T Accounts: Basic Representations of The Accounts

Recap from Week 2 Rules Of Double-entry Bookkeeping Recap from Week 2 Rules Of Double-entry Bookkeeping
T Accounts
Very useful to understand how the double-entry system works. They
are the basic representations of the accounts and have three parts: The following relationship is useful to visualize the rules for Owner’s
Equity Accounts
Title of Account
Owner’s Equity
Debit Credit Decreases Increases
(debits) (credits)
According to the rules of double-entry bookkeeping Expenses Revenues
Increases Decreases Decreases Increases
For every transaction:
(debit) (credit) (debit) (credit)
1 at least one account is debited and at least one account is credited Withdrawals Capital
2 the total amount of debits must equal total of credits Increases Decreases Decreases Increases
Assets = Liabilities + Owner’s Equity (debit) (credit) (debit) (credit)
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase
Dr.Serhan Duran (METU) EM 501 Week 3 Industrial Engineering Dept. 1 / 41 Dr.Serhan Duran (METU) EM 501 Week 3 Industrial Engineering Dept. 2 / 41
Recap from Week 2 Recording Business Transactions The Measurement of the Business Income Timing Issues
Formal process for recording the transactions: Timing Issues

1 Analyze the transactions from the source documents It will be easy if we could wait to prepare financial statements until a
2 Enter the transactions into the Journal company ended its operations. Then, its final balance sheet and the
amount of lifetime income could be easily determined.
General Journal Page 1
Date Description Post Debit Credit Unfortunately, all companies find it desirable to report the results
Ref. of their business activities frequently
2007 Jan. 8 Prepaid Insurance 480 Therefore, accountants divide the economic life of a business into
Cash 480
artificial time periods
3 Transfer data from journal to the Ledger by debiting and crediting This is called a time period assumption
the particular accounts involved (called posting) And time period assumption requires methods to handle the
General Ledger transactions affecting more than one of these arbitrary time
Accounts Payable Account No:212 periods
Post Balance Accounting time periods are usually
Date Item Ref. Debit Credit Debit Credit
a year (fiscal year)
2007 Jan. 5 J1 1,500 1,500
a month or a quarter (interim periods)
6 J1 2,600 4,100
9 J1 1,000 3,100 Fiscal year and calendar year may not be the same
The Measurement of the Business Income Timing Issues The Measurement of the Business Income Timing Issues
Revenues
Businesses
Simply, equal the price of goods sold and services rendered over a
exist to earn income
specific period of time. They can be
activities do not necessarily coincide with standard periods of time
Cash
are required to report income or loss regularly
Money to be received later
Income Statements at the end of every quarter for investors
taxable income reports annually for government Notes Receivable
Accounts Receivable
The primary objective of accounting is measuring the net income of the
businesses according to the generally accepted accounting principles. Expenses
Simply, are the costs of goods and services used up in the course of
Net Income
generating revenues. They can be
net increase in the owner’s equity that results from the operations
Salaries
of the company
Rent
Net Income = revenues - expenses
Utilities (Telephone, Electric, Water, etc.)
If the result is negative, we call it a net loss
Depreciation
The Measurement of the Business Income Temporary or Nominal Accounts The Measurement of the Business Income Issues in Calculating Revenues and Expenses
Temporary or Nominal Accounts Issues in Calculating Revenues and Expenses

used in the calculation of the net income 1 The Accounting Period Issue
1 revenue accounts the difficulty of assigning revenues and expenses to a short period
2 expense accounts of time
are only needed to accumulate the balances over the accounting estimating the number of years an asset will be useful
period a cost figure associated to each year
the balances are transferred to the owner’s equity when
2 The Continuity Issue
accounting period is over the revenues or expenses needed to be allocated over several
accounting periods
start each accounting period with zero balance. assume that business will continue to operate indefinitely (ongoing
concern)
Permanent Accounts 3 The Matching Issue
Balance sheet accounts raises from the rule:
Asset Accounts Revenues must be assigned to the accounting period in which the
Liability Accounts goods are sold or the services performed, and expenses must be
Capital Account assigned to the accounting period in which they are used to
Their balances extend beyond the end of an accounting period produce revenue
The Measurement of the Business Income Issues in Calculating Revenues and Expenses The Measurement of the Business Income Adjusting the Accounts
Cash Basis of Accounting

