WILEY

IFRS EDITION

Prepared by
Coby Harmon
University
1-1
of California, Santa Barbara
Westmont College
 CHAPTER

1 Accounting in Action
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Explain what accounting is.
2 State the accounting equation, and define its components.
3 Analyze the effects of business transactions on the accounting equation.

1-2
 What is Accounting?
Learning
Accounting consists of three basic Objective 1
Explain what
activities—it accounting is.

◆ identifies,

◆ records, and

◆ communicates

the economic events of an organization to interested users.

1-3 LO 1
 Three Activities
Illustration 1-1
The activities of the accounting process

The accounting process includes

the bookkeeping function.

1-4 LO 1
 Assumptions

Review Question
Which of the following is not a step in the accounting
process?
a. Identification.
b. Recording.
c. Economic entity.
d. Communication

1-5 LO 1
 Accounting Standards

International Accounting Standards

Board (IASB) http://www.iasb.org/

International Financial
Reporting Standards

1-6 LO 1
 The Basic Accounting Equation
Learning
Basic Accounting Equation Objective 2
State the
accounting
◆ Provides the underlying framework for equation, and
define its
recording and summarizing economic components.
events.

◆ Assets must equal the sum of liabilities

and equity.

Assets = Liabilities + Equity

1-7 LO 2
 Basic Accounting Equation

Assets = Liabilities + Equity

Assets
◆ Resources a business owns.

◆ Provide future services or benefits.

◆ Cash, Inventory, Equipment, etc.

1-8 LO 2
 Basic Accounting Equation

Assets = Liabilities + Equity

Liabilities
◆ Claims against assets (debts and obligations).

◆ Creditors (party to whom money is owed).

◆ Accounts Payable, Notes Payable, Salaries and Wages

Payable, etc.

1-9 LO 2
 Basic Accounting Equation

Assets = Liabilities + Equity

Equity
◆ Ownership claim on total assets.

◆ Referred to as residual equity.

◆ Share Capital—Ordinary and Retained Earnings.

1-10 LO 2
 Equity Illustration 1-7
Increases and
decreases in equity

Investments by shareholders represent the total amount paid

in by shareholders for the ordinary shares they purchase.

1-11 LO 2
 Stockholders’ Equity Illustration 1-7
Increases and
decreases in equity

Revenues result from business activities entered into for the

purpose of earning income.
Common sources of revenue are: sales, fees, services,
commissions, interest, dividends, royalties, and rent.

1-12 LO 2
 Stockholders’ Equity Illustration 1-7
Increases and
decreases in equity

Expenses are the cost of assets consumed or services used in

the process of earning revenue.
Common expenses are: salaries expense, rent expense, utilities
expense, property tax expense, etc.

1-13 LO 2
 Stockholders’ Equity Illustration 1-7
Increases and
decreases in equity

Dividends are the distribution of cash or other assets to

shareholders.
Dividends reduce retained earnings. However, dividends are not
expenses.

1-14 LO 2
 > DO IT!

Classify the following items as issuance of stock, dividends,

revenues, or expenses. Then indicate whether each item
increases or decreases stockholders’ equity.

Classification Effect on Equity

1. Rent Expense Expense Decrease

2. Service Revenue Revenue Increase

3. Dividends Dividends Decrease

4. Salaries and Wages

Expense Decrease
Expense

1-15 LO 2
 The Basic Accounting Equation
Learning
Transactions are a business’s economic Objective 3
Analyze the
events recorded by accountants. effects of
business
◆ May be external or internal. transactions on
the accounting
equation.
◆ Not all activities represent transactions.

◆ Each transaction has a dual effect on the accounting

equation.

1-16 LO 3
 Transaction Analysis

Illustration: Are the following events recorded in the accounting

records?
Discuss product
Purchase
Event design with Pay rent
computer
potential customer

Criterion Is the financial position (assets, liabilities, or

stockholder’s equity) of the company changed?

