ACCOUNTING CYCLE TEACHING MODEL Miranda Wilson, Justin Ruffin, Benjamin Bailey
MBA201 Financial Accounting
Discussion of the Purpose and Approach of the Workshop The objective of this workshop, is to explain the accounting cycle with a thorough clarification of each step along with rules to remember such as GAAP, account classifications like; assets, liabilities, and equity, We also included key concepts such as the accounting equation, debits & credits, and double entry accounting. In an effort to explain this as effectively and comprehensively as possible, we have created a fictitious company, Sneaker World Company, which customizes sneakers and socks for the National Basketball Association (NBA). For an additional reference, we have also created an app, complete with a linked twitter page, YouTube videos, and the handbook from today’s presentation. In today’s world, Technology is everywhere and students use their smartphones and other devices daily. Therefore, we have confidence in this Application; we will be able to gain the attention of the students with this app because it will be right there on their phones. Our objective is that each student will use the app for visual representation of major concepts and a more technological approach to learning key concepts and the accounting cycle. Furthermore, we also aim to make accounting easier to understand in order to better equip the future business leaders of tomorrow!! Introduction to the Audience Welcome to the 2012 NexGen Inc. accounting workshop! We are Miranda Wilson, Justin Ruffin, and Benjamin Bailey and today we will conduct a Workshop based on accounting and the accounting cycle. In section one; we will explain to you the rules to remember. Section two consists of account classifications, financial statements, and key concepts and terms related to accounting. After we explain the main ideas and terms, in section three, we will walk you through the accounting cycle step by step. We have created a fictitious company, Sneaker World co., to help explain the accounting cycle, through its business transactions. Sneaker World co. is one of the primary company’s used in customizing shoes and socks for the National Basketball Association. We will use daily business transactions to exhibit how each action in the cycle is appropriately finalized. We also have prepared an application that will provide more visual aid for the accounting cycle, it will be available for download at your leisure online
Section 1 Things to remember *This section provides an explanation of rules you will need to remember. These rules will help you to better understand why transactions are analyzed and recorded the way they are.
Use of GAAP What is GAAP? Why is it used?
Before a business can record a single transaction, they must follow a set of rules that guide them in identifying transactions, recording transactions, and communicating their accounting activities. These rules are known as Generally Accepted Accounting Principles or GAAP. GAAP principles are made of at least of four simple principles that guide business transactions. Below, we have listed these principles with their explanations, in order for you to better understand them. Principles 1. Cost Principle-‐ The cost principle simply means that accounting information is based on actual cost. This principle guides a business when recording assets. We will explain later what assets are, but remember that there is a cost associated with recording an asset. 2. Revenue Recognition Principle-‐ This principle helps a business to understand when to record revenue. According to this principle, revenue is recognized when it is earned or when services are rendered. This information is important when communicating how profitable the business is. 3. Expense Recognition Principle (Matching)-‐ This principle requires that a business record or the expenses it incurred to generate revenue. What does this mean? This simply means that a business must MATCH its expenses with the revenue the business earned in the same accounting period. 4. Full Disclosure Principle-‐ This principle requires a company to report the details behind financial statements that would impact a user’s decision. Why? A business should broadcast or openly report details behind a financial statement, to better communicate to the user.
