedures for Stockholders’ Equity
LO 2

3-‹#›

INVESTOR INSIGHT
Keeping Score
The Chicago Cubs baseball team has these major revenue and expense accounts:
Revenues Expenses
Admissions (ticket sales) Players’ salaries
Concessions Administrative salaries
Television and radio Travel
Advertising Ballpark maintenance
Chicago Cubs
LO 2

3-‹#›

STOCKHOLDERS’ EQUITY RELATIONSHIPS
ILLUSTRATION 3-15
Stockholders’ equity
relationships
LO 2

3-‹#›

LO 2

Normal Balance Credit
Normal Balance Debit
DEBIT/CREDIT RULES

3-‹#›

Balance Sheet Income Statement
=
+
=
–
Asset
Liability
Equity
Revenue
Expense
Debit
Credit

SUMMARY OF DEBIT/CREDIT RULES

LO 2

3-‹#›

Relationship among the assets, liabilities and stockholders’ equity of a business:
The equation must be in balance after every transaction. For every Debit there must be a Credit.
ILLUSTRATION 3-16
Assets
Liabilities
=
Stockholders’ Equity
Basic Equation
Expanded Basic Equation
+
SUMMARY OF DEBIT/CREDIT RULES

LO 2

3-‹#›

SUMMARY OF DEBIT/CREDIT RULES
Review Question
Debits:
increase both assets and liabilities.
decrease both assets and liabilities.
increase assets and decrease liabilities.
decrease assets and increase liabilities.
LO 2

3-‹#›

SUMMARY OF DEBIT/CREDIT RULES
Review Question
Accounts that normally have debit balances are:
assets, expenses, and revenues.
assets, expenses, and equity.
assets, liabilities, and dividends.
assets, dividends, and expenses.
LO 2

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The Recording Process
LEARNING OBJECTIVE
Indicate how a journal is used in the recording process.
3
LO 3
Analyze business transactions
Journalize the transaction
Post to ledger accounts
Analyze each transaction in terms of its effect on the accounts.
Enter the transaction information in a journal.
Transfer the journal information to the appropriate accounts in the ledger.

3-‹#›

THE RECORDING PROCESS
Analyze business transactions
Journalize the transaction
Post to ledger accounts
Analyze transaction
Enter
transaction
Transfer from journal to ledger
ILLUSTRATION 3-17
The recording process
LO 3

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Transactions recorded in chronological order in a journal before they are transferred to the accounts.
Contributions to the recording process:
Discloses the complete effects of a transaction.
Provides a chronological record of transactions.
Helps to prevent or locate errors because the debit and credit amounts can be easily compared.
THE JOURNAL
LO 3

3-‹#›

Journalizing – Entering transaction data in the journal.
Illustration: Presented below is information related to Sierra Corporation.
Oct. 1 Sierra issued common stock in exchange for $10,000 cash.
1 Sierra borrowed $5,000 by signing a note.
2 Sierra purchased equipment for $5,000.
Instructions – Journalize these transactions.
THE JOURNAL
LO 3

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THE JOURNAL
Oct. 1 Sierra issued common stock in exchange for $10,000 cash.

General Journal
Cash
Common Stock
10,000
10,000
Oct. 1
LO 3

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THE JOURNAL
Oct. 1 Sierra borrowed $5,000 by signing a note.

General Journal
Cash
Notes Payable
5,000
5,000
Oct. 1
LO 3

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THE JOURNAL
Oct. 2 Sierra purchased equipment for $5,000.

General Journal
Equipment
Cash
5,000
5,000
Oct. 2
LO 3

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THE JOURNAL

ILLUSTRATION 3-18
Recording transactions in
journal form
LO 3

3-‹#›

ACCOUNTING ACROSS THE ORGANIZATION
Boosting Profits
Microsoft originally designed the Xbox 360 to have 256 megabytes of memory. But the design department said that amount of memory wouldn’t support the best special effects. The purchasing department said that adding more memory would cost $30—which was 10% of the estimated selling price of $300. The marketing department, however, “determined that adding the memory would let Microsoft reduce marketing costs and attract more game developers, boosting royalty revenue. It would also extend the life of the console, generating more sales.” As a result of these changes, Xbox enjoyed great success. But, it does have competitors. Its newest video game console, Xbox One, is now in a battle with Sony’s Playstation4 for market share. How to compete? First, Microsoft bundled the critically acclaimed Titan fall with its Xbox One. By including the game most Xbox One buyers were going to purchase anyway, Microsoft was making its console more attractive. In addition, retailers are also discounting the Xbox, which should get the momentum going for increased sales. What Microsoft is doing is making sure that Xbox One is the center of the home entertainment system in the long run.
LO 3

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Journal Entries
The following events occurred during the first month of business of Hair It Is Inc., Kate Browne’s beauty salon:
Issued common stock to shareholders in exchange for $20,000 cash.
Purchased $4,800 of equipment on account (to be paid in 30 days).
Interviewed three people for the position of stylist.
The three activities are recorded as follows:
DO IT!
3
1. Cash 20,000
Common Stock 20,000
2. Equipment 4,800
Accounts Payable 4,800
3. No entry because no transaction occurred.
LO 3