Record/
Don’t Record
Illustration 1-8
Transaction-identification
process
1-17 LO 3
 Transaction Analysis

Illustration 1-9
Expanded accounting equation

1-18 LO 3
 Transaction Analysis
TRANSACTION 1. INVESTMENT BY STOCKHOLDERS Ray and
Barbara Neal decide to start a smartphone app development company that
they incorporate as Softbyte SA. On September 1, 2017, they invest
€15,000 cash in the business in exchange for €15,000 of ordinary
shares. The ordinary shares indicates the ownership interest that the
Neals have in Softbyte SA. This transaction results in an equal increase in
both assets and equity.
Illustration 1-10

Assets = Liabilities + Equity

Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000

1-19 LO 3
 TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte
SA purchases computer equipment for €7,000 cash.
Illustration 1-10

Assets = Liabilities + Equity

Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
1-20 LO 3
 TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte SA
purchases for €1,600 headsets and other accessories expected to last
several months. The supplier allows Softbyte to pay this bill in October.
Illustration 1-10 Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
1-21 LO 3
 TRANSACTION 4. SERVICES PERFORMED FOR CASH Softbyte SA
receives €1,200 cash from customers for app development services it has
performed. Illustration 1-10

Assets = Liabilities + Equity

Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
1-22 LO 3
 TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte
SA receives a bill for €250 from the Programming News for advertising on
its website but postpones payment until a later date. Illustration 1-10

Assets = Liabilities + Equity

Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
1-23 LO 3
 TRANSACTION 6. SERVICES PROVIDED FOR CASH AND CREDIT.
Softbyte provides €3,500 of services. The company receives cash of
€1,500 from customers, and it bills the balance of €2,000 on account.
Illustration 1-10 Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
1-24 LO 3
 TRANSACTION 7. PAYMENT OF EXPENSES Softbyte SA pays the
following expenses in cash for September: office rent €600, salaries and
wages of employees €900, and utilities €200. Illustration 1-10

Assets = Liabilities + Equity

Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
1-25 LO 3
 TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte SA
pays its €250 Programming News bill in cash. The company previously (in
Transaction 5) recorded the bill as an increase in Accounts Payable.
Illustration 1-10 Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
1-26 LO 3
 TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte SA
receives €600 in cash from customers who had been billed for services
(in Transaction 6). Illustration 1-10

Assets = Liabilities + Equity

Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
1-27 LO 3
 TRANSACTION 10. DIVIDENDS The corporation pays a dividend of
€1,300 in cash to Ray and Barbara Neal, the shareholders of Softbyte SA.
Illustration 1-10
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies + Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
€8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 + €4,700 - €1,950 - €1,300

1-28 €18,050 €18,050 LO 3

 Summary of Transactions

1. Each transaction must be analyzed in terms of its

effect on:
a. The three components of the basic accounting
equation.
b. Specific types (kinds) of items within each
component.
2. The two sides of the equation must always be equal.
3. The Share Capital—Ordinary and Retained Earnings
columns indicate the causes of each change in the
shareholders’ claim on assets.

1-29 LO 3
 Review Questions on the
Transaction Analysis

1-30
 > DO IT!

Transactions made by Virmari & Co. SA, a public accounting firm, for
the month of August are shown below. Prepare a tabular analysis
which shows the effects of these transactions on the expanded
accounting equation, similar to that shown in Illustration 1-10.

1. The company issued ordinary shares for €25,000 cash.

2. The company purchased €7,000 of office equipment on credit.

3. The company received €8,000 cash in exchange for services

performed.

4. The company paid €850 for this month’s rent.

5. The company paid a dividend of €1,000 in cash to shareholders.

1-31 LO 3
 > DO IT!

1. The company issued ordinary shares for €25,000 cash.

Assets = Liabilities + Equity

Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
1-32 LO 3
 > DO IT!

2. The company purchased €7,000 of office equipment on credit.

Assets = Liabilities + Equity

Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
1-33 LO 3
 > DO IT!

3. The company received €8,000 cash in exchange for services

performed.
Assets = Liabilities + Equity
Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
1-34 LO 3
 > DO IT!

4. The company paid €850 for this month’s rent.

Assets = Liabilities + Equity

Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
1-35 LO 3
 > DO IT!

