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121 Notes On Certain Topics

124 & 122 – Accounting Is Fun!

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Review Topics

1. A = L + OE and DR = CR2. Matching Principle3. Accrual Accounting4. Historical Cost Principle5. Adjustments – Depreciation6. Contra Accounts7. Reversing Entries8. Transpositions and Slides

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Present The Fundamental Accounting Equation With The T Account Form, And Label The Debit

And Credit Sides As Well As The Plus And Minus Sides

= + + - + - - + - + - + + -DR CR DR CR DR CR DR CR DR CR

ExpensesAssets Liabilities Owner's Equity Revenues

•We switch the plus and minus signs around on the other side of the equals sign so that we will be able to carry out double-entry accounting

•Whenever there is a minus in front of the account, we must “switch the plus & minus around”

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Debits Must Always Equal CreditsDR = CR

The critical rule to remember is that the amount placed on the debit side of one or more accounts MUST equal that amount placed on the credit side of another account or accounts.

= + + - + - - + - + - + + -DR CR DR CR DR CR DR CR DR CR

ExpensesAssets Liabilities Owner's Equity Revenues

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Matching PrincipleThe principle that the revenue for one time period is matched up or compared with the related expenses for the same time period

• To get an more accurate net income number (and resultant balance sheet accounts), we always want to match all the expenses of one period to the all the revenues of that same period

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Accrual Accounting• Accrual– Recognition of an expense or a revenue that has been

incurred or earned but has not yet been recorded• Expense meaning of accrual:

– Record (recognize) an expense when it has been incurred but not yet recorded in the books

• Regardless of when the cash is paid

• Revenue meaning of accrual:– Record (recognize) a revenue when it has been earned but not yet

recorded in the books• Regardless of when the cash is received

• Accrued earnings are a better financial measurement for the economic activity for the accounting period Define incur: To come in existence;

To bring upon oneself

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Historical Cost Principle• The principle that a purchased asset should be

recorded at its actual, or historical, cost• Historical cost:

– Actual cost– What you paid for it– The amount that was on the receipt– Remember: this is different from “market value”

• We will see that the historical cost principle is the reason we will create a new account for depreciation expense

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Adjustments - Depreciation• Originally we bought equipment for $49,720

– We paid the cash or incurred debt for it, so why can’t we just record it as an expense?

• Because the income statement would show expenses that are too large

• Because the equipment will probably be around for many more years!

• The Equipment will probably help to generate revenue for many more years to come

• As a result, we must chop the original cost up into pieces and spread the pieces out over the useful life of the asset– This is called depreciation

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Straight-line Depreciation• A means of calculating depreciation in which

the cost of an asset, less any trade-in value, is allocated evenly over the useful life of the asset

• (Cost - Trade-in Value)/(Useful Life in Years)

Cost $49,720.00Estimated Salvage $6,880.00Useful Years 7

Annual Depreciation $6,120.00

Monthly Depreciation $510.00

Assumptions

(49720-6880)/7

(49720-6880)/7/12

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Adjustment for Depreciation of Equipment

• We have calculated the depreciation expense• Expenses are debits• But what is the credit entry?

– Equipment?– No: The historical cost principle says that we must

keep the original cost on the books!• We cannot credit the Equipment account• We credit the contra account: Accumulated

Depreciation

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Definitions: Contra Account

• Contra Account– An account that is contrary to, or a

deduction from, another account; for example, Accumulated Depreciation is listed as a deduction from Equipment

• Contra Account Two Rules:1. Contra accounts are always “attached” to

another account2. Contra accounts are always a subtraction

from the account it is attached to

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Accumulated Depreciation• Accumulated depreciation is a contra asset

account– It is “connected” to the related asset account– The debit still means left– The credit still means right– But the plus and minus signs are reversed

• Because it is subtracted from the related asset account!

• When depreciation is recorded, we do not directly subtract (credit) the related asset, such as equipment– The amount of depreciation should be recorded

in the account: accumulated depreciation

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Accumulated Depreciation

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Book Value or Carrying Value

• The cost of an asset minus the accumulated depreciation

• Listed on the balance sheet

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Reversing Entries

• The reverse of certain adjusting entries, recorded as of the first day of the following fiscal period

• Make it easier for the accountant next period– Next period the accountant does not need to worry

about compound entries for payables and receivables where the cash is paid or is received

• The use of reversing entries is optional

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Determine Which Adjusting Entries Can Be Reversed

1. Must be first day of the period after you made adjusting entries

2. Look at all adjusting entries and find entries that meet all three qualifications:

1. An asset or liability was increased2. The asset or liability did not have a previous balance3. Entry does not involve merchandise inventory or contra

accounts

3. Reverse it by making a new journal entry with the reverse debits and credits

– When you post, don’t forget to write “reversing” in item column in the ledger accounts

• Example

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Adjusting Entries

DescriptionPost.Ref. Debit Credit

20- Adjusting EntriesDec. 31 Wage Expense 1,200.00

Wages Payable 1,200.00

General Journal Page 96

Date

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Journalize the Reversing Entries

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Posting Reversing Entries to Wages Payable Account

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Posting Reversing Entries to Wages Expense Account

Notice that posting of $2,000 wages expense results in an $800 balance.

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Transpositions and Slides ErrorsFinding an error from Trial Balance difference (DR ≠ CR:

DR – CR)• Transposition error

– Digits have been transposed (switched around)• Slide error

– The decimal point in an amount has been misplaced– “Slide the decimal place”

Error Type Original Number Mistakenly written as Difference Evenly divided by 9?96 69 27 3

549 945 -396 -44197 791 -594 -66513 315 198 22

27430 2743 24687 2743230 23 207 2344 440 -396 -44

430 34 396 4464390 9436 54954 6106

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Transpositions and Slides

• Finding an error from Trial Balance difference (DR ≠ CR: DR – CR)– Divide the difference between two trial

balance totals by 2. See if the result matches a transaction amount.

– Errors divisible by 9: If an error exists and the amount of difference between the totals of the trial balance is evenly divisible by 9, the error consists of either a transposition or a slide or both.