3-‹#›

The Accounting Cycle
LEARNING OBJECTIVE
Explain how a ledger and posting help in the recording process.
4
LO 4
Analyze business transactions
Post to ledger accounts
Journalize the transaction
Trial Balance
Adjusting Entries
Adjusted Trial Balance
Financial Statements
Closing Entries
Post-Closing Trial Balance

3-‹#›

The Ledger is comprised of the entire group of accounts maintained by a company.
THE LEDGER

ILLUSTRATION 3-19
The general ledger
LO 4

3-‹#›

Listing of accounts used by a company to record transactions.
CHART OF ACCOUNTS

ILLUSTRATION 3-20
Chart of accounts for Sierra
Corporation
LO 4

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General Ledger
J1
The process of transferring journal entry amounts to ledger accounts.
POSTING

General Journal
Cash
Common Stock
10,000
10,000
Oct. 1
J1
Oct. 1
Stock issued
10,000
10,000
101
LO 4

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POSTING
Review Question
Posting:
normally occurs before journalizing.
transfers ledger transaction data to the journal.
is an optional step in the recording process.
transfers journal entries to ledger accounts.
LO 4

3-‹#›

ETHICS INSIGHT
A Convenient Overstatement
Sometimes a company’s investment securities suffer a permanent decline in value below their original cost. When this occurs, the company is supposed to reduce the recorded value of the securities on its balance sheet (“write them down” in common financial lingo) and record a loss. It appears, however, that during the financial crisis of 2008, employees at some financial institutions chose to look the other way as the value of their investments skidded. A number of Wall Street traders that worked for the investment bank Credit Suisse Group were charged with intentionally overstating the value of securities that had suffered declines of approximately $2.85 billion. One reason that they may have been reluctant to record the losses is out of fear that the company’s shareholders and clients would panic if they saw the magnitude of the losses. However, personal self-interest might have been equally to blame—the bonuses of the traders were tied to the value of the investment securities.
Source: S. Pulliam, J. Eaglesham, and M. Siconolfi , “U.S. Plans Changes on Bond Fraud,” Wall Street Journal Online (February 1, 2012).
Credit Suisse Group
LO 4

3-‹#›

Follow these steps:
1. Determine what type of account is involved.
2. Determine what items increased or decreased and by how much.
3. Translate the increases and decreases into debits and credits.
RECORDING PROCESS ILLUSTRATED
ILLUSTRATION 3-21
Investment of cash by
stockholders
LO 4

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LO 4
ILLUSTRATION 3-22

3-‹#›

LO 4
ILLUSTRATION 3-23

3-‹#›

ILLUSTRATION 3-24
LO 4

3-‹#›

ILLUSTRATION 3-25
LO 4

3-‹#›

ILLUSTRATION 3-26
LO 4

3-‹#›

ILLUSTRATION 3-27
LO 4

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LO 4
ILLUSTRATION 3-28

3-‹#›

ILLUSTRATION 3-29
LO 4

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ILLUSTRATION 3-30
LO 4

3-‹#›

ILLUSTRATION 3-31
LO 4

3-‹#›

LO 4

JOURNALIZING SUMMARY
ILLUSTRATION 3-32
General journal for Sierra Corporation

3-‹#›

LO 4
Illustration 3-32

3-‹#›

ILLUSTRATION 3-33
General ledger for Sierra Corporation
POSTING SUMMARY

3-‹#›

Selected transactions from the journal of Faital Inc. during its first month of operations are presented below. Post these transactions to T-accounts.
Posting
DO IT!
4

LO 4

3-‹#›

The Accounting Cycle
LEARNING OBJECTIVE
Prepare a trial balance.
5
LO 5
Analyze business transactions
Post to ledger accounts
Journalize the transaction
Prepare a Trial Balance
Adjusting Entries
Adjusted Trial Balance
Financial Statements
Closing Entries
Post-Closing Trial Balance

3-‹#›

A list of accounts and their balances at a given time.
Accounts are listed in the order in which they appear in the ledger.

Purpose is to prove that debits equal credits.
May also uncover errors in journalizing and posting.
Useful in the preparation of financial statements.
TRIAL BALANCE
▼ HELPFUL HINT
Note that the order of
presentation in the trial balance is:
Assets
Liabilities
Stockholders’ equity
Revenues
Expenses
LO 5

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TRIAL BALANCE
ILLUSTRATION 3-34
Sierra Corporation
trial balance
LO 5

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The trial balance may balance even when
a transaction is not journalized,
a correct journal entry is not posted,
a journal entry is posted twice,
incorrect accounts are used in journalizing or posting, or
offsetting errors are made in recording the amount of a transaction.
ETHICS NOTE An error is the result of an unintentional mistake. It is neither ethical nor unethical. An irregularity is an intentional misstatement, which is viewed as unethical.
LIMITATIONS OF A TRIAL BALANCE
LO 5