5. The company paid a dividend of €1,000 in cash to shareholders.

Assets = Liabilities + Equity

Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

€31,150 + €7,000 = €7,000 + €25,000 + €8,000 - €850 - €1,000

€38,150 €38,150
1-36 LO 3
 WILEY

IFRS EDITION

Prepared by
Coby Harmon
University
2-1
of California, Santa Barbara
Westmont College
 CHAPTER

2 The Recording Process

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain what an account is and how it helps in the recording process.

2. Define debits and credits and explain their use in recording business transactions.
3. Understand the accounting cycle.
4. Identify the basic steps in the recording process.
5. Explain what a journal is and how it helps in the recording process.
6. Explain what a ledger is and how it helps in the recording process.
7. Explain what posting is and how it helps in the recording process.
8. Prepare a trial balance and explain its purposes.
9. Explain the reasons for adjusting entries and identify the major types of them.
10. Prepare an adjusted trial balance.
2-2
 The Account
Learning
Objective 1 ◆ Record of increases and decreases in
Explain what an a specific asset, liability, stockholders’
account is and equity, revenue, or expense item.
how it helps in
the recording ◆ Debit = “Left”
process.
◆ Credit = “Right”

Account Name
An account can Debit / Dr. Credit / Cr.
be illustrated in a
T-account form.

2-3 LO 1
 Debits and Credits
Learning
DEBIT AND CREDIT PROCEDURES Objective 2
Define debits and
credits and
Double-entry system explain their use
in recording
◆ Each transaction must affect two or more business
transactions.
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.

2-4 LO 2
 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
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000

Balance $15,000

2-5 LO 2
 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
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance $1,000

2-6 LO 2
 Debits and Credits

Assets ◆ Assets - Debits should exceed

Debit / Dr. Credit / Cr.
credits.

◆ Liabilities – Credits should

Normal Balance
exceed debits.
Chapter
3-23

◆ Normal balance is on the

increase side.
Liabilities
Debit / Dr. Credit / Cr.

Normal Balance

Chapter
3-24

2-7 LO 2
 Debits and Credits

Equity ◆ Issuance of share capital and

Debit / Dr. Credit / Cr.
revenues increase equity (credit).

◆ Dividends and expenses decrease

Normal Balance
equity (debit).
Chapter
3-25

Share Capital-Ordinary Retained Earnings Dividends

Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.

Normal Balance Normal Balance Normal Balance

Chapter Chapter Chapter

3-25 3-25 3-23

2-8 LO 2
 Debits and Credits

Revenues ◆ The purpose of earning revenues

Debit / Dr. Credit / Cr.
is to benefit the shareholders.

◆ The effect of debits and credits on

Normal Balance
revenue accounts is the same as
Chapter
3-26
their effect on equity.

◆ Expenses have the opposite

Expenses
Debit / Dr. Credit / Cr.
effect: expenses decrease equity.

Normal Balance

Chapter
3-27

2-9 LO 2
 Debits and Credits
Liabilities
Debit / Dr. Credit / Cr.
Normal Normal
Balance Balance
Debit Credit Normal Balance

Assets Chapter
3-24

Equity
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Normal Balance
Normal Balance

Chapter
3-23

Expenses Chapter
3-25
Revenues
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Normal Balance
Normal Balance

Chapter
3-27 Chapter
3-26

2-10
LO 2
 Summary of Debit/Credit Rules

Statement of
Financial Position Income Statement
Asset = Liability + Equity Revenue - Expense

Debit

Credit

2-11 LO 2
 Summary of Debit/Credit Rules

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.

2-12 LO 2
 Summary of Debit/Credit Rules

Question
Accounts that normally have debit balances are:

a. assets, expenses, and revenues.

b. assets, expenses, and equity.

c. assets, liabilities, and dividends.

d. assets, dividends, and expenses.

2-13 LO 2
 Equity
Relationships

Illustration 2-11
Equity relationships

2-14 LO 2
 Summary of Debit/Credit Rules

Relationship among the assets, liabilities, and equity of a

business:
Illustration 2-12
Summary of debit/credit rules

The equation must be in balance after every transaction.

Total Debits must equal total Credits.

2-15 LO 2
 Learning Objective 3
The Accounting Cycle Understand the accounting
cycle.