Consider the end-of period trial balance for John Miller Advertising
the revenues and expenses are accounted for on a cash received Company.
or cash paid basis
mostly the matching rule can not be satisfied
John Miller Advertising Company Wrong Balances
Trial Balance
Therefore, the accountants develop: January 31, 2007
Prepaid Rent of $800
Cash $1,720
Accounts Receivable 2,800
Accrual Accounting Art Supplies 1,800 Rent Expense of $0
Office Supplies 800
Prepaid Rent 800
record the financial effects in the periods in which the transactions Prepaid Insurance 480
Adjustments Needed
occur Art Equipment
Office Equipment
4,200
3,000
done by two ways: Accounts Payable $3,170 To correct the balances
Unearned Art Fees 1,000
1 by recording revenues when earned and expenses when incurred John Miller, Capital 10,000 before preparing
John Miller, Withdrawals 1,400
2 by adjusting accounts Advertising Fees Earned 4,200 financial statements
Wages Expense
Utility Expense
1,200
100
starting the new
We practice the first rule, by recording a revenue earned on credit in Telephone Expense 70 period
18,370 18,370
the accounts receivable and a expense when billed to the accounts
payable.
The Measurement of the Business Income Adjusting the Accounts The Measurement of the Business Income Deferrals
Deferral of Expenses
Accountants use Adjusting Entries to apply accrual accounting to
transactions that span over multiple accounting periods.
The Adjustment Entries Deferral Expenses
have at least one permanent account (balance sheet) and at least Some expenditures are customarily paid in advance (ex. rent,
one temporary account (income sheet) insurance, supplies)
never involve cash account Companies often make expenditures that benefit more than one
There are two main types of adjustments: period
1 Deferral is the postponement of the recognition of an expense These expenditures generally are debited to an asset account
already paid/incurred or postponement of a revenue already
received At the end of the accounting period, the amount that has been
used in costs or revenues that are recorded but must be proportioned used is transferred from asset account to an expense account
between two or more accounting periods Examples:
2 An Accrual is the recognition of a revenue or expense that has 1 Prepaid expenses
arisen but not yet been recorded 2 Depreciation of plant and equipment
when a fee is earned or a wage expense is incurred but not recorded
The Measurement of the Business Income Deferrals The Measurement of the Business Income Deferrals
Deferral of Expenses Deferral of Expenses
Deferral of Prepaid Expenses