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Review Question
A trial balance will not balance if:
a correct journal entry is posted twice.
the purchase of supplies on account is debited to Supplies and credited to Cash.
a $100 cash dividends is debited to the Dividends account for $1,000 and credited to Cash for $100.
a $450 payment on account is debited to Accounts Payable for $45 and credited to Cash for $45.
TRIAL BALANCE
LO 5

3-‹#›

Trial Balance
DO IT!
5
The following accounts come from the ledger of SnowGo Corporation at December 31, 2017.
Equipment $88,000
Dividends 8,000
Accounts Payable 22,000
Salaries and Wages
Expense 42,000
Accounts Receivable 4,000
Service Revenue 95,000
Common Stock $20,000
Salaries and Wages
Payable 2,000
Notes Payable (due in
3 months) 19,000
Utilities Expense 3,000
Prepaid Insurance 6,000
Cash 7,000
Prepare a trial balance in good form.
LO 5

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LO 5

3-‹#›

KEY POINTS
A Look at IFRS
LEARNING OBJECTIVE
Compare the procedures for the recording process under GAAP and IFRS.
6
Similarities
Transaction analysis is the same under IFRS and GAAP.
Both the IASB and the FASB go beyond the basic definitions provided in the textbook for the key elements of financial statements, that is assets, liabilities, equity, revenues, and expenses. The implications of the expanded definitions are discussed in more advanced accounting courses.
LO 6

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A Look at IFRS
KEY POINTS
Similarities
As shown in the textbook, dollar signs are typically used only in the trial balance and the financial statements. The same practice is followed under IFRS, using the currency of the country where the reporting company is headquartered.
A trial balance under IFRS follows the same format as shown in the textbook.
LO 6

3-‹#›

A Look at IFRS
KEY POINTS
Differences
IFRS relies less on historical cost and more on fair value than do FASB standards.
Internal controls are a system of checks and balances designed to prevent and detect fraud and errors. While most public U.S. companies have these systems in place, many non-U.S. companies have never completely documented the controls nor had an independent auditor attest to their effectiveness.
LO 6

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A Look at IFRS
LOOKING TO THE FUTURE
The basic recording process shown in this textbook is followed by companies around the globe. It is unlikely to change in the future. The definitional structure of assets, liabilities, equity, revenues, and expenses may change over time as the IASB and FASB evaluate their overall conceptual framework for establishing accounting standards.
LO 6

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IFRS Practice
Which statement is correct regarding IFRS?
IFRS reverses the rules of debits and credits, that is, debits are on the right and credits are on the left.
IFRS uses the same process for recording transactions as GAAP.
The chart of accounts under IFRS is different because revenues follow assets.
None of the above statements are correct.

A Look at IFRS

LO 6

3-‹#›

IFRS Practice
A trial balance:
is the same under IFRS and GAAP.
proves that transactions are recorded correctly.
proves that all transactions have been recorded.
will not balance if a correct journal entry is posted twice.

A Look at IFRS

LO 6

3-‹#›

IFRS Practice
One difference between IFRS and GAAP is that:
GAAP uses accrual-accounting concepts and IFRS uses primarily the cash basis of accounting.
IFRS uses a different posting process than GAAP.
IFRS uses more fair value measurements than GAAP.
the limitations of a trial balance are different between IFRS and GAAP.

A Look at IFRS

LO 6

3-‹#›

Account Name
Debit / Dr.
Credit / Cr.

Chapter
3-23
Assets
Assets
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-24
Liabilities
Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance

Chapter 3-*

Assets
Debit / Dr.
Credit / Cr.
Normal Balance

Chapter 3-*

Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance

Chapter
3-25
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Common Stock
Common Stock
Chapter
3-23
Dividends
Dividends
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-25
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Stockholders
Stockholders
’
’
Equity
Equity
Chapter
3-25
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Retained Earnings
Retained Earnings

Chapter 3-*

Debit / Dr.
Credit / Cr.
Normal Balance
Retained Earnings

Chapter 3-*

Debit / Dr.
Credit / Cr.
Normal Balance
Common Stock

Chapter 3-*

Dividends
Debit / Dr.
Credit / Cr.
Normal Balance

Chapter 3-*

Debit / Dr.
Credit / Cr.
Normal Balance
Stockholders’ Equity

Chapter
3-27
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Expense
Expense
Chapter
3-26
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Revenue
Revenue

Chapter 3-*

Debit / Dr.
Credit / Cr.
Normal Balance
Expense

Chapter 3-*

Debit / Dr.
Credit / Cr.
Normal Balance
Revenue

Chapter
3-23
Assets
Assets
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-27
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Expense
Expense
Chapter
3-24
Liabilities
Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-25
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Stockholders
Stockholders
’
’
Equity
Equity
Chapter
3-26
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Revenue
Revenue

