Chapter 3 2021

3 The Accounting Process
Learning Contents
1 The identification
2 The recording
3 The measurement
4 The communication
2-1
3.1 The Identification
Learning Objectives
Defining the source document for recording business
1 transactions
2 Identifying basic information in source documents
3 Types source documents
2-2
LEARNING Defining the source document for
OBJECTIVE
1
recording business transactions
 Source documents are the physical basis upon which

business transactions are recorded.
 Source documents can provide evidence that a

transaction has occurred. Source documents are typically
retained for use as evidence when auditors later review a
company's financial statements, and need to verify that
transactions have, in fact, occurred.
2-3
LEARNING
2 Identifying basic information
OBJECTIVE
in source documents
They usually contain the following information:

 The date of the transaction
 A reference number
 A description of a business transaction
 The amount (money, quantity, labor hour)
 The name, signature and seal of businesses/people
 The others
2-4
LEARNING
OBJECTIVE
3 Types source documents
2-5
Types of Source Documents
• Quotation
• Purchase Order
• Sales Order
• Delivery note
• Goods received note
• Credit Note
• Debit Note
• Invoice…
2-6
Quotation – This is an agreement, usually written,

from a producer to a potential customer to sell
goods or services at a particular price and quantity.
The quotation may include the cost to produce,
deliver and finance the purchase
Purchase Order – This is a written order giving the
authorization to purchase goods or services from a
supplier
2-7
Sales Order – A sales order (SO) is an internal

document that is generated from a customer's
purchase order. This document is generated
to create an audit trail/control to be used to monitor
the entire sales process using the company’s
internal numbering system instead of relying on the
customer's purchase order, and the numbering
system that it is based on.
2-8
Credit Note – This document is sent by a supplier to

a customer to reduce the liability of the customer. In
essence it is a negative invoice that is issued when
goods are returned, when there was an
overpayment, or when some other event has
occurred that has the effect of reducing the amount
that the customer owes to the supplier.
2-9
Debit Note – This document is sent from a customer

to a supplier to request a credit note in respect to an
overpayment or return of goods.
Invoice – This document is sent to request payment
for monies owed, for goods that were delivered, or
services that were rendered
2-10
2-11
2-12
3.2 The Recording
Learning Contents
1 The recording process.
2 Adjusting the accounts.
3 Completing the accounting cycle.
2-13
3.2.1 The Recording Process
Learning Objectives
Describe how accounts, debits, and credits are used to
1 record business transactions.
2 Indicate how a journal is used in the recording process.
Explain how a ledger and posting help in the recording

3 process.
2-14
LEARNING Describe how accounts, debits, and credits
1
OBJECTIVE are used to record business transactions.
A part of the accounting system used

The
to classify and summarize the
Account
increases, decreases, and balances
of each asset, liability, owners' equity
item, revenue, and expense.
2-15
How to Open Accounts

 Firms set up accounts for each different business element,
such as cash, accounts receivable, and accounts payable.
 A firm sets up an account whenever it needs to provide

useful information about a particular business item to
some party having a valid interest in the business.
2-16
How to Open Accounts
 The chart of accounts is a complete listing of the titles

and numbers of all the accounts in the ledger. The chart
of accounts can be compared to a table of contents. The
groups of accounts usually appear in this order: assets,
liabilities, stockholders' equity, dividends, revenues, and
expenses.
2-17
Types of Accounts
Assets
BS Account: real
Liabilities
(permanent) accounts
Equity
Relationship to FS
I/CS Account: Income

nominal (temporary)
accounts Expenses
Control accounts
Accounts Detailed
information level
Subsidiary accounts
Real accounts
Function Contra accounts
Nominal accounts
2-18
General Form of Accounts
An account can
be illustrated in a
T-account form.
Three parts:
(1) A title/name
(2) A left or debit side
(3) A right or credit side.
2-19
• Do NOT think of the way others use these terms

(such as your banks)!
• Do NOT be thinking of your plastic “debit cards”
and “credit cards”!
• Do NOT mistakenly think of Debit as “debt” and
Credit as “credit” (as the world defines them)!
• Do NOT mistakenly think of Debit as “good
things” and credits as “bad things”
• “Debit” means LEFT; “Credit” means RIGHT!!!!
2-20
• “Debit” means LEFT

• “Credit” means RIGHT
• Debit (Debere)- Dr
• Credit (Credere)- Cr
2-21
Beginning balance+ Increase

= Decrease + Ending balance
2-22
Form of The Specific Account
 Assets - Debits should exceed

credits.
 Liabilities – Credits should

exceed debits.
 Normal balance is on the

increase side.
Liabilities
Debit / Dr. Credit / Cr.
Normal Balance
Chapter
3-24
2-23
 Revenues increase owner’s equity