At the end of the accounting period, a portion (or all) of these
Adjustment b): On January 8, John Miller paid for a one-year life
goods or services will have been used or expired
insurance policy, $480, with coverage effective January 1. By January
The part that has been benefited is treated as an expense at the 31, one twelfth of it expired and should be recorded as an expense.
end of the period.
Adjustment a): John Miller paid 2 months rent, $800 in advance. By Insurance Expense Prepaid Insurance
January 31, half of it had expired and should be treated as an expense. Jan.31 40 Jan.8 480 Jan.31 40
Rules
Rent Expense Prepaid Rent
Decrease in assets is credited to the asset accounts, decrease in
Jan.31 400 Jan.2 800 Jan.31 400
owner’s equity is recorded as debits.
Rules
Adjustment c and d): On January 6, John Miller purchased art Depreciation of Plant and Equipment
supplies costing $1,800 and office supplies, $800. At the end of
buys a long-lived asset is prepaying for usefulness at the start of
January, $500 worth of art supplies and $200 worth of office supplies
the purchase
are used, and therefore must be treated as expenses.
the asset is a deferral of an expense
Office Supplies Office Supplies Expense must allocate the cost of asset over its useful life
Jan.6 800 Jan.31 200 Jan.31 200 amount of expense allocated to each accounting period is called
the depreciation or depreciation expense.
Art Supplies Art Supplies Expense
the asset accounts are not credited directly.
Jan.6 1,800 Jan.31 500 Jan.31 500
Instead, the accumulated depreciation accounts are used
Rules 1 contra-asset accounts and
2 they are coupled with the corresponding asset accounts
Decrease in assets is credited to the asset accounts, decrease in 3 The balance of the contra account is shown in the balance sheet as
owner’s equity is recorded as debits. a deduction from the asset
Adjustment e): John Miller purchased art equipment, $4,200, on Adjustment f) On January 5, he also purchased office equipment for
January 4. Company estimates that the useful life of the art equipment $3,000. Again assuming that its life is 5 years, $50 of depreciation cost
is 5 years (60 months), and will be worthless at the end of its life. is incurred at the end of January.
Therefore the depreciation cost for a month is 70 (=4,200/60). At the
end of January, $70 of depreciation cost is incurred. Accumulated Depreciation,
Office Equipment
Office Equipment
Accumulated Depreciation, Jan.5 3,000
Art Equipment Jan.31 50
Art Equipment
Jan.4 4,200
Jan.31 70 Depreciation Expense,
Depreciation Expense, Office Equipment
Art Equipment Jan.31 50
Jan.31 70
Rules
Rules
Rules: Decrease in assets is credited to the asset accounts, decrease
in owner’s equity is recorded as debits.
Deferral of Expenses Deferral of Revenues
Let’s see a partial balance sheet for the John Miller’s company:
John Miller Advertising Company
Partial Balance Sheet, January 31, 2007
Plant and Equipment Deferral of Revenues
Art Equipment $4,200 Just as expenses can be paid in advance, revenues can be
Less Accumulated Depreciation 70 4,130 received before they are earned
Office Equipment $3,000 Revenues received in advance is an obligation for company to
Less Accumulated Depreciation 50 2,950 deliver the goods or perform services
Total Plant and Equipment $7,080 Therefore unearned revenues are liabilities accounts
the proportion of the revenue that is earned must be recorded as
The value of the asset after the accumulated depreciation is subtracted
revenue
is called the carrying value or the Book Value.
Benefits of usage of contra accounts
1 recognizes that depreciation is an estimate
2 preserves the original asset value.
The Measurement of the Business Income Deferrals The Measurement of the Business Income Accruals
Deferral of Revenues Accrued Revenues
Adjustment h) On January 31, John Miller earned a fee of $200 for an

Adjustment g) On January 15, John Miller accepted an advance fee, advertising service on an ongoing project which is not recorded.
$1000, for artwork to be done. Assume that at the end of January,
$400 of it is earned. Adv. Fee Earned
Fees Receivable Jan.10 1,400
Art Fees Earned Unearned Art Fees Jan.31 200 Jan.19 2,800
Jan.31 400 Jan.31 400 Jan.15 1000 Jan.31 200
Rules Rules
Increase in owner’s equity is credited, decrease in liabilities is recorded Increase in owner’s equity is credited, increase in assets is recorded as
as debits. debits. When the project is finished, the customer will be billed, and the
account receivable will be debited and Fees receivable will be credited.
The Measurement of the Business Income Accruals The Measurement of the Business Income Adjusted Trial Balance
Accrued Expenses John Miller Advertising Company