Chapter 3-*

Debit / Dr.
Credit / Cr.
Normal Balance
Stockholders’ Equity

Chapter 3-*

Debit / Dr.
Credit / Cr.
Normal Balance
Revenue

Chapter 3-*

Assets
Debit / Dr.
Credit / Cr.
Normal Balance

Chapter 3-*

Debit / Dr.
Credit / Cr.
Normal Balance
Expense

Chapter 3-*

Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance

Account TitleRef.DebitCreditDate
Sheet1

Date Account Title Ref. Debit Credit

Sheet1

Date Account Title Ref. Debit Credit

Sheet1

Date Account Title Ref. Debit Credit

Cash
Acct. No. 101
ExplanationRef.DebitCreditBalanceDate
Account TitleRef.DebitCreditDate
Chart of Accounts

Chart of Accounts
Acct. No. Account
100 Cash
105 Accounts receivable
110 Inventory
130 Building
200 Accounts payable
220 Note payable
300 Common stock
330 Retained earnings
400 Sales
500 Cost of goods sold

General Ledger

General Journal
Date Account Title Ref. Debit Credit
Jan. 3 Cash 100 100,000
Common stock 300 100,000
10 Building 130 150,000
Note payable 220 150,000
15 Inventory 110 60,000
Accounts payable 200 60,000
20 Accounts receivable 105 75,000
Sales 400 75,000
20 Cost of goods sold 500 30,000
Inventory 110 30,000
29 Cash 100 40,000
Accounts receivable 105 40,000
General Ledger
Cash Acct. No. 100
Date Explanation Ref. Debit Credit Balance
Jan. 3 Sale of common stock GJ 100,000 100,000
20 GJ 40,000 140,000
Accounts Receivable Acct. No. 105
Date Explanation Ref. Debit Credit Balance
Jan. 20 GJ 75,000 75,000
GJ 40,000 35,000
Inventory Acct. No. 110
Date Explanation Ref. Debit Credit Balance
Jan. 15 GJ 60,000 60,000
20 GJ 30,000 30,000
Building Acct. No. 130
Date Explanation Ref. Debit Credit Balance
Jan. 10 GJ 150,000 150,000
Accounts payable Acct. No. 200
Date Explanation Ref. Debit Credit Balance
Jan. 15 GJ 60,000 (60,000)
Notes payable Acct. No. 220
Date Explanation Ref. Debit Credit Balance
Jan. 10 GJ 150,000 (150,000)
Common stock Acct. No. 300
Date Explanation Ref. Debit Credit Balance
Jan. 3 Sale for cash GJ 100,000 (100,000)
Retained Earnings Acct. No. 330
Date Explanation Ref. Debit Credit Balance
– 0
Sales Acct. No. 400
Date Explanation Ref. Debit Credit Balance
Jan. 20 GJ 75,000 (75,000)
Cost of Goods Sold Acct. No. 500
Date Explanation Ref. Debit Credit Balance
Jan. 20 GJ 30,000 30,000

Trial Balance

Trial Balance
Acct. No. Account Debit Credit
100 Cash 140,000
105 Accounts receivable 35,000
110 Inventory 30,000
130 Building 150,000
200 Accounts payable 60,000
220 Note payable 150,000
300 Common stock 100,000
330 Retained earnings
400 Sales 75,000
500 Cost of goods sold 30,000
385,000 385,000

Journal Entry

No. Account Debit Credit
1 10,000

Sheet1 (2)

Date Account Title Ref. Debit Credit
Jan. 3 Cash 100 100,000
Common stock 300 100,000
Cash Acct. No. 101
Date Explanation Ref. Debit Credit Balance

Sheet1

Date Account Title Ref. Debit Credit

Accrual Accounting Concepts

Kimmel ● Weygandt ● Kieso

Accounting, Sixth Edition

4-‹#›

Prepare adjusting entries for deferrals.
CHAPTER OUTLINE
Explain the accrual basis of accounting and the reasons for adjusting entries.
1
2
LEARNING OBJECTIVES
Prepare adjusting entries for accruals.
3
Prepare an adjusted trial balance and closing entries.
4

4-‹#›

LEARNING OBJECTIVE
Explain the accrual basis of accounting and the reasons for adjusting entries.
1
LO 1
Generally a month, a quarter, or a year.
Fiscal year vs. calendar year.
Accountants divide the economic life of a business into artificial time periods (Periodicity Assumption).

Jan.
Feb.
Mar.
Apr.
Dec.
. . . . .

▼ HELPFUL HINT
An accounting time period that is one year long is called a fiscal year.

4-‹#›

Periodicity Assumption
Review Question
What is the periodicity assumption?
Companies should recognize revenue in the accounting period in which it is earned.
Companies should match expenses with revenues.
The economic life of a business can be divided into artificial time periods.
The fiscal year should correspond with the calendar year.
LO 1

4-‹#›

Companies recognize revenue in the accounting period in which the performance obligation is satisfied.
REVENUE RECOGNITION PRINCIPLE
LO 1

4-‹#›
TEACHING TIP
Service businesses recognize revenue when the services are performed, although many customers may have been billed for the services (on account). The cash has not been received; however, the services have been performed. Therefore, revenue should be recognized.