1. Analyze business transactions

9. Prepare a post-closing 2. Journalize the

trial balance transactions

8. Journalize and post

3. Post to ledger accounts
closing entries

7. Prepare financial
4. Prepare a trial balance
statements

6. Prepare an adjusted trial 5. Journalize and post

balance adjusting entries

Illustration 4-11
2-16
Steps in the accounting cycle
LO 3
 The Recording Process
Learning
The basic steps in the recording process are: Objective 4
Identify the basic
steps in the
(1) analyze each transaction in terms of its effect recording
process.
on the accounts,

(2) enter the transaction information in a journal.

(Journalizing)

(3) transfer the journal information to the

appropriate accounts in the ledger.
( Posting )

Note: Business documents, such as a sales receipt, a check,

or a bill, provide evidence of the transaction.
2-17 LO 4
 Steps in the Recording Process
Learning
The Journal Objective 5
Explain what a
journal is and
◆ Book of original entry. how it helps in
the recording
◆ Transactions recorded in chronological process.

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.

2-18 LO 5
 The Journal

JOURNALIZING - Entering transaction data in the journal.

Illustration: On September 1, shareholders invested €15,000 cash
in the corporation in exchange for ordinary shares, and Softbyte
purchased computer equipment for €7,000 cash.
Illustration 2-14

GENERAL JOURNAL

Date Account Title Ref. Debit Credit

Sept. 1 Cash 15,000
Share Capital—Ordinary 15,000

Equipment 7,000
Cash 7,000
2-19 LO 5
 The Journal

SIMPLE AND COMPOUND ENTRIES

Illustration: On July 1, Tsai Company purchases a delivery truck
costing NT$420,000. It pays NT$240,000 cash now and agrees to
pay the remaining NT$180,000 on account. Illustration 2-15
Compound journal entry

GENERAL JOURNAL

Date Account Title Ref. Debit Credit

July 1 Equipment 420,000
Cash 240,000
Accounts Payable 180,000

2-20 LO 5
 > DO IT!

As president and sole shareholder, Kate Browne engaged in

the following activities in establishing her salon, Hair It Is
Company SA.

1. Opened a bank account in the name of Hair It Is Company

SA and deposited €20,000 of her own money in this
account in exchange for ordinary shares.

2. Purchased equipment on account (to be paid in 30 days)

for a total cost of €4,800.

3. Interviewed three applicants for the position of beautician.

Prepare the entries to record the transactions.

2-21 LO 5
 > DO IT!

Prepare the entries to record the transactions.

1. Opened a bank account and deposited €20,000.

Cash 20,000
Share Capital—Ordinary 20,000

2. Purchased equipment on account (to be paid in 30 days)

for a total cost of €4,800.
Equipment 4,800
Accounts Payable 4,800

3. Interviewed three applicants for the position of beautician.

No entry
2-22 LO 5
 Steps in the Recording Process
Learning
The Ledger Objective 6
Explain what a
ledger is and
◆ General Ledger contains all the asset,
how it helps in
liability, and equity accounts. the recording
process.

Illustration 2-16
The general ledger
2-23 LO 6
 Posting
Learning
Objective 7
Explain what
posting is and
how it helps in
the recording
process.

Transferring
journal entries
to the ledger
accounts.

Illustration 2-18
Posting a journal
entry

2-24 LO 7
 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.

2-25 LO 7
 The Recording Process Illustrated

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.
Illustration 2-20
Investment of cash
by shareholders

2-26 LO 7
2-27 Illustration 2-23
Payment of monthly rent LO 7
Illustration 2-26
Hiring of employees

2-28 LO 7
 Illustration 2-27
2-29 Declaration and payment of dividend LO 7
2-30 Illustration 2-29
Receipt of cash for services performed LO 7
 > DO IT!
Como Company SpA recorded the following transactions in a general
journal during the month of March. Post these entries to the Cash
account, knowing that the cash balance at the beginning of March
was 600.
Mar. 4 Cash 2,280
Service Revenue 2,280
15 Salaries and Wages Expense 400
Cash 400
19 Utilities Expense 92
Cash 92

2-31 LO 7
 The Unadjusted Trial Balance
Learning
A trial balance Objective 8
Prepare a trial
◆ is a list of accounts and their balances balance and
explain its
at a given time. purposes.