Section 2 THINGS TO REMEMBER *Now that you have an understanding of the rules that guide business transactions, this next section will teach you the following: • • • •
How to classify accounts Financial statements What statement each account is on Key Concepts such as the accounting equation, debits/credits, and double entry accounting
ASSETS-‐ An Asset is simply a resource that is owned or controlled by a business. Assets are expected to yield future benefits for the business. What does that mean? This often means that a business expects to gain a profit or revenue from owning these assets. In other words, as the business, an asset is WHAT YOU OWN and you expect to make money from what you own. Accounts that are classified as assets are Cash, Land, Building, Office Equipment, Supplies, Accounts Receivable, Land, Prepaid Expenses, and Prepaid Insurance. LIABILITIES-‐ A liability is a creditor’s claim on assets. What does this mean? Businesses do not expect to gain or benefit from liabilities. Liabilities are obligations a company must pay. In other words, Liabilities are WHAT YOU OWE as the business. Accounts that are classified as liabilities are Accounts payable, Insurance payable, Wages payable, Notes Payable, and unearned revenue. EQUITY-‐ An equity account is the owner’s claim on assets and deals with a company’s stock. Equity can also be determined when a business subtract what is OWNS (Assets) from what it OWES (Liabilities) or Assets -‐ Liabilities. Accounts that are classified as equity are Common Stock, Dividends, and Retained Earnings. *ASSETS LIABILITIES AND EQUITY ARE LISTED ON THE BALANCE SHEET
Assets Cash-‐ this account should show the businesses cash balance. A business uses this account when there are increases or decreases to the company’s money. This money can be in the form of cash, coins, or checks. Land-‐ this account refers to any property that the business owns. The business would use this account when it buys or sells land. Building-‐ this account refers to any facilities that business owns. The business would use this account if it purchased or sold a building, factory, or warehouse. Office Equipment and Supplies-‐ this account refers to any equipment or supplies used by the business. The business would use this account if it buys, sells, or uses equipment/supplies for the business. Equipment can be classified as cash registers, printers, or copy machines. Supplies can be classified as store supplies (bags or gift wrapping) or office supplies (pens, pencils, and paper). Accounts Receivable-‐ this account is used when a business makes sales on credit. This is different from when cash is received because someone owes the business if they make a sale on credit. This account is affected when they expect to receive cash or have received cash from the person who owes them. Prepaid Accounts-‐ Prepaid accounts are also known as prepaid expenses, prepaid insurance, or prepaid rent. These accounts are affected when a company pays an expense in advance. This would occur if a company paid the rent for December in the month of May. LIABILITIES Accounts Payable-‐ this account is affected when the business makes a purchase on credit. This account is not the same as Account Receivable. The business made a purchase so now the business owes who they made the purchase with. The business would use this account when a transaction adds to what it owes or subtracts from what it owes. Notes Payable-‐ this account is affected if a business took out a loan and signed a promissory note. When the business pays that promissory note, Notes Payable is decreased. When the note is established, Notes payable is increased. Wages Payable-‐ this account would be affected when the business pays wages to its employees. Employees are considered as liabilities to the company. Paying the employees decreases the company’s assets (cash).
Unearned Revenue-‐ this account is affected when a customer pays for a service in advance. The revenue is considered unearned because the business hasn’t yet provided the service. REMEMBER According to the revenue recognition principle, revenue can’t be recognized until it is earned. EQUITY Common Stock-‐ this account is affected when an owner invests into the business. When in owner makes an investment into the business, the owner makes an exchange for common stock. This account has a positive effect on equity. Dividends-‐ this account is used when assets are distributed to stockholders. What does this mean? When a business pays dividends to its stockholders, that business is paying out cash dividends. Therefore the business is losing cash (an asset) when it pays its stockholders. In other words, a dividend is the opposite of an owner investment. This account has a negative effect on equity. Revenue and Expenses also have an effect on equity even though these accounts aren’t listed on the balance sheet. *REVENUE AND EXPENSES ARE LISTED ON THE INCOME STATEMENT
CHART CHART OOF F AACCOUNTS CCOUNTS
Illustrated below is a typical chart of accounts. A chart of accounts is simply a list of all a business’s accounts and their balances. Every business has its own accounts and numbering system specific to their business. Asset accounts are usually 100-‐199. Liability accounts are usually 200-‐299. Equity accounts are typically 300-‐399. This chart is usually listed with values but, we listed it with description to further your understanding of accounts. CLASSIFICATION DESCRIPTION
Cash 101 Land 102 Building 103 Office Equipment 104
Cash, Coins, or Checks Property owned by the Business Warehouses, Factories, Stores, or any other building owned by the business Computers, Copy Machines, or Cash Registers 5
Supplies 105 Accounts Receivable 106
Writing utensils, Paper, or Tape When a business makes a sale on credit and expects to receive When a business makes a payment in advance When a company makes a purchase on credit Effected when a company makes a payment on a promissory note When a business pays wages to its employees Effected when a business receives money for future services. This money hasn’t been earned When an owner invests in the business What the owner has after net income is added and dividends are subtracted. Payments to stock holders
Prepaid Expenses 107 Accounts Payable 201 Notes Payable 202 Wages Payable 203 Unearned Revenue 204 Common Stock 301 Retained earnings 302 Dividends 303
Assets = Liabilities + Equity This means that total liabilities and total equity added together, should equal total assets. This equation is important when considering how financial statements are related. There is also an extended form of this equation.