Illustration: Assume Conrad Dry Cleaners cleans clothing on June 30, but customers do not claim and pay for their clothes until the first week of July. The journal entries for June and July would be:
REVENUE RECOGNITION PRINCIPLE
LO 1

4-‹#›

“Let the expenses follow the revenues.”
ILLUSTRATION 4-1
EXPENSE RECOGNITION PRINCIPLE
LO 1

4-‹#›

ILLUSTRATION 4-1
GAAP relationships in revenue and expense recognition
EXPENSE RECOGNITION PRINCIPLE
LO 1

4-‹#›

INVESTOR INSIGHT
Reporting Revenue Accurately
The Until recently, electronics manufacturer Apple was required to spread the revenues from iPhone sales over the two-year period following the sale of the phone. Accounting standards required this because Apple was obligated to provide software updates after the phone was sold. Since Apple had service obligations after the initial date of sale, it was forced to spread the revenue over a two-year period. As a result, the rapid growth of iPhone sales was not fully reflected in the revenue amounts reported in Apple’s income statement. A new accounting standard now enables Apple to report much more of its iPhone revenue at the point of sale. It was estimated that under the new rule revenues would have been about 17% higher and earnings per share almost 50% higher.
Apple Inc.
LO 1

4-‹#›

Accrual-Basis Accounting
Transactions recorded in the periods in which the events occur.
Revenues are recognized when services performed, even if cash was not received.
Expenses are recognized when incurred, even if cash was not paid.
ACCRUAL VERSUS CASH BASIS
LO 1

4-‹#›

Cash-Basis Accounting
Revenues are recognized only when cash is received.
Expenses are recognized only when cash is paid.
Not in accordance with generally accepted accounting principles (GAAP).
ACCRUAL VERSUS CASH BASIS
LO 1

4-‹#›
TEACHING TIP
Explain to students that many businesses use the cash basis of accounting. These businesses outgrow the method when accounts receivable and accounts payable become substantial. Also, if the businesses need audited financial statements, they must comply with GAAP and use the accrual basis. Remind them that companies can use the cash method and that its use does not mean that income is being manipulated. Without this discussion, some students may unfairly criticize an employer, relative or friend who is using the cash basis of accounting.

2016
2017
Illustration: Suppose that Fresh Colors paints a large building in 2016. In 2016, it incurs and pays total expenses (salaries and paint costs) of $50,000. It bills the customer $80,000, but does not receive payment until 2017.

ACCRUAL VERSUS CASH BASIS
ILLUSTRATION 4-2
Accrual-versus cash-basis accounting
LO 1

4-‹#›

Periodicity Assumption
Review Question
Which one of these statements about the accrual basis of accounting is false?
Companies record events that change their financial statements in the period in which events occur, even if cash was not exchanged.
Companies recognize revenue in the period in which the performance obligation is satisfied.
This basis is in accord with generally accepted accounting principles.
Companies record revenue only when they receive cash, and record expense only when they pay out cash.
LO 1

4-‹#›

Adjusting entries
ensure that the revenue recognition and expense recognition principles are followed.
are required every time a company prepares financial statements.
includes one income statement account and one balance sheet account.
THE NEED FOR ADJUSTING ENTRIES
LO 1

4-‹#›

Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which they are incurred.
b. revenues are recognized in the period in which the performance obligation is satisfied.
c. balance sheet and income statement accounts have correct balances at the end of an accounting period.
d. All of the above.
Review Question
THE NEED FOR ADJUSTING ENTRIES
LO 1

4-‹#›

Deferrals:
1. Prepaid expenses: Expenses paid in cash and recorded as assets before they are used or consumed.
2. Unearned revenues: Cash received before service are performed.
Accruals:
1. Accrued revenues: Revenues for services performed but not yet received in cash or recorded.
2. Accrued expenses: Expenses incurred but not yet paid in cash or recorded.
TYPES OF ADJUSTING ENTRIES
ILLUSTRATION 4-3
Categories of adjusting entries
LO 1

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LO 1
Trial Balance – Each account is analyzed to determine whether it is complete and up-to-date.
TYPES OF ADJUSTING ENTRIES
ILLUSTRATION 4-4
Trial balance

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Timing Concepts
Below is a list of concepts in the left column, with descriptions of the concepts in the right column. There are more descriptions provided than concepts. Match the description of the concept to the concept.
DO IT!
1
LO 1
1. ____ Accrual-basis accounting.
2. ____ Calendar year.
3. ____ Periodicity assumption.
4. ____ Expense recognition principle.
(a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be matched with results (revenues).
(c) Accountants divide the economic life of a business into time periods.
(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.
f
e
c
b

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Analyze business transactions
Journalize
Post
Trial Balance
Journalize and Post Adjusting Entries
Adjusted Trial Balance
Financial Statements
Closing Entries
Post-Closing Trial Balance
To defer means to postpone or delay.
LO 2
LEARNING OBJECTIVE
Prepare adjusting entries for deferrals.
2