◆ proves the mathematical equality of debits and credits

after posting.

The steps for preparing a trial balance are:

1. List the account titles and their balances.

2. Total the debit and credit columns.

3. Prove the equality of the two columns.

2-32 LO 8
 The Unadjusted Trial Balance

Note : Each account is analyzed to

determine whether it is complete
and up-to-date for financial
statement purposes.
( Adjusting Entries )

2-33
 The Basics of Adjusting Entries
Learning
Objective 9
Explain the
reasons for
Adjusting Entries adjusting entries,
and identify the
◆ Ensure that the revenue recognition and major types of
them.
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

statement of financial position account.
2-34 LO 9
 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. statement of financial position and income statement accounts

have correct balances at the end of an accounting period.

d. All the responses above are correct.

2-35 LO 9
 Types of Adjusting Entries

Deferrals Accruals

Prepaid Expenses. Accrued Revenues.

Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet
(Assets) received in cash or recorded.
(Assets)

Unearned Revenues. Accrued Expenses.

Cash received before Expenses incurred but not yet
services are performed. paid in cash or recorded.
(Liabilities) (Liabilities)

Illustration 3-2
Categories of adjusting entries
2-36 LO 9
 The Adjusted Trial Balance and
Financial Statements
Learning
Objective 10
Prepare an
adjusted trial
Preparing the Adjusted Trial Balance balance and
the financial
◆ Prepared after all adjusting entries are statements.

journalized and posted.

◆ Purpose is to prove the equality of debit balances and

credit balances in the ledger.

◆ Is the primary basis for the preparation of financial

statements.
LO 10
2-37
 Example of Unadjusted Trial Balance Illustration 2-32
A trial balance

2-38 LO 10
Example of Adjusted Trial Balance

Illustration 3-25
2-39 Adjusted trial balance LO 10
 > DO IT!

2-40 LO 10
2-41 LO 10
 WILEY

IFRS EDITION

Prepared by
Coby Harmon
University
4-1
of California, Santa Barbara
Westmont College
 CHAPTER
Financial Statements
3
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Understand the five financial statements and how they are prepared
2. Identify the sections of a classified statement of financial position.
3. Prepare an income statement for a service and a merchandising
company.

4-2
 The Financial Statements
Learning
Companies prepare five financial Objective 1
Understand
statements : the five
financial
Retained Statement statements
Income and how they
Earnings of are prepared.
Statement
Statement Financial
Position
Statement Comprehens
of Cash ive Income
Flows Statement

Note : Financial Statements are prepared directly from the

Adjusted Trial Balance.
4-3 LO 1
 Retained Earnings Statement

◆ Reports the changes in retained earnings for a

specific period of time.

◆ The time period is the same as that covered by the

income statement.

◆ Information provided indicates the reasons why

retained earnings increased or decreased during the
period.

4-4 LO 1
 Statement of Cash Flows

◆ Information on the cash receipts and payments for a

specific period of time.

◆ Answers the following:

HELPFUL HINT
► Where did cash come from? Investing activities
pertain to investments
► What was cash used for? made by the company,
not investments made
► What was the change in the by the owners.

cash balance?

4-5 LO 1
 Illustration 3-26
Preparation of the income statement and retained
earnings statement from the adjusted trial balance
4-6 LO 1
 Illustration 3-27
Preparation of the statement of financial
position from the adjusted trial balance
4-7 LO 1
 Statement of Financial Position
Learning
◆ Reports the assets, liabilities, and equity at a Objective 2
Identify the
specific date.
sections of a
classified
◆ Lists assets at the top, followed by liabilities and statement of
equity. financial
position.
◆ Total assets must equal total liabilities and equity.

◆ Is a snapshot of the company’s financial

condition at a specific moment in time (usually
the month-end or year-end).

◆ To improve understanding, companies group

similar assets and similar liabilities together.

4-8 LO 2
 Illustration 4-17
Classified statement
of financial position

4-9 LO 2
 Illustration 4-17
Classified statement
of financial position

4-10 LO 2
 Intangible Assets

◆ Assets that do not have physical substance.