(credit).
 Expenses decrease owner’s equity

(debit).
Because revenues increase owner’s equity, a revenue account has the

same debit/credit rules as the Owner’s Capital account. Expenses have
the opposite effect.
2-24
2-25
 The purpose of earning revenues

is to benefit the owner(s).
 The effect of debits and credits on

revenue accounts is the same as
their effect on Owner’s Capital.
 Expenses have the opposite

effect: expenses decrease owner’s
equity.
2-26
Normal Normal Liabilities
Balance Balance
Debit Credit
Normal Balance
Assets
Debit / Dr. Credit / Cr. Chapter
3-24
Normal Balance
Chapter
3-23
2-27
Income Summary
Transferring expense Transferring income

Transferring profits in term Transferring losses in term
2-28
Form of The Special Account
Depreciation of fixed asset
Beginning balance:
Accumulated depreciation at
beginning of accounting period
Debiting: Decreases in Crediting: Increases in

depreciation of fixed depreciation of fixed assets
assets in period in period
Ending balance: Accumulated

depreciation
2-29
Advanced payment from customers

Beginning balance: Advanced
payment remained at beginning
of accounting period
Debiting: Advanced payment Crediting: Advanced payment

decreased in accounting period increased in accounting period
Ending balance: Advance

payment remained at the end of
accounting period
2-30
Advanced payment to suppliers account

Beginning balance: Prepaid
to sellers at beginning of
accounting period
Debiting: Advanced payment Crediting: Advanced payment

to suppliers increased in to suppliers decreased in
accounting period accounting period
Ending balance: Prepaid to

sellers at the end of
accounting period
2-31
Deferred revenue account

Beginning balance:
Unallocated deferred revenue
at beginning of accounting
period
Debiting: Allocate deferred Crediting: Deferred
revenue accounted into revenue increased in
income in accounting period accounting period
Ending balance: Unallocated

deferred revenue at end of
accounting period
2-32
Prepaid expense account

Beginning balance:
Unallocated prepaid expense at
beginning of accounting period
Debiting: Actual prepaid cost Crediting: Prepaid expense

arising in accounting period allocated in accounting period
Ending balance: Unallocated

prepaid expense at end of
accounting period
2-33
Provision for payable expenses account

Beginning balance: Provision
for payable expenses
accumulated at beginning of
accounting period
Debiting: Actual payable Crediting: To record provision
expenses arising in for payables appropriated and
accounting period charged to expenses in
accounting period
Ending balance: Accumulated

provision for payable expenses
at the end of accounting period
2-34
Debits/Credits Rules
Balance Sheet Income Statement

Asset = Liability + Equity Revenue - Expense
Debit
Credit
2-35
Question
Debits:
a. increase both assets and liabilities.
b. decrease both assets and liabilities.
c. increase assets and decrease liabilities.
d. decrease assets and increase liabilities.
2-36
Question
Accounts that normally have debit balances are:
a. assets, expenses, and revenues.
b. assets, expenses, and equity.
c. assets, liabilities, and owner’s drawing.
d. assets
2-37
Summary of Debit/Credit Rules
Relationship among the assets, liabilities and owner’s equity

of a business:
Illustration 2-11
Basic
Equation Assets = Liabilities + Owner’s Equity
Expanded
Equation
Debit/Credit
Effects
The equation must be in balance after every transaction. Total

Debits must equal total Credits.
2-38
Debit and Credit Procedures
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 at least one other account.
 DEBITS must equal CREDITS.
2-39
Debits and Credits
If the sum of Debit entries are greater than the sum of

Credit entries, the account will have a debit balance.
Account Name
Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000
$18,000 $3,000
Balance $15,000
2-40
Debits and Credits
If the sum of Credit entries are greater than the sum of

Debit entries, the account will have a credit balance.
Account Name
Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3
$10,000 $11,000
Balance $1,000
2-41
DO IT! 1 Normal Account Balances
Kate Browne has just rented space in a shopping mall. In this space,
she will open a hair salon to be called “Hair It Is.” A friend has advised
Kate to set up a double-entry set of accounting records in which to
record all of her business transactions. Identify the balance sheet
accounts that Kate will likely need to record the transactions needed
to open her business. Indicate whether the normal balance of each
account is a debit or a credit.
Assets Liabilities Equity
Cash (debit) Notes payable (credit) Owner’s Capital (credit)

Supplies (debit) Accounts payable
Equipment (debit) (credit)
2-42
LEARNING Indicate how a journal is used in the
2
OBJECTIVE recording process.
Steps in the Recording Process

Illustration 2-12
Analyze each transaction Enter transaction in a journal Transfer journal information to

ledger accounts
Business documents, such as a sales slip, a check, or a bill,

provide evidence of the transaction.
2-43
Summary of steps to record a transaction
(1). Identify that items are affected and consider

whether they are being increased or decreased and by
how much.
(2). Determine what type of account is involved.
(3). Translate the increases and decreases into debits

and credits.
2-44
DO IT! 2 Recording Business Activities
Prepare the entries to record the transactions.
1. Opened a bank account and deposited $20,000.