Assets = Liabilities + Equity
Common Stock – Dividends + Revenue -‐ Expenses Debits and Credits-‐ Debits and Credits can be used increase or decrease an account depending on the transaction. Debits and Credits do NOT simply mean to increase or decrease, it all depends on the transaction. There are transactions where a debit increase the credit decreases. For transactions where a credit increases, the debit decreases. A T account represents a ledger account and is a tool used to determine the effects of transactions on 6
accounts. The left side of a t account is the debit side and the right side is the credit side. Below is an illustration of a t account. Account Title (Left Side) (Right Side) Debits Credit Another important thing to remember is the normal side for accounts. • •
The normal side for Assets and Expenses is the debit side. The normal side for Liabilities, Equity, and Revenue is the credit side
Double Entry Accounting-‐ This concept means that each transaction requires at least one debit and one credit. Furthermore, the total amount debited should be equal to the total amount credited. This does NOT mean that a business has to have the same amount of debit accounts as credit accounts in each transaction.
FINANCIAL STATEMENTS There are 4 different financial statements. These statements are the income statement, statement of retained earnings, balance sheet, and statement of cash flows. Although there are 4 statements we are going to focus on 3 in this workshop. Income Statement-‐A business uses this statement to report its net income/loss. Net income/loss is determined by subtracting expenses from revenue (Revenue-‐ Expenses.) Revenue and Expense accounts are found on the income statement. The income statement is for a period in time. Net income is then used on the statement of retained earnings. Statement of Retained Earnings-‐ the statement of retained earnings shows any changes in retained earnings by adding net income to beginning retained earnings and subtracting dividends. This is the equation to find retained earnings: Beginning retained earnings +Net income-‐Dividends= Ending Retained Earnings Ending Retained earnings is then used on the Balance Sheet. Balance Sheet-‐ the balance sheet reports the current balances of assets, liabilities, and equity at any point in time. Assets are totaled, and then liabilities and equity are also totaled. After a business has totaled everything on the balance sheet, the business has to make sure the totals agree with the accounting equation. 7
Section 3 *OK! Now that you’ve learned about classifying accounts, financial statements, and important key concepts, let’s discuss the most important aspect of this workshop, the accounting cycle. In order for you to have a better understanding of the accounting cycle, we created a fictitious company, Sneaker World, and showed you how they would go through an accounting cycle step-‐by-‐step.
Step 1- Analyze Transactions The accounting process begins with analyzing transactions. This is an important step that prepares a business for journalizing. Analyzing transactions is simply when a business looks at it’s transactions to see which accounts are affected. We listed all of the transactions a company like Sneaker World would make in the period below:
Transactions Jan 1, 2012
Owners invested $650,000 cash and $150,000 building into the business in exchange for common stock.
Jan 2, 2012
Sneaker World purchased cash registers for the business for $3000.
Jan 5, 2012
Sneaker World paid its utilities in advance for the next 8 months $10,000.
Jan 6, 2012
Sneaker World purchased supplies for the business $2200.
Jan 9, 2012
Sneaker World customized sneakers for LA Lakers $82,000.
Jan 11, 2012
Sneaker World paid its rent for the month of January 1,000.
Jan 12, 2012
Sneaker World paid its insurance premium $2000.
Jan 12, 2012
Customized sneakers for the NY Knicks for $4000 on account.