Illustration 4-18
Intangible assets section

4-11 LO 2
 Property, Plant, and Equipment

◆ Long useful lives.

◆ Currently used in operations.

◆ Depreciation - allocating the cost of assets to a number

of years.

◆ Accumulated depreciation - total amount of

depreciation expensed thus far in the asset’s life.

4-12 LO 2
 Property, Plant, and Equipment

Illustration 4-19
Property, plant, and equipment section

4-13 LO 2
 Long-Term Investments

◆ Investments in ordinary shares and bonds of other

companies.
◆ Investments in non-current assets such as land or buildings
that a company is not using in its operating activities.

Illustration 4-20
Long-term investments section
4-14 LO 2
 Current Assets

◆ Assets that a company expects to convert to cash or

use up within one year or the operating cycle, whichever
is longer.

◆ Operating cycle is the average time it takes from the

purchase of inventory to the collection of cash from
customers.

4-15 LO 2
 Current Assets

Illustration 4-21
Current assets section

4-16 LO 2
 Equity

◆ Proprietorship - one capital account.

◆ Partnership - capital account for each partner.
◆ Corporation – Share Capital and Retained Earnings.

Illustration 4-22
4-17 Equity section LO 2
 Non-Current Liabilities

◆ Obligations a company expects to pay after one year.

Illustration 4-23
Non-current liabilities section

4-18 LO 2
 Current Liabilities

◆ Obligations company is to pay within the coming year or

its operating cycle, whichever is longer.

◆ Usually list notes payable first, followed by accounts

payable. Other items follow in order of magnitude.

◆ Liquidity - ability to pay obligations expected to be due

within the next year.

4-19 LO 2
 Current Liabilities

Illustration 4-24
Current liabilities section

4-20 LO 2
 Income Statement
Learning Objective 3
Prepare an income
◆ Reports the profitability of the company’s statement for a service and
a merchandising company.
operations over a specific period of time.

◆ Shows net income (or net loss).

◆ Does not include investment and dividend

transactions between the shareholders and the
business.

◆ Primary source of information for evaluating a

company’s performance.

◆ Format is designed to differentiate between the various

sources of income and expense.

4-21 LO 3
 Service Company:

◆Lists revenues first, followed by expenses.

4-22 LO 3
 Merchandising Company:

Income Measurement
Not used in a
Sales Less
Illustration 5-1
Service business.
Revenue Income measurement process for a
merchandising company

Cost of Equals Gross Less

Goods Sold Profit

Operating Equals Net

Cost of goods sold is the total Income
Expenses
cost of merchandise sold during (Loss)
the period.

4-23 LO 3
Income
Statement
The income statement
is a primary source of
information for
evaluating a
company’s
performance.

4-24 Illustration 5-14 LO 3

Income
Statement
Key Items:
◆ Net sales

4-25 Illustration 5-14 LO 3

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit

4-26 Illustration 5-14 LO 3

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit

Illustration 5-11
Gross profit rate formula
and computation

4-27 Illustration 5-14 LO 3

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses

4-28 Illustration 5-14 LO 3

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Other income
and expense

4-29 Illustration 5-14 LO 3

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Other income
and expense

4-30 Illustration 5-14 LO 3

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Other income and
expense
◆ Interest expense

4-31 Illustration 5-14 LO 3

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Other income and
expense
◆ Interest expense
◆ Net income

4-32 Illustration 5-14 LO 3

 COMPREHENSIVE INCOME
◆ Other comprehensive income items are not part of net income.

- Includes certain adjustments to pension plan assets, gains and losses

on foreign currency translation, and unrealized gains and losses on
certain types of investments.