Dr Cash 20,000
Cr Owner’s Capital 20,000
2. Purchased equipment on account (to be paid in 30 days)

for a total cost of $4,800.
Dr Equipment 4,800
Cr Accounts Payable 4,800
3. Interviewed three persons for the position of hair stylist.

No entry
2-45 LO 2
The Journal
 Book of original entry.
 Transactions recorded in chronological order.
 Contributions to the recording process:

1. Discloses the complete effects of a transaction.
2. Provides a chronological record of transactions.
3. Helps to prevent or locate errors because the debit

and credit amounts can be easily compared.
2-46
JOURNALIZING - Entering transaction data in the journal.

Illustration: On September 1, Ray Neal invested $15,000 cash in
the business, and Softbyte purchased computer equipment for
$7,000 cash.
GENERAL JOURNAL
GENERAL JOURNAL
Source
Amount
Date doccument Explaination Account Title Ref.
N D Debit Credit
Sept.1 Ower invested Cash 15,000
Owner’s Capital 15,000
Purchased computer equipment Equipment 7,000

Cash 7,000
2-47
SIMPLE AND COMPOUND ENTRIES

Illustration: On July 1, Butler Company purchases a delivery truck
costing $14,000. It pays $8,000 cash now and agrees to pay the
remaining $6,000 on account.
GENERAL JOURNAL
Date Account Title Ref. Debit Credit
July 1 Equipment 14,000
Cash 8,000
Accounts payable 6,000
2-48 LO 2
DO IT! 2 Recording Business Activities
Kate Browne engaged in the following activities in establishing

her salon, Hair It Is:
1. Opened a bank account in the name of Hair It Is and

deposited $20,000 of her own money in this account as her
initial investment.
2. Purchased equipment on account (to be paid in 30 days)

for a total cost of $4,800.
3. Interviewed three persons for the position of hair stylist.
Prepare the entries to record the transactions.
2-49 LO 2
LEARNING Explain how a ledger and posting help in the

3
OBJECTIVE recording process.
The Ledger
 General Ledger contains all the asset, liability, and owner’s
equity accounts.
Illustration 2-15
2-50 LO 3
The Ledger
STANDARD FORM OF ACCOUNT

CASH NO.111
Source
Amount
Date doccument Explaination Ref.
N D Debit Credit
Sept.1 Beginning balance
Sum
Ending balance
2-51 LO 3
Ledger
POSTING
Transferring
journal entries
to the ledger
accounts.
2-52
Posting
Question
Posting:
a. normally occurs before journalizing.
b. transfers ledger transaction data to the journal.
c. is an optional step in the recording process.
d. transfers journal entries to ledger accounts.
2-53 LO 3
DO IT! 3 Posting
Kate Brown recorded the following transactions in a general journal

during the month of March. Post these entries to the Cash account.
Mar. 4 Cash 2,280

Service Revenue 2,280
Mar. 15 Salaries and Wages Expense 400
Cash 400
Mar. 19 Utilities Expense 92
Cash 92
2-54 LO 3
3.2.2 Adjusting The Accounts
Learning Objectives
Explain the accrual basis of accounting and the
1 reasons for adjusting entries.
2 Prepare adjusting entries for deferrals.
3 Prepare adjusting entries for accruals.
3-55
LEARNING Explain the accrual basis of accounting

1
OBJECTIVE and the reasons for adjusting entries.
Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.
Generally a
Alternative Terminology
 month, The time period assumption
is also called the
 quarter, or periodicity assumption.
 year.
3-56 LO 1
Fiscal and Calendar Years
 Monthly and quarterly time periods are called interim

periods.
 Most large companies must prepare both quarterly

and annual financial statements.
 Fiscal Year = Accounting time period that is one year

in length.
 Calendar Year = January 1 to December 31.
3-57 LO 1
Fiscal and Calendar Years
Question
The time period assumption states that:
a. revenue should be recognized in the accounting

period in which it is earned.
b. expenses should be matched with revenues.
c. the economic life of a business can be divided into

artificial time periods.
d. the fiscal year should correspond with the calendar

year.
3-58 LO 1
Accrual- versus Cash-Basis Accounting
Accrual-Basis Accounting
 Transactions recorded in the periods in which the
events occur.
 Companies recognize revenues when they perform

services (rather than when they receive cash).
 Expenses are recognized when incurred (rather than

when paid).
 In accordance with generally accepted accounting

principles (GAAP).
3-59 LO 1
Accrual- versus Cash-Basis Accounting
Cash-Basis Accounting
 Revenues recognized when cash is received.
 Expenses recognized when cash is paid.
 Cash-basis accounting is not in accordance with

generally accepted accounting principles (GAAP).
3-60 LO 1
Recognizing Revenues and Expenses
REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.
3-61 LO 1
EXPENSE RECOGNITION PRINCIPLE

