Assignment Type:Individual Project Deliverable Length:3- pages
Points Possible:125 Due Date:2/23/2013 11:59:59 PM CT
You are an accountant in a medium-sized manufacturing company. You have been asked to mentor an accounting clerk who is new to your accounting department.
· Explain why adjusting entries are necessary.
· Describe the 4 types of adjusting entries, and provide a manufacturing industry example of each.
· Describe how these entries would be recorded in a computerized accounting system.
· Describe 1 ethical issue that could result from the preparation of these manufacturing entries.
·
The Accounting Cycle
To organize a business, you would need an
attorney, a banker, a business plan, a
budget, capital funds, an idea, and a research project. The United States Small Business
Administration (SBA) website gives a lot of details about starting a business and how
to finance the venture.
The basic accounting equation is Assets = Liabilities + Owners Equity.
Assets are property, plant, and equipment owned by the business. Assets include cash,
accounts receivable, notes receivable, equipment, inventory, buildings, land, patents,
and goodwill.
Liabilities are debts owed by the business that are waiting to be paid. Liabilities
include accounts payable, notes payable,
mortgages payable, wages payable, taxes
payable, and all other payables.
Owners equity is the ownership of the business. Owners equity is everything
contributed by the owner or owners of the business. Owners equity looks different for
sole proprietors and partners accounts than it does for corporations, but both types of
accounts include retained earnings.
Sole proprietors and partners accounts are the same. They list the name of each owner,
any capital, and the name of each owner’s drawing account.
Corporations have categories of stock instead of the individual names of owners, and
there are no drawing accounts for stockholders. If stockholders want to make a
withdrawal, they sell their stock. There is additional capital when stockholders pay
more for the stock than the par (face) value.
Remember the differences between sole proprietors, partners, and stockholders. Sole
proprietorships are one-owner companies; they are the most common type of business
in the U.S. Partnerships are two or more owners doing business together to earn a
profit. Corporations are formed using Articles of Incorporation and are usually set up
by a corporate attorney. A company protects its owners against personal liability to
debtors by incorporating.
There are different types of stock that are used by corporations. They include the
following:
· Common stock certificates represent a piece of corporate ownership.
· Preferred stock certificates represent a piece of corporate ownership. Preferred stockholders do not get to vote, but they get dividends before
common stockholders.
· Cumulative preferred stock is preferred stock that enables dividends
to accumulate until they are paid.
· Treasury stock is stock purchased back by the company from
stockholders.
Companies are not required to pay dividends to their stockholders; however, it is a
good business practice.
Companies declare dividends at the end of the corporate fiscal year. Once dividends
are declared, they become a liability to the corporation and accountants must record
them as a payable until they are paidthey are an expense.
Double entry accounting means that for every journal entry there is at least one debit
and one credit, and they must balance.
The accounting cycle includes the following steps in order of priority:
1. journal entries (For each financial transaction there will be an entry
into the journal called a journal entry. Journals track all financial
transactions in chronological order according to date.)
2. post to the ledger
3. trial balance
4. adjusting journal entries
5. adjusted trial balance
6. financial statements
7. closing entries
Accruals match revenues and expenses to the proper period. They are manual adjusting
journal entries.
A general ledger and subsidiary ledgers are reports that use unique sets of account
numbers that allow the sorting of payments to specific vendors or by category, such as
electricity consumption. Using account numbers helps accountants track income and
expenses by account to make sure they are staying within their current budget. Using
account numbers also helps accountants prepare budgets for future periods.
Use of Accounts
An account is a means of storing all records related to a particular asset, liability,
expense, or revenue transaction.
Asset accounts include cash, accounts receivable, and machinery and
equipment.
Liability accounts include accounts payable, long-term debt, and notes
payable. In fact, all accounts ending with the word payable are liability
accounts and represent monies owed by the firm to an outside entity or person.
Equity accounts include common stock and retained earnings (the profits of
the business that have not been paid out to owners of the business in the form of
dividends).
Expense accounts include rent, salaries and utilities.
Revenue accounts include all sales accounts.
An account includes three elements:
title
debit side (left side)
credit side (right side)
To visually show an account’s activities, accountants often use a system that resembles
the letter T, known as a T-account. The name of the account is on the top, all credit
transactions appear on the right, and all debit transactions appear on the left.