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Deferrals are either:
Prepaid expenses
OR
Unearned revenues.
Deferrals
LO 2

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Expenses paid in cash before they are used or consumed.
insurance
supplies
advertising
Cash Payment
Expense Recorded
BEFORE
rent
equipment
buildings
Prepayments often occur in regard to:
PREPAID EXPENSES
LO 2

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Prepaid Expenses
Costs that expire either with the passage of time or through use.
Adjusting entry results in an increase (a debit) to an expense account and a decrease (a credit) to an asset account.
PREPAID EXPENSES
LO 2

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Adjusting entries for prepaid expenses
Increases (debits) an expense account and
Decreases (credits) an asset account.
ILLUSTRATION 4-5
Adjusting entries for prepaid expenses
PREPAID EXPENSES
LO 2

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Illustration: Sierra Corporation purchased supplies costing $2,500 on October 5. Sierra recorded the purchase by increasing (debiting) the asset Supplies. This account shows a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business on October 31 reveals that $1,000 of supplies are still on hand.
Supplies
1,500
Supplies Expense
1,500
Oct. 31
ILLUSTRATION 4-6
($2,500 – 1,000 = $1,500)
Supplies
LO 2

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Illustration: On October 4, Sierra Corporation paid $600 for a one-year fire insurance policy. Coverage began on October 1. Sierra recorded the payment by increasing (debiting) Prepaid Insurance. This account shows a balance of $600 in the October 31 trial balance. Insurance of $50 ($600 ÷ 12) expires each month.
Prepaid Insurance
50
Insurance Expense
50
Oct. 31
ILLUSTRATION 4-7
Insurance
LO 2

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Buildings, equipment, and motor vehicles (long-lived assets) are recorded as assets, rather than an expense, in the year acquired.
Depreciation is the process of allocating the cost of an asset to expense (depreciation) over its useful life.
Depreciation does not attempt to report the actual change in the value of the asset.
Depreciation
LO 2

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Illustration: For Sierra Corporation, assume that depreciation on the office equipment is $480 a year, or $40 per month.
Accumulated Depreciation-Equipment
40
Depreciation Expense
40
Oct. 31
ILLUSTRATION 4-8
Depreciation
LO 2

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Statement Presentation
Accumulated Depreciation-Equipment is a contra asset account.
Appears just after the account it offsets (Equipment) on the balance sheet.
ILLUSTRATION 4-9
Balance sheet presentation of
accumulated depreciation
Depreciation
▼ HELPFUL HINT
All contra accounts have increases, decreases, and normal balances opposite to the account to which they relate.
LO 2

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ILLUSTRATION 4-10
Accounting for prepaid expenses

PREPAID EXPENSES
LO 2

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Receipt of cash recorded as a liability before services are performed.
rent
airline tickets
Cash Receipt
Revenue Recorded
BEFORE
magazine subscriptions
customer deposits
Unearned revenues often occur in regard to:
UNEARNED REVENUES
LO 2

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Adjusting entry is made to record the revenue for services performed during the period and to show the liability that remains.
Adjusting entry results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.
UNEARNED REVENUES
LO 2

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Adjusting entries for unearned revenues
Decrease (a debit) to a liability account.
Increase (a credit) to a revenue account.
ILLUSTRATION 4-11
UNEARNED REVENUES
LO 2

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Illustration: Sierra Corporation received $1,200 on October 2 from R. Knox for guide services for multi-day trips expected to be completed by December 31. Unearned Service Revenue shows a balance of $1,200 in the October 31 trial balance. From an evaluation of the service Sierra performed for Knox during October, the company determines that it has earned $400 in October.
Service Revenue
400
Unearned Service Revenue
400
Oct. 31
ILLUSTRATION 4-12
UNEARNED REVENUES
LO 2

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ILLUSTRATION 4-13
Accounting for unearned revenues
Unearned Revenues recorded in liability accounts are now recognized as revenue for services performed.
ACCOUNTING FOR UNEARNED REVENUES
Examples
Reason for
Adjustment
Accounts Before
Adjustment
Adjusting
Entry
Rent, magazine subscriptions, customer deposits for future service.
Liabilities overstated.
Revenues understated.
Dr. Liabilities
Cr. Revenues
UNEARNED REVENUES
LO 2

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ACCOUNTING ACROSS THE ORGANIZATION
Turning Gift Cards into Revenue
Those of you who are marketing majors (and even most of you who are not) know that gift cards are among the hottest marketing tools in merchandising today. Customers purchase gift cards and give them to someone for later use. In a recent year, gift-card sales were expected to exceed $124 billion. Although these programs are popular with marketing executives, they create accounting questions. Should revenue be recorded at the time the gift card is sold, or when it is exercised? How should expired gift cards be accounted for? In a recent balance sheet, Best Buy reported unearned revenue related to gift cards of $406 million.
Source: “2014 Gift Card Sales to Top $124 Billion, But Growth Slowing,” PRNewswire (December 10, 2014).
LO 2

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Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for $4,000 of the unearned service revenue reported.
Prepare the adjusting entries for the month of March.
DO IT!
2
LO 2