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

follow the revenues.”
3-62 LO 1
3-63 LO 1
Question
One of the following statements about the accrual basis of
accounting is false? That statement is:
a. Events that change a company’s financial statements are
recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which the performance
obligation is satisfied.
c. The accrual basis of accounting is in accord with generally
accepted accounting principles.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.
3-64 LO 1
The Need for Adjusting Entries
Adjusting Entries
 Ensure that the revenue recognition and expense
recognition principles are followed.
 Necessary because the trial balance may not contain

up-to-date and complete data.
 Required every time a company prepares financial

statements.
 Will include one income statement account and one

balance sheet account.
3-65 LO 1
The Need for Adjusting Entries
Question
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which
they are incurred.
b. revenues are recorded in the period in which
services are performed.
c. balance sheet and income statement accounts
have correct balances at the end of an accounting
period.
d. all of the above.
3-66 LO 1
Types of Adjusting Entries
Illustration 3-2
Categories of adjusting entries
Deferrals Accruals
1. Prepaid Expenses. 1. Accrued Revenues.

Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet
received in cash or recorded.
2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.
3-67 LO 1
Types of Adjusting Entries
Trial Balance – Each account is analyzed to determine

whether it is complete and up-to-date.
Illustration 3-3
3-68 LO 1
DO IT! 1 Timing Concepts
A list of concepts is provided in the left column below, with a description of the
concept in the right column below. There are more descriptions provided than
concepts. Match the description of the concept to the concept.
f Accrual-basis accounting.
1. ___ (a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be matched
e Calendar year.
2. ___
with results (revenues).
c Time period assumption.
3. ___ (c) Accountants divide the economic life of
b Expense recognition
4. ___ a business into artificial time periods.
principle. (d) Companies record revenues when they
receive cash and record expenses
when they pay out cash.
(e) An accounting time period that starts on
January 1 and ends on December 31.
(f) Companies record transactions in the
period in which the events occur.
3-69 LO 1
LEARNING
OBJECTIVE
2 Prepare adjusting entries for deferrals.
Deferrals are expenses or revenues that are recognized

at a date later than the point when cash was originally
exchanged. There are two types:
 Prepaid expenses
 Unearned revenues
3-70 LO 2
Prepaid Expenses
Payment of cash, that is recorded as an asset to show

the service or benefit the company will receive in the
future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:

 insurance  rent
 supplies  equipment
 advertising  buildings
3-71 LO 2
Prepaid Expenses
 Expire either with the passage of time or through use.
 Adjusting entry:
► Increase (debit) to an expense account and
► Decrease (credit) to an asset account.
Illustration 3-4
3-72 LO 2
Supplies
Illustration: Pioneer Advertising

purchased supplies costing $2,500 on
October 5. Pioneer recorded the payment
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.
Oct. 31 Supplies Expense 1,500

Supplies 1,500
3-73 LO 2
Supplies
Illustration 3-5
3-74 LO 2
Insurance
Illustration: On October 4, Pioneer

Advertising paid $600 for a one-year fire
insurance policy. Coverage began on October
1. Pioneer 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.
Oct. 31 Insurance Expense 50

Prepaid Insurance 50
3-75 LO 2
Insurance
Illustration 3-6
3-76 LO 2
Depreciation
 Buildings, equipment, and motor vehicles

(assets that provide service for many years) are
recorded as assets, rather than an expense, on
the date acquired.
 Depreciation is the process of allocating the cost

of an asset to expense over its useful life.
 Depreciation does not attempt to report the actual

change in the value of the asset.
► Allocation concept, not a valuation concept.
3-77 LO 2
Depreciation
Illustration: For Pioneer Advertising, assume

that depreciation on the equipment is $480 a
year, or $40 per month.
Oct. 31
Depreciation expense 40
Accumulated depreciation 40
Accumulated Depreciation is called

a contra asset account.
3-78 LO 2
Illustration 3-7
3-79 LO 2
Depreciation
STATEMENT PRESENTATION
 Accumulated Depreciation is a contra asset account
(credit).
 Offsets related asset account on the balance sheet.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Illustration 3-8
3-80 LO 2
Prepaid Expenses
Summary of the accounting for prepaid expenses.
Illustration 3-9
Accounting for prepaid expenses
3-81 LO 2
Unearned Revenues
Receipt of cash that is recorded as a liability because

the service has not been performed.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:
 Rent  Magazine subscriptions