Title
Debit Credit
Balance Sheet Account Debit and Credit Rules
Normally, all asset accounts have debit balances. Therefore, an increase in an asset is
recorded on the debit (left) side of the account. Normally, liabilities and equity
accounts have credit balances. Therefore, increases in liabilities and owners’ equity
accounts are recorded by credit entries (right side) and decreases in these accounts are
recorded by debits (left side).
Because of these rules, every transaction that is recorded will have an equal dollar
amount of debits and credits. Remember the accounting equation states: Assets = Liabilities + Owners Equity
The assets have debit balances, while the liabilities and owner’s equity have credit
balances, thus the two sides of the equations should be equal. For this equation to
remain in balance, any change in the left side of the equation must have an equal
change in the right side. For example, if there is an increase in assets, there must be an
offsetting increase in liabilities or equity for the same amount. This system of equal
debits and credits is called double-entry accounting.
Examples of Journal Entries
Assume that ABC Company purchased a building and some land from the City of
Santa Barbara on January 1st. They paid $40,000 cash for the building and financed the
purchase of the land for $60,000 by issuing a note payable due in 90 days. The journal
entry to record the transaction would be the following:
Debit Credit
Debit Building $40,000
Debit Land $60,000
Credit Cash $40,000
Credit Notes Payable $60,000
In 90 days, they need to pay the note. The entry to record this transaction is as follows:
Debit Credit
Debit Notes Payable $60,000
Credit Cash $60,000
The Journal
All transactions are recorded as they occur in an accounting record known as a journal
and the recording of these transactions is known as journalizing the transactions. The
various ledger accounts are updated periodically (typically monthly) in a process
known as posting the journal entries. Posting is a fancy name for updating the ledger
accounts and, in a computerized accounting system, will occur with only a few
keystrokes. If one looks at a journal, or general journal as it is typically called, one
will see a list of all transactions including the date of the transaction, the various
accounts debited and credited, and a description of the transaction. It is important that
accountants provide accurate descriptions of each transaction so that users of the
information will know why the transaction was recorded.
Importance of Accounting in Everyday Life
While one does not typically record personal expenses using double-entry accounting,
one could certainly do so and then prepare financial statements that represent the
financial condition. Accounting software such as Quicken can be used to track and record all personal transactions such as our household expenses and income. This data
can then be downloaded into tax preparation software such as Turbo Tax to facilitate
the preparation of income tax returns.
Trial Balance and Adjustments
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Trial Balance
After all transactions are recorded for the accounting cycle (for example, a
month) a trial balance should be prepared to ensure that debits and credits
are equal. A trial balance is simply a two-column listing of all accounts with
their debit or credit balances. The trial
balance will contain balance sheet and
income statement accounts. Typically, the order of the accounts will be as
follows:
1. assets
2. liabilities
3. equity
4. revenue
5. expenses
If the total of the debits and credits are not equal, then one or more errors
occurred. Typical errors include mathematical mistakes, clerical errors, or the
posting of debit as a credit, or vice versa. It should be noted, however, that
most computerized accounting systems do not allow a transaction to be
recorded that is not in balance.
Adjusting Entries
After the trial balance has been prepared, some entries need to be adjusted.
Some business activities affect multiple accounting periods, so to ensure
compliance with the matching principle, adjusting entries are needed. For
example, if a magazine sells subscriptions and receives a payment for a 1-
year subscription, an adjusting entry is needed each month to record 1-
month’s worth of revenue. Another example is an insurance policy paid for 1-
year’s worth of insurance, but the expense needs to be recognized monthly.
The types of adjusting entries needed depend on the activities of the business
entity. All adjusting entries will fall into one of the four general categories
(Miegs et al., 2003, p. 137):
Converting assets to expenses. A cash expenditure (or cost) that
will benefit more than one accounting period is usually recorded by
debiting an asset account (for example, supplies or unexpired
insurance) and by crediting the cash account. The asset account
represents the deferral of an expense. The entry is accomplished by
debiting the appropriate expense account and crediting the related Trial Balance and Adjustments
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asset account.