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Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
Insurance expires at the rate of $100 per month.
SOLUTION
DO IT!
2
Insurance Expense 100
Prepaid Insurance 100
LO 2

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Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
The equipment depreciates $200 a month.
SOLUTION
DO IT!
2
Depreciation Expense 200
Accumulated Depreciation 200
LO 2

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Adjusting Entries for Deferrals
The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.
During March, services were performed for $4,000 of the unearned service revenue reported.
SOLUTION
DO IT!
2
Unearned Service Revenue 4,000
Service Revenue 4,000
LO 2

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Analyze business transactions
Journalize
Post
Trial Balance
Journalize and Post Adjusting Entries
Adjusted Trial Balance
Financial Statements
Closing Entries
Post-Closing Trial Balance
Increase both a balance sheet and an income statement account.
LO 3
LEARNING OBJECTIVE
Prepare adjusting entries for accruals.
3

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Made to record:
Revenues for services performed and
OR
Expenses incurred
in the current accounting period that have not been recognized through daily entries.
Adjusting Entries for Accruals
LO 3

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Revenues for services performed but not yet received in cash or recorded.
rent
interest
services performed
BEFORE
Accrued revenues often occur in regard to:
Cash Receipt
Revenue Recorded
Adjusting entry results in:
ACCRUED REVENUES
LO 3

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Accrued Revenues
An adjusting entry serves two purposes:
Shows the receivable that exists, and
Records the revenues for services performed.
ACCRUED REVENUES
LO 3

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Adjusting entries for accrued revenues
Increases (debits) an asset account.
Increases (credits) a revenue account.
ILLUSTRATION 4-14
ACCRUED REVENUES
LO 3

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Illustration: In October, Sierra Corporation performed guide services for $200 that were not billed to clients before October 31.
Service Revenue
200
Accounts Receivable
200
Oct. 31
ILLUSTRATION 4-15
ACCRUED REVENUES
LO 3

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ILLUSTRATION 4-16
Accounting for accrued revenues
Services performed but not yet received in cash or recorded.
ACCOUNTING FOR ACCRUED REVENUES
Examples
Reason for
Adjustment
Accounts Before
Adjustment
Adjusting
Entry
Interest, rent, services performed but not collected.
Assets understated.
Revenues understated.
Dr. Assets
Cr. Revenues
ACCRUED REVENUES
LO 3

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Expenses incurred but not yet paid in cash or recorded.
BEFORE
Accrued expenses often occur in regard to:
Cash Payment
Expense Recorded
utilities
salaries
Adjusting entry results in:
Interest
taxes
ACCRUED EXPENSES
LO 3

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An adjusting entry serves two purposes:
Records the obligations, and
Recognizes the expenses.
ACCRUED EXPENSES
LO 3

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Adjusting entries for accrued expenses
Increases (debits) an expense account.
Increases (credits) a liability account.
ILLUSTRATION 4-17
ACCRUED EXPENSES
LO 3

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Illustration: Sierra Corporation signed a three-month note payable in the amount of $5,000 on October 1. The note requires Sierra to pay interest at an annual rate of 12%.
Interest Payable
50
Interest Expense
50
Oct. 31
ILLUSTRATION 4-19
ILLUSTRATION 4-18
Formula for computing interest
Accrued Interest
$5,000 x 12% x 1/12 = $50
LO 3

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ILLUSTRATION 4-20
Illustration: Sierra Corporation last paid salaries 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. Thus, accrued salaries at October 31 are $1,200 ($400 × 3 days).
Accrued Salaries
LO 3

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Salaries and Wages Payable
1,200
Salaries and Wages Expense
1,200
Oct. 31
ILLUSTRATION 4-21
Illustration: Sierra Corporation last paid salaries 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. Thus, accrued salaries at October 31 are $1,200 ($400 × 3 days).
Accrued Salaries
LO 3

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ILLUSTRATION 4-22
Accounting for accrued expenses

ACCRUED EXPENSES
LO 3

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PEOPLE, PLANET, AND PROFIT INSIGHT
Got Junk?
Do you have an old computer or two in your garage? How about an old TV that needs replacing? Many people do. Approximately 163,000 computers and televisions become obsolete each day. Yet, in a recent year, only 11% of computers were recycled. It is estimated that 75% of all computers ever sold are sitting in storage somewhere, waiting to be disposed of. Each of these old TVs and computers is loaded with lead, cadmium, mercury, and other toxic chemicals. If you have one of these electronic gadgets, you have a responsibility, and a probable cost, for disposing of it. Companies have the same problem, but their discarded materials may include lead paint, asbestos, and other toxic chemicals.
LO 3

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ILLUSTRATION 4-23
Summary of adjusting entries
SUMMARY OF BASIC RELATIONSHIPS
LO 3

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Adjusting Entries for Accruals
Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly financial statements. The following information relates to August.
At August 31, the company owed its employees $800 in salaries that will be paid on September 1.
On August 1, the company borrowed $30,000 from a bank on a 15-year mortgage. The annual interest rate is 10%.
Revenue for services performed but unrecorded for August totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.
DO IT!
3
LO 3