 Airline tickets  Customer deposits
3-82 LO 2
Unearned Revenues
 Adjusting entry is made to record the revenue for

services performed during the period and to show the
liability that remains at the end of the period.
 Results in a decrease (debit) to a liability account

and an increase (credit) to a revenue account.
Illustration 3-10
3-83 LO 2
Unearned Revenues
Illustration: Pioneer Advertising received

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

Service Revenue 400
3-84 LO 2
Unearned Revenues
Illustration 3-11
3-85 LO 2
Unearned Revenues
Summary of the accounting for unearned revenues.

Illustration 3-12
3-86 LO 2
DO IT! 2 Adjusting Entries for Deferrals
The ledger of Hammond Company, 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 one-half of the unearned
service revenue.
Prepare the adjusting entries for the month of March.
3-87 LO 2

Debit Credit
Supplies 2,800
Equipment 25,000
1. Insurance expires at the rate of $100 per month.
Insurance Expense 100

Prepaid Insurance 100
3-88 LO 2

Debit Credit
Supplies 2,800
Equipment 25,000
2. Supplies on hand total $800.
Supplies Expense 2,000

Supplies 2,000
3-89 LO 2

Debit Credit
Supplies 2,800
Equipment 25,000
3. The equipment depreciates $200 a month.
Depreciation Expense 200

Accumulated Depreciation—Equipment 200
3-90 LO 2

Debit Credit
Supplies 2,800
Equipment 25,000
4. During March, services were performed for one-half of the unearned

service revenue.

3-91 LO 2
LEARNING
OBJECTIVE
3 Prepare adjusting entries for accruals.
Accruals are made to record
 Revenues for services performed but not yet

recorded at the statement date.
 Expenses incurred but not yet paid or recorded at

the statement date.
3-92 LO 3
Accrued Revenues
Revenues for services performed but not yet received

in cash or recorded.
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur in regard to:

 Rent
 Interest
 Services
3-93 LO 3
Accrued Revenues
 Adjusting entry shows the receivable that exists and

records the revenues for services performed.
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
Illustration 3-13
3-94 LO 3
Accrued Revenues
Illustration: In October Pioneer Advertising

performed services worth $200 that were not
billed to clients on or before October 31.
Oct. 31
Accounts Receivable 200
Service Revenue 200
On November 10, Pioneer receives cash of $200 for the services

performed.
Nov. 10 Cash 200

3-95 LO 3
Accrued Revenues
Illustration 3-14
3-96 LO 3
Accrued Revenues
Summary of the accounting for accrued revenues.

Illustration 3-15
3-97 LO 3
Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:

 Rent  Taxes
 Interest  Salaries
3-98 LO 3
Accrued Expenses
 Adjusting entry records the obligation and recognizes

the expense.
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Illustration 3-16
3-99 LO 3
Accrued Expenses
ACCRUED INTEREST
Illustration: Pioneer Advertising signed a three-month note
payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.
Illustration 3-17
Oct. 31 Interest expense 50

Interest payable 50
3-100 LO 3
Accrued Expenses
Illustration 3-18
3-101 LO 3
Accrued Expenses
ACCRUED INTEREST
Illustration: Pioneer Advertising paid salaries and wages on
October 26; the next payment of salaries will not occur until
November 9. The employees receive total salaries of $2,000 for a
five-day work week, or $400 per day.
Illustration 3-19
3-102 LO 3
Accrued Expenses
Illustration 3-20
3-103 LO 3
Accrued Expenses
Summary of the accounting for accrued expenses.

Illustration 3-21
3-104 LO 3
Summary of Basic Relationships
Illustration 3-22
3-105 LO 3
DO IT! 3 Adjusting Entries for Accruals
Micro Computer Services began operations on August 1, 2017. At the

end of August 2017, management prepares monthly financial
statements. The following information relates to August.
1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a local bank
on a 15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August
totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.
3-106 LO 3
DO IT! 3 Adjusting Entries for Accruals
Prepare the adjusting entries needed at August 31, 2017.