Adjusted Trial Balance January 31, 2007
Cash $1,720
Accounts Receivable 2,800
Art Supplies 1,300
Office Supplies 600
Adjustment i) On January 31, assume that John Miller’s secretary will Prepaid Rent 400
Prepaid Insurance 440
have worked three more days after her last paycheck. Let’s assume Art Equipment 4,200
Accumulated Depreciation,
that these three days worth $180. Art Equipment 70
Office Equipment 3,000
Accumulated Depreciation,
Wages Expense Office Equipment
Accounts Payable
50
$3,170
Wages Payable Jan.12 600 Unearned Art Fees
John Miller, Capital
600
10,000
Jan.31 180 Jan.26 600 John Miller, Withdrawals
Advertising Fees Earned
1,400
4,400
Jan.31 180 Wages Expense
Utility Expense
1,380
100
Telephone Expense 70
Rent Expense 400
Insurance Expense 40
Art Supplies Expense 500
Rules Office Supplies Expense 200
Depreciation Expense,
Decrease in owner’s equity is debited, increase in liabilities is recorded Office Equipment 70
Depreciation Expense,
as credits. Art Equipment 50
Art Fees Earned 400
Fees Receivable 200
Wages Payable 180
18,870 18,870
The Measurement of the Business Income Accounting Cycle The Measurement of the Business Income Accounting Cycle
The purpose of the accounting system is to treat the business

transactions as raw material and develop the finished product of
accounting - financial statements - in a systematic way. The steps
followed in the accounting cycle are: Work Sheet
1 Transactions are analyzed from the source documents, is used as preliminary step in preparation of the financial
statements
2 Transactions are recorded in the journal,
lessens the possibility of leaving out an adjustment
3 Entries are posted to ledger,
helps checking the arithmetical accuracy of accounts
4 Accounts are adjusted at the end of the period with the help of
work sheet, facilitates the preparation of financial statements
5 Financial statements are prepared from work sheet, is not published, a tool for accountants
6 The accounts are closed to conclude the current period.
We have already learned the first four steps. Now, we will review them
in conjunction with work sheet and learn the last two steps.
The Measurement of the Business Income Accounting Cycle The Measurement of the Business Income Accounting Cycle
Account Names Deb. Cre. Deb. Cre. Deb. Cre. Deb. Cre. Deb. Cre.
Cash $1,720 $1,720 1,720
Acc. Receivable 2,800 2,800 2,800
Steps in Preparation of Work Sheets Art Supplies
Off. Supplies
1,800
800
(c)500
(d)200
1,300
600
1,300
600
Prepaid Rent 800 (a)400 400 400
1 Enter and total the account balances in Trial Balance columns Prepaid Insurance 480 (b)40 440 440
Art Equipment 4,200 4,200 4,200
2 Enter and total the adjustments in Adjustment columns Acc. Depreciation,
Art Equipment (e)70 70 70
Office Equipment 3,000 3,000 3,000
3 Enter the account balances in the adjusted trial balance columns Acc. Depreciation,
Office Equipment (f)50 50 50
by combining balances in steps 1 and 2 and total the account Accounts Payable $3,170 3,170 3,170
Unearned Art Fees 1,000 (g)400 600 600
balances J. M., Capital 10,000 10,000 10,000
J. M., Withdraw 1,400 1,400 1,400
4 Extend the account balances from adjusted trial balance columns Adv. Fees Earned 4,200 (h) 200 4,400 4,400
to Income Statement or balance sheet columns Wages Expense
Utility Expense
1,200
100
(i)180 1,380
100
1,380
100
all revenue and expense account balances to income statement Telephone Exp. 70 70 70
Rent Expense (a)400 400 400
columns Insurance Exp. (b)40 40 40
Art Supplies Exp. (c)500 500 500
all asset, liability, owner’s capital and withdrawal account balances Off. Supplies Exp. (d) 200 200 200
Depreciation Exp.,
to balance sheet columns Art Equipment (e)70 70 70
Depreciation Exp., (f) 50 50 50
5 Total the income statement columns and the balance sheet Office Equipment
Art Fees Earned (g)400 400 400
columns. Enter the net income (loss) in both pairs of columns as Fees Receivable (h)200 200 200
Wages Payable (i)180 180 180
balancing figure, recompute the column totals.
2,040 2,040 18,870 18,870 2,810 4,800 16,060 14,070
Net Income 1,990 1,990
4,800 4,800 16,060 16,060