Converting liabilities to revenue. A business may collect cash in
advance for services to be rendered in future periods. For example, an
airline receives payment in advance for tickets that are sold. The
company cannot record the revenue until the passenger takes the
flight. After the flight is taken, an entry is made to debit the liability
account (in this example, unearned revenue) and credit the revenue
account.
Accruing unpaid expenses. One example of an expense that must
be accrued would be interest on a note. The interest may not be paid
until a point in the future, but must still be recognized on a monthly
basis.
Accruing uncollected revenue. Revenue may be earned during the
current accounting period, but the cash may not be received until a
future period. For example, the electric utility provides electricity but
bills in arrears for these services. The utility can accrue the revenue
that is earned monthly, even though payment will not be made until a
future date.
Every adjusting entry will involve the recognition of revenue or the recording
of an expense, therefore, a revenue or expense account should be debited or
credited with every adjusting entry. Many adjusting entries are based on
estimates or approximations because the actual revenue or expense may be
unknown.
Accounting Principles & Materiality
Adjusting entries are required for accountants to comply with the realization
and matching principles of accounting. The adjusting entries ensure that
revenue is recognized when it is earned and expenses are recognized when
resources are used.
The concept of materiality applies to adjusting entries as well. A transaction is
considered material if knowledge of this transaction would be useful to a
decision maker. The concepts of materiality must be reconciled with the need
for the financial-reporting process to be cost-effective. If the costs involved in
recording a transaction would not be particularly meaningful to a decision
maker, and the costs associated with recording the transaction would exceed
the benefits, the transaction is considered immaterial.
Materiality may result in some transactions being expensed immediately Trial Balance and Adjustments
3
rather than accrued and expensed over a period of time. For example, many
companies expense office supplies as they are purchased rather than
attempting to record the expenses as they are incurred. If the dollar amount
is so small as to be meaningless to a decision maker, then it can be
considered an immaterial event.
Materiality must be determined by management and is a matter of
professional judgment. A $100 transaction to a mom-and-pop operation
might be considered material, whereas a $100 transaction to a company the
size of General Motors would be considered immaterial.
Adjusted Trial Balance & Financial Statements
After adjusting entries are recorded, accountants should prepare an adjusted
trial balance. As with the unadjusted trial balance, the debits and credits in
the adjusted trial balance should equal.
The adjusted trial balance also assists
accountants in determining if any adjusting entries have been overlooked, as
it would be easy to see if expenses or revenues have not been recorded or
appear to be out of line with past periods. Typically, the financial statements
are prepared directly from the adjusted trial balance.
Reference
Miegs, R. F., Williams, J. R., Haka, S. F., & Bettner, M. S. (2003). Financial
accounting (11th ed.). New York: McGraw-Hill/Irwin.
The Accounting Cycle Steps
The accounting cycle is the series of accounting tasks that are completed to record all
economic transactions of the business. Each entity has a financial year, known as its
fiscal year. This year may or may not coincide with the calendar year. All financial
transactions are recorded on a daily basis, with an accounting cycle occurring on a
monthly basis. The cycle ends with the preparation of the four financial statements:
balance sheet, income statement, statement of cash flows, and the statement of
stockholder’s equity. This process is characterized as a cycle because the steps are
repeated on a monthly and sometimes daily basis to prepare the financial statements.
The accounting system includes records for every economic transaction that will
appear in the financial statements. A separate record is kept for every asset, liability,
equity, expense, and revenue account found in the balance sheet and income statement.
These records are called accounts. The entire collection of account is called a ledger,
or the general ledger.
The accounting cycle is comprised of a series of steps:
1. Recording transactions (known as journalizing)
2. Posting journal entries to ledger accounts
3. Preparing a trial balance (a listing of each account and its balance)
4. Making adjustments at the end of the period
5. Preparing an adjusted trial balance
6. Preparing financial statements
These transactions occur on a monthly basis. In addition, at the end of the fiscal year,
two additional steps are needed:
7. Posting closing journal entries
8. Preparing an after-closing trial balance
The accounting cycle not only facilitates the preparation of financial statements but
also provides information used by management to run the day-to-day business
operations. These accounting records help to establish control over assets and keep
track of daily business activities, such as customer payments. The information is also
used to evaluate the performance of departments within the organization.