1. At August 31, the company owed its employees $800 in
salaries and wages that will be paid on September 1.
Salaries and Wages Expense 800
Salaries and Wages Payable 800
2. On August 1, the company borrowed $30,000 from a local bank
on a 15-year mortgage. The annual interest rate is 10%.
Interest Expense 250
Interest Payable 250
3. Revenue for services performed but unrecorded for August

totaled $1,100.
Accounts Receivable 1,100
3-107 LO 3
3.2.3
Completing the
Accounting Cycle
Learning Objectives
1 Prepare closing entries.
2 Describe the nature, purpose and prepare a trial balance.
3 Explain how to prepare correcting entries.
3-108
LEARNING Prepare closing entries and a post-
1
OBJECTIVE closing trial balance.
At the end of the accounting period, the company makes

the accounts ready for the next period.
2-109
Preparing Closing Entries
Closing entries formally recognize in the ledger the transfer of

 net income (or net loss) to owner’s capital.
Companies generally journalize and post closing entries only at

the end of the annual accounting period.
Closing entries produce a zero balance in each temporary
account.
2-110 LO 2
Illustration 4-9
Diagram of closing
process—proprietorship
Owner’s Capital is a
permanent account.
All other accounts are
temporary accounts.
2-111 LO 2
CLOSING
ENTRIES
ILLUSTRATED
2-112
Posting
Closing
Entries
2-113
Describe the nature and purpose of a

NOTES 1
subsidiary ledger.
Used to keep track of individual balances.

Two common subsidiary ledgers are:
1. Accounts receivable (customers’)
2. Accounts payable (creditors’) Illustration 7-2
Relationship of general ledger and
subsidiary ledgers
2-114 LO 2
Subsidiary Ledger
A subsidiary ledger is a group of similar accounts whose

combined balances equal the balance in a specific
general ledger account. A subsidiary ledger contains the
details to support a general ledger control account.
By having the details of the general ledger control account
in a subsidiary ledger, a company can better control its
financial information.
2-115 LO 2
Subsidiary Ledger Example Illustration 7-4

Relationship of general
and subsidiary ledgers
2-116 LO 2
Subsidiary Ledger Example
2-117 LO 2
Subsidiary Ledger Example
2-118 LO 2
Advantages of Subsidiary Ledgers
1. Show in a single account transactions affecting

one customer or one creditor.
2. Free the general ledger of excessive details.
3. Help locate errors in individual accounts.
4. Make possible a division of labor.
2-119 LO 2
NOTES 2 Record transactions in special journals.
Used to record similar types of transactions. Illustration 7-5

Use of special journals
and the general journal
If a transaction cannot be recorded in a special journal, the

company records it in the general journal.
2-120
Sales Journal
Illustration 7-6
JOURNALIZING CREDIT SALES Journalizing the sales

journal—perpetual
inventory system
Perpetual inventory system, one entry at selling price in Sales Journal

results in a debit to Accounts Receivable and a credit to Sales. Another entry
at cost results in a debit to Cost of Goods Sold and a credit to Inventory.
2-121 LO 3
POSTING THE SALES JOURNAL

Illustration 7-7
2017 2017
2017
2017
Companies make daily postings from

the sales journal to the individual
2017 accounts receivable in the
subsidiary ledger.
2-122 LO 3
POSTING THE SALES JOURNAL
Illustration 7-7
2017 2017
2017
2017
Posting to the general ledger is done

monthly.
2017
2-123 LO 3
ADVANTAGES OF SALES JOURNAL
 One-line entry for each sales transaction saves time.
 Only totals, rather than individual entries, are posted

to the general ledger.
 A division of labor results.
2-124 LO 3
Cash Receipts Journal
Illustration 7-9
Journalizing and posting
the cash receipts journal
2017
In the cash receipts journal, companies record all receipts of cash.
2-125 LO 3
Posting
Not all of the

subsidiary or Illustration 7-9
general ledger
accounts are
shown on the
illustration to
the right. See
Illustration 7-9
for the
complete
illustration.
Illustration 7-9
Journalizing and
posting the cash
receipts journal
2-126
Purchases Journal Illustration 7-13
the purchases journal
2017
2017
2017
Daily postings are made from the

2017
purchases journal to the accounts
payable subsidiary ledger.
2-127 LO 3
Purchases Journal Illustration 7-13

the purchases journal
2017
2017
2017
At the end of the accounting

period, the company posts totals to
the general ledger.
2-128 LO 3
Cash Payments Journal Illustration 7-16
the cash payments journal
2017
In a cash payments (cash disbursements) journal, companies record all

disbursements of cash.
2-129 LO 3
Cash Payments Journal Illustration 7-16
2017
2017
2017
2017
2-130 LO 3
Cash Payments Journal
2017
2017
2017
2017
Illustration 7-16
2017
2017
2-131 LO 3
Effects of Special Journals on General