The Measurement of the Business Income Accounting Cycle The Measurement of the Business Income Financial Statements for John Miller Advertising Co.
Completed Worksheet helps John Miller Advertising Company, Income Statement

For the month Ended January 31, 2007
1 Recording the adjusting entries Revenues
Date Description Post Debit Credit Advertising Fees Earned $4,400
Ref. Art Fees Earned 400
2007 Jan. 31 Rent Expense 400 Total Revenues 4,800
Prepaid Rent 400 Expenses
Wages Expense $1,380
31 Insurance Expense 40 Utility Expense 100
Prepaid Insurance 40 Telephone Expense 70
Rent Expense 400
31 Art Supplies Expense 500 Insurance Expense 40
Art Supplies 500 Art Supplies Expense 500
Office Supplies Expense 200
31 Office Supplies Expense 200 Depreciation Expense, Office Eq. 70
Office Supplies 200 Depreciation Expense, Art Eq. 50
2 Preparing financial statements Total Expenses 2,810
3 Recording the closing entries Net Income $1,990
The Measurement of the Business Income Financial Statements for John Miller Advertising Co. The Measurement of the Business Income Financial Statements for John Miller Advertising Co.
John Miller Advertising Company

John Miller Advertising Company Balance Sheet
January 31, 2007
Statement of Owner’s Equity Assets
For the month Ended January 31, 2007 Cash
Accounts Receivable
$1,720
2,800
John Miller, Capital, January 1, 2007 - Fees Receivable 200
Art Supplies 1,300
Add: Investment by John Miller $10,000 Office Supplies 600
Prepaid Rent 400
Net Income 1,990 $11,990 Prepaid Insurance 440
Art Equipment $4,200
Subtotal $11,990 Less Accumulated Depreciation 70 4,130
Less Withdrawals 1,400 Office Equipment $3,000

Less Accumulated Depreciation 50 2,950
John Miller, Capital, January 31, 2007 $10,590 Total Assets $14,540
Liabilities
Accounts Payable $3,170
Unearned Art Fees 600
Wages Payable 180
CAUTION Total Liabilities $3,950
Owner’s Equity
After adjustments are done, on the worksheet the balance on the John Miller, Capital $10,590
Capital account is still seen as $10,000. The correct balance of Total Liabilities and Owner’s Equity $14,540
$10,590 will be obtained by closing the temporary accounts.
The Measurement of the Business Income Closing Entries The Measurement of the Business Income Closing Entries
Closing Entries
Journal entries made at the end of the accounting period
1 set stage for the next accounting period Steps in Closing Entries
clears the balances on revenue, expense and withdrawal accounts 1 Transfer the credit balances from income statement accounts to
2 summarize a period’s revenues and expenses by transferring the Income Summary account
balances to Income Summary Account 2 Transfer the debit balances from income statement accounts to
the Income Summary account
Income Summary Account 3 Transfer the Income Summary balance to the Capital Account
temporary account 4 Transfer the Withdrawals account balance to the Capital Account
provide space to show all revenues and expenses in a single net
figure
its balance is transferred to the capital account
Transfer the credit balances from income statement accounts to the Transfer the debit balances from income statement accounts to the
Income Summary account Income Summary account
Adv. Fee Earned Date Description Post Debit Credit

Jan.31 4,400 Jan.10 1,400 Ref.
Jan.19 2,800 2007 Jan. 31 Income Summary 2,810
Jan.31 200 Office Wage Expense 1,380
Utility Expense 100
Art Fees Earned Income Summary Telephone Expense 70
Rent Expense 400
Jan.31 400 Jan.31 400 Jan.31 4,800 Insurance Expense 40
Art supplies Expense 500
Date Description Post Debit Credit Office supplies Expense 200
Ref. Depreciation Expense,
2007 Jan. 31 Advertising Fees Earned 4,400 Office Equipment 50
Art Fees Earned 400 Depreciation Expense,
Income Summary 4,800 Art Equipment 70
Close revenue accounts Close expense accounts
Utility Expense Telephone Expense