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Adjusting Entries for Accruals
Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly financial statements. Prepare the adjusting entries needed at August 31, 2017.
At August 31, the company owed its employees $800 in salaries that will be paid on September 1.
SOLUTION
DO IT!
3
Salaries and Wages Expense 800
Salaries and Wages Payable 800
LO 3

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Adjusting Entries for Accruals
Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly financial statements. Prepare the adjusting entries needed at August 31, 2017.
On August 1, the company borrowed $30,000 from a bank on a 15-year mortgage. The annual interest rate is 10%.
SOLUTION
DO IT!
3
Interest Expense 250
Interest Payable 250
LO 3

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Adjusting Entries for Accruals
Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly financial statements. Prepare the adjusting entries needed at August 31, 2017.
Revenue for services performed but unrecorded for August totaled $1,100.
SOLUTION
DO IT!
3
Accounts Receivable 1,100
Service Revenue 1,100
LO 3

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Analyze business transactions
Journalize
Post
Trial Balance
Adjusting Entries
Adjusted trial balance
Prepare financial statements
Journalize and post closing entries
Prepare a post-closing trial balance
LO 4
LEARNING OBJECTIVE
Prepare an adjusted trial balance and closing entries.
4

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After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance).
The adjusted trial balance’s purpose is to prove the equality of debit balances and credit balances in the ledger.
The adjusted trial balance is the primary basis for the preparation of the financial statements.
PREPARE ADJUSTED TRIAL BALANCE
LO 4

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LO 4
ILLUSTRATION 4-26
Adjusted trial balance

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PREPARE ADJUSTED TRIAL BALANCE
Which of the following statements is incorrect concerning the adjusted trial balance?
An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made.
The adjusted trial balance provides the primary basis for the preparation of financial statements.
The adjusted trial balance lists the account balances segregated by assets and liabilities.
The adjusted trial balance is prepared after the adjusting entries have been journalized and posted.
Review Question
LO 4

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Financial statements are prepared directly from the Adjusted Trial Balance.
Balance Sheet
Income Statement
Retained Earnings Statement
PREPARING FINANCIAL STATEMENTS
LO 4

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ILLUSTRATION 4-27
Preparation of the income statement and retained earnings statement from the adjusted trial balance
4-68

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Tell students to look at the date on the income statement in Illustration 4-27. The date is “For the Month Ending October 31, 2014.” How can one be sure the revenues and expenses reported on the income statement are just for that period? Closing entries transfer the temporary account balances to the stockholders’ equity account and reduce the balances in the temporary accounts to zero. Therefore, at the beginning of the period the temporary accounts have a balance of zero and the revenues and expenses accumulated are for that particular period.

ILLUSTRATION 4-28
Preparation of the balance sheet from the adjusted trial balance
LO 4

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Quality of Earnings – company provides full and transparent information.
Earnings Management – the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. Companies may manage earnings by:
one-time items to prop up earnings numbers.
inflating revenue numbers in the short-run.
improper adjusting entries.
As a result of the Sarbanes-Oxley Act, many companies are trying to improve the quality of their financial reporting.
QUALITY OF EARNINGS
LO 4

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Trial Balance
DO IT!
4a

LO 4

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Trial Balance
DO IT!
(a) Determine the net income for the quarter April 1 to June 30.

LO 4
4a

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Trial Balance
DO IT!
Determine the total assets and total liabilities at June 30, 2017.

LO 4
4a

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Trial Balance
DO IT!
Determine the balance in Retained Earnings at June 30, 2017.
Retained earnings, April 1 $ 0
Add: Net income 2,490
Less: Dividends 600
Retained earnings, June 30 $1,890
LO 4
4a

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At the end of the accounting period, companies transfer the temporary account balances to the permanent stockholders’ equity account—Retained Earnings.
ILLUSTRATION 4-29
Temporary versus permanent accounts
CLOSING THE BOOKS
LO 4

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In addition to updating Retained Earnings to its correct ending balance, closing entries produce a zero balance in each temporary account.
ILLUSTRATION 4-30
The closing process
Preparing Closing Entries
LO 4

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LO 4
ILLUSTRATION 4-31

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Illustration 4-32
Posting of closing entries
Preparing Closing Entries
LO 4

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The purpose of the post-closing trial balance is to prove the equality of the permanent account balances that the company carries forward into the next accounting period.
All temporary accounts will have zero balances.
Preparing a Post-Closing Trail Balance
LO 4

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1. Analyze business transactions

2. Journalize the transactions

6. Prepare an adjusted trial balance
7. Prepare financial statements
8. Journalize and post closing entries
9. Prepare a post-closing trial balance
4. Prepare a trial balance
3. Post to ledger accounts
Journalize and post adjusting entries:
Deferrals/Accruals

ILLUSTRATION 4-33
Required steps in the accounting cycle
SUMMARY OF THE ACCOUNTING CYCLE
LO 4

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