Illustration 5-15
Separate statement of net Reported in a combined statement of net income and comprehensive income,
income and comprehensive
or in a separate schedule that reports only comprehensive income.
income

4-33 LO 3
 Review Questions on the
Financial Statements

4-34
 > DO IT!
You are presented with the following list of accounts from the adjusted
trial balance for merchandiser Gorman Company. Indicate in which
financial statement and under what classification each of the following
would be reported.
Financial
Account Statement Classification
Accounts payable SFP Current liabilities
Accounts receivable SFP Current assets
Accumulated Depreciation-Buildings SFP Property, plant, and equipment
Accumulated Depreciation-Equipment SFP Property, plant, and equipment
Advertising Expense IS Operating expenses
Buildings SFP Property, plant, and equipment
Cash SFP Current assets
Depreciation Expense IS Operating expenses
Dividends RES Deduction section

4-35
 > DO IT!
You are presented with the following list of accounts from the adjusted
trial balance for merchandiser Gorman Company. Indicate in which
financial statement and under what classification each of the following
would be reported.
Financial
Account Statement Classification
Equipment SFP Property, plant, and equipment
Freight-Out IS Operating expenses
Gain on Disposal of Plant Assets IS Other income and expense
Insurance Expense IS Operating expenses
Interest Expense IS Interest expense
Interest Payable SFP Current liabilities
Inventory SFP Current assets
Land SFP Property, plant, and equipment
Notes Payable (due in 3 years) SFP Non-current liabilities

4-36
 > DO IT!
You are presented with the following list of accounts from the adjusted
trial balance for merchandiser Gorman Company. Indicate in which
financial statement and under what classification each of the following
would be reported.
Financial
Account Statement Classification
Property Taxes Payable SFP Current liabilities
Salaries and Wages Expense IS Operating expenses
Salaries and Wages Payable SFP Current liabilities
Sales Returns and Allowances IS Sales
Sales Revenue IS Sales
Share Capital—Ordinary SFP Equity
Utilities Expense IS Operating expenses

4-37
 > DO IT!
The following accounts were taken from the financial statements of Callahan
Company.

Match each of the following accounts to its proper statement of financial

position classification, shown below. If the item would not appear on a
statement of financial position, use “NA.”
Current assets (CA) Current liabilities (CL)
Long-term investments (LTI) Non-current liabilities (NCL)
Property, plant, and equipment (PPE) Equity (E)
Intangible assets (IA)

4-38
 Financial Statements

Review Question
The financial statement that reports assets, liabilities, and
equity is the:

a. income statement.

b. retained earnings statement.

c. statement of financial position.

d. statement of cash flows.

4-39
 Financial Statements

Review Question
Net income will result during a time period when:

a. assets exceed liabilities.

b. assets exceed revenues.

c. expenses exceed revenues.

d. revenues exceed expenses.

4-40
 Income Statement

Question
The income statement for a merchandiser shows each of
the following features except:
a. gross profit.
b. cost of goods sold.
c. a sales section.
d. investing activities section.

4-41
 > DO IT!

Presented below is selected information related to Flanagan Group plc

at December 31, 2017. Flanagan reports financial information monthly.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(a) Determine the total assets of Flanagan at December 31, 2017.
(b) Determine the net income that Flanagan reported for December
2017.
(c) Determine the equity of Flanagan at December 31, 2017.

4-42
 Information related to Flanagan Group plc at December 31, 2017.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(b) Determine the net income reported for December 2017.
Revenues
Service revenue £36,000
Expenses
Rent expense £11,000
Salaries and wages expense 7,000
Utilities expense 4,000
Total expenses 22,000
Net income £14,000
4-43
 Information related to Flanagan Group plc at December 31, 2017.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(a) Determine the total assets of Flanagan at December 31, 2017.

Equipment £10,000
Cash 8,000
Accounts Receivable 9,000
Total assets £27,000

4-44
 Information related to Flanagan Group plc at December 31, 2017.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(c) Determine the equity of Flanagan at December 31, 2017.

Total assets [as computed in (a)] £27,000

Less: Liabilities
Notes payable £16,500
Accounts payable 2,000 18,500
Equity £ 8,500

4-45
 > DO IT!

4-46
 > DO IT!
(a) Determine the net income for the quarter April 1 to June 30.

4-47
 > DO IT!
(c) Determine the amount that appears for retained earnings at June
30, 2017.

4-48
 > DO IT!
(b) Determine the total assets and total liabilities at June 30, 2017,
for Skolnick Co.

4-49