Jan.29 100 Jan.31 100 Jan.30 70 Jan.31 70 Transfer the Income Summary balance to the Capital Account
Depreciation Expense, Depreciation Expense, John Miller, Capital Income Summary

Art Equipment Office Equipment Jan.1 10,000 Jan.31 2,810 Jan.31 4,800
Jan.31 70 Jan.31 70 Jan.31 50 Jan.31 50 Jan.31 1,990 Jan.31 1,990
Rent Expense Insurance Expense Date Description Post Debit Credit

Jan.31 400 Jan.31 400 Jan.31 40 Jan.31 40 Ref.
2007 Jan. 31 Income Summary 1,990
John Miller, Capital 1,990
Office Supplies Expense Art Supplies Expense Close Income
Jan.31 200 Jan.31 200 Jan.31 500 Jan.31 500 Summary Account
Wages Expense
Jan.12 600 Jan.31 1,380 Income Summary
Jan.26 600 Jan.31 2,810 Jan.31 4,800
Jan.31 180
Transfer the Withdraws account balance to the Capital Account

Accounts After Closing
John Miller, Capital
Jan.31 1,400 Jan.1 10,000 John Miller, Withdrawal After all steps in the closing process have been completed and all of
Jan.31 1,990 Jan.25 1,400 Jan.31 1,400 the adjusting and closing entries have been posted to ledger accounts
from journal entries:
Bal. 10,590
1 Accounts with zero balance
Revenue Accounts
Date Description Post Debit Credit
Expense Accounts
Ref.
Withdrawals Account
2007 Jan. 31 John Miller, Capital 1,400
John Miller, Withdrawals 1,400
2 Capital Account shows the right balance
Close Net income is transferred to capital account
Withdrawals Account Withdrawals are deducted from capital account
The Measurement of the Business Income Closing Entries
Overview of Accounting System
INPUT PROCESS OUTPUT
Transaction
Source WORK Financial
JOURNAL LEDGER
Documents SHEET Statements
Closing
Analyzing Recording Posting Adjusting Preparing
Dr.Serhan Duran (METU) EM 501 Week 3 Industrial Engineering Dept. 41 / 41

T Accounts: Basic Representations of The Accounts

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Recap from Week 2 Rules Of Double-entry Bookkeeping Recap from Week 2 Rules Of Double-entry Bookkeeping

Formal process for recording the transactions: Timing Issues

Temporary or Nominal Accounts Issues in Calculating Revenues and Expenses

Cash Basis of Accounting

Deferral of Expenses Deferral of Expenses

Deferral of Prepaid Expenses

Deferral of Expenses Deferral of Expenses

Deferral of Expenses Deferral of Expenses

Deferral of Expenses Deferral of Revenues

Deferral of Revenues Accrued Revenues

Adjustment h) On January 31, John Miller earned a fee of $200 for an

Accrued Expenses John Miller Advertising Company

The purpose of the accounting system is to treat the business

4,800 4,800 16,060 16,060

Completed Worksheet helps John Miller Advertising Company, Income Statement

John Miller Advertising Company

Less Withdrawals 1,400 Office Equipment $3,000

Adv. Fee Earned Date Description Post Debit Credit

Utility Expense Telephone Expense

Depreciation Expense, Depreciation Expense, John Miller, Capital Income Summary

Rent Expense Insurance Expense Date Description Post Debit Credit

Transfer the Withdraws account balance to the Capital Account

Overview of Accounting System

INPUT PROCESS OUTPUT

Analyzing Recording Posting Adjusting Preparing

Dr.Serhan Duran (METU) EM 501 Week 3 Industrial Engineering Dept. 41 / 41

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