Journal
 Special journals substantially reduce the number of

entries that companies make in the general journal.
 Only transactions that cannot be entered in a

special journal are recorded in the general journal.
 Also, correcting, adjusting, and closing entries are

made in the general journal.
2-132 LO 3
Illustration 7-18
the general journal
2-133
LO 3
LEARNING Describe the nature, purpose and
2
OBJECTIVE prepare a trial balance
A trial balance is a list of accounts and their balances at

a given time, as a method of testing the accuracy of
double entry bookkeeping.
Two types of trial balance:
• Initial trial balance
• Extended (adjusted, post- closing) trial balance
2-138
The purpose of trial balance
The purpose of a trial balance is to prove that the value of

all the debit value balances equal the total of all the credit
value balances. If the total of the debit column does not
equal the total value of the credit column then this would
show that there is an error in the nominal ledger
accounts. This error must be found before a profit and
loss statement and balance sheet can be produced.
2-139
Prepare trial balance
 A company prepares a trial balance periodically, usually

at the end of every reporting period.
 The steps for preparing a trial balance are:
1. List the account titles and their balances in the
appropriate debit or credit column. They list accounts in
the order in which they appear in the ledger. Debit
balances appear in the left column and credit balances in
the right column
2. Total the debit and credit columns.
3. Prove the equality of the two columns
2-140
Prepare trial balance
POST- CLOSING TRIAL BALANCE
Name of Beginning balance Incurred in period Ending balance

account
Debit Credit Debit Credit Debit Credit
Cash 4,880 5,250 7,650 2,480
Total
2-141
Limitations of trial balance
A trial balance does not guarantee freedom from

recording errors, however. Numerous errors may exist
even though the totals of the trial balance columns agree.
For example, the trial balance may balance even when:
1. A transaction is not journalized.
2. A correct journal entry is not posted.
3. A journal entry is posted twice.
2-142
Limitations of trial balance
4. Incorrect accounts are used in journalizing or posting.

5. Offsetting errors are made in recording the amount of
a transaction.
As long as equal debits and credits are posted, even to
the wrong account or in the wrong amount, the total
debits will equal the total credits. The trial balance does
not prove that the company has recorded all
transactions or that the ledger is correct.
2-143
Correcting
LEARNING
OBJECTIVE 3 Entries—An
Correcting entriesAvoidable Step
Errors that occur in recording transactions should be
 Unnecessary if accounting records are free of errors.
 Made whenever an error is discovered.
 Posted before closing entries.
Instead of preparing a correcting entry, it is possible to

reverse the incorrect entry and then prepare the
correct entry.
2-144
Correcting entries
If an error is found in an accounting book, they must not be

erased and must be rectified in one of the following manners:
 Cross out the error, write the correct text or number

above, and request the chief accountant to sign next to it;
 Rewrite the incorrect number in red ink or in round

brackets, then write the correct number and request the
chief accountant to sign next to it;
 Issue “chứng từ điều chỉnh" (“corrective note”) and write

the difference.
2-145
Correcting entries
Accounting Errors that

Affect the Trial Balance
Types of
accounting errors
Accounting Errors that do
not Affect the Trial Balance
2-146
Correcting entries
Errors that affect the trial balance are usually a result of a
one sided entry in the accounting records or an incorrect
addition.
As a temporary measure, to balance the trial balance. the
difference in the trial balance is allocated to a suspense
account, and a suspense account reconciliation is
carried out at a later stage.
2-147
Correcting entries
Suspense accounts, as well as being used to correct some

errors, are also opened when it is not known immediately
where to post an amount. When the mystery is solved, the
suspense account is closed and the amount correctly
posted using a journal entry.
A suspense account is an account showing a balance
equal to the difference in a trial balance
2-148
Correcting entries
For example, an accountant draws up a trial balance and finds
that total debits exceed total credits by $162. He knows that there
is an error somewhere, but for the time being he opens a
suspense account and enters a credit of $162 in it.
This serves two purposes.
(a) As the suspense account now exists, the accountant
will not forget that there is an error (of $162) to be sorted out.
(b) Now that there is a credit of $162 in the suspense
account, the trial balance balances.
When the cause of the $162 discrepancy is tracked down,
it is corrected by means of a journal entry. For example, the credit
of $162 should be to purchases. The journal entry would be:
DEBIT Suspense a/c $162
CREDIT Purchases $162
To close off suspense a/c and correct error
2-149
Correcting entries
For example, suppose the trial balance showed total debits of
84,600 but total credits of 83,400 leaving a difference of 1,200
as shown below.
Suspense Accounts – Trial Balance Difference

Account Debit Credit
Trial Balance Totals 84,600 83,400
Difference 1,200
Total 84,600 84,600
Suspense Account Posting

Suspense account 1,200
2-150
Correcting entries
To make the trial balance balances a single entry is posted to the
accounting ledgers in a suspense account.
When the accounting error is identified a correcting entry is
made. Suppose the difference was an addition error on the rent
account, then the correcting entry would be as follows:
Suspense Account – Accounting error correction
Suspense account 1,200
Rent 1,200
2-151
Correcting entries
The type of accounting errors that do not affect the trial balance
are summarized in the table below.
Summary of Accounting Error Types
Accounting Errors Description
Correct amount, wrong type of
Error of Principle in Accounting
account
Errors of Omission in Accounting Entry missed from accounting records
Correct amount and type of account
Error of Commission
but wrong account
Two or more errors balance each
Compensating Error
other out
Error of Original (transposition) Entry Correct accounts, wrong amounts
Correct amount and account, entries
Complete Reversal of Entries
reversed
2-152
Correcting Entries—An Avoidable Step
CASE 1: On May 18, Mercato purchased on account equipment

costing $450. The transaction was journalized and posted as a debit to
Equipment $45 and a credit to Accounts Payable $45. The error was
discovered on June 3.
Incorrect Equipment 45
entry
Accounts Payable 45
Correct Equipment 450
entry
Accounts Payable 450
Correcting Equipment 405

entry Accounts Payable 405
2-153 LO 3
Correcting Entries—An Avoidable Step
CASE 2: On May 10, Mercato Co. journalized and posted a $50 cash
collection on account from a customer as a debit to Cash $50 and a
credit to Service Revenue $50. The company discovered the error on
May 20, when the customer paid the remaining balance in full.
Incorrect Cash 50
entry
Service Revenue 50
Correct Cash 50
entry
Correcting Service Revenue 50

entry Accounts Receivable 50
2-154 LO 3
DO IT! 3 Correcting Entries
Sanchez Company discovered the following errors made in

January 2017 .
1. A payment of Salaries and Wages Expense of $600 was

debited to Supplies and credited to Cash, both for $600.
2. A collection of $3,000 from a client on account was debited
to Cash $200 and credited to Service Revenue $200.
3. The purchase of supplies on account for $860 was debited
to Supplies $680 and credited to Accounts Payable $680.
Correct the errors without reversing the incorrect entry.
2-155 LO 3

January 2017 .
1. A payment of Salaries and Wages Expense of $600 was

debited to Supplies and credited to Cash, both for $600.
Correct the error without reversing the incorrect entry.
Salaries and Wages Expense 600

Supplies 600
2-156 LO 3

January 2017 .
2. A collection of $3,000 from a client on account was debited

to Cash $200 and credited to Service Revenue $200.
Service Revenue 200

Cash 2,800
Accounts Receivable 3,000
2-157 LO 3

January 2017 .
3. The purchase of supplies on account for $860 was debited

to Supplies $680 and credited to Accounts Payable $680.
Supplies ($860 - $680) 180

Accounts Payable 180
2-158 LO 3

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3 The Accounting Process

3.1 The Identification

2 Identifying basic information in source documents

3 Types source documents

 Source documents are the physical basis upon which

 Source documents can provide evidence that a

They usually contain the following information:

Types of Source Documents

Quotation – This is an agreement, usually written,

Types of Source Documents

Sales Order – A sales order (SO) is an internal

Credit Note – This document is sent by a supplier to

Types of Source Documents

Debit Note – This document is sent from a customer

Types of Source Documents

1 The recording process.

2 Adjusting the accounts.

3 Completing the accounting cycle.

3.2.1 The Recording Process

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

Explain how a ledger and posting help in the recording

A part of the accounting system used

How to Open Accounts

 A firm sets up an account whenever it needs to provide

 The chart of accounts is a complete listing of the titles

I/CS Account: Income

Function Contra accounts

General Form of Accounts

• Do NOT think of the way others use these terms

• “Debit” means LEFT

General Form of Accounts

Beginning balance+ Increase

 Assets - Debits should exceed

 Liabilities – Credits should

 Normal balance is on the

Form of The Specific Account

 Revenues increase owner’s equity

 Expenses decrease owner’s equity

Because revenues increase owner’s equity, a revenue account has the

Form of The Specific Account

 The purpose of earning revenues

 The effect of debits and credits on

 Expenses have the opposite

Form of The Specific Account

Transferring expense Transferring income

Depreciation of fixed asset

Debiting: Decreases in Crediting: Increases in

Ending balance: Accumulated

Form of The Special Account

Advanced payment from customers

Debiting: Advanced payment Crediting: Advanced payment

Ending balance: Advance

Advanced payment to suppliers account

Debiting: Advanced payment Crediting: Advanced payment

Ending balance: Prepaid to

Form of The Special Account

Deferred revenue account

Ending balance: Unallocated

Prepaid expense account

Debiting: Actual prepaid cost Crediting: Prepaid expense