Jan 13, 2012
Sneaker World purchased computers for the office for $450
Jan 13, 2012
Customized socks for Chicago Bulls for $700
Jan 15, 2012
Sneaker World paid to restore the front of the store $200.
Jan 15, 2012
Sneaker World purchases cleaning supplies for $800
Jan 15, 2012
Milwaukee Bucks order shoes for game vs. Lakers on January 24th for $15,000
Jan 16, 2012
Customized shoes Miami heat for $5,000
Jan 16, 2012
Sneaker World purchases bags on account $725
Jan 17, 2012
Sneaker World pays off insurance $2000
Jan 17, 2012
Sneaker World pays employee wages $2,100
Jan 18, 2012
Customized shoes for Boston Celtics for $3,800 on account
Jan 19, 2012
Milwaukee Bucks pay for shoes ordered on the 15th
Jan 20, 2012
Sneaker World pays for the bags purchased on the 16th
Step 2- Journalize A general journal is what a company uses to keep a complete record of each transaction and the debits and credits for each one. Every company uses a general journal. Remember a business’s transactions mean nothing until they are on the books or recorded in the general journal. A general journal entry includes the date of the transaction, the titles of the accounts affected in the transactions, the amount of each debit and credit, and, if needed an explanation for the transaction. . Debits are always listed first, and the credits follow when recording transactions. Recording entries in a journal is referred to as journalizing. Remember when recording entries in the general journal to apply the key concepts of double entry accounting and debits and credits. Below we put Sneaker World’s transactions for the period into General Journal format.
General Journal Accounts
2 3 4 5 6 7 8
Cash Building Common Stock Equipment Cash Pre-‐paid Expenses Cash Supplies Cash Cash Fees Earned Rent Expense Cash Pre-‐paid Insurance Cash Accounts Receivable
Amount $650,000 $150,000 $800,000 $3,000 $3,000 $10,000 $10,000 $2,200 $2,200 $82,000 $82,000 $1,000 $1,000 $2,000 $2,000 $4,000 9
9 10 11 12 13 14 15 16 17 18 19
Fees Earned Office Equipment (computer) Cash Cash Fees Earned Miscellaneous Expenses Cash Cleaning Supplies Cash Accounts Receivable Unearned Revenue Cash Fees Earned Supplies (bags) Accounts payable Insurance Expense Pre-‐paid insurance Wage Expense Cash Accounts Receivable Fees Earned Cash Unearned Revenue Fees Earned Accounts Receivable Accounts Payable Cash
$4,000 $450 $450 $700 $700 $200 $200 $800 $800 $15,000 $15,000 $5,000 $5,000 $725 $725 $2,000 $2,000 $2175 $2175 $3,800 $3,800 $15,000 $15,000 $15,000 $15,000 $725 $725
Step 3- Post Posting involves transferring information from the general journal to the general ledger. A general ledger is simply a collection of all accounts. Posting is simply transferring all journal entries to assigned T accounts in the general ledger. Remember what we discussed earlier about T accounts in the key concepts section. Below are T accounts that would appear in Sneaker World’s General Ledger.
Cash 650,000 82,000 700 5000 15000 752,700 730,225
3,000 10,000 2,200 1,000 2,000 450 200 800 2,100 725 22,475
Building 150,000 150,000
Accounts Payable 725 0
Common Stock 800,000 800,000
Equipment 3,000 450 3,450
Pre-‐paid Expenses 10,000 10,000
Supplies 2,200 800 725 3,725
Rent Expense 1,000 1,000
Insurance Expense 2,000 2,000 Pre-‐paid Insurance 2,000 2,000 Accounts Receivable 4,000 15,000 15,000 15,000 3,800 22,800 7,800
Miscellaneous Expenses 200 200
82,000 4,000 700 5,000 15,000 3,800 110,500
Unearned Revenue 15,000 15,000
Wages Expense 2,100 2,100
Step 4- Preparing an unadjusted trial balance A trial balance is a tool that a business uses to make sure of all debit account balances are equal to the sum of a credit balances. It is a list of accounts and their balances at any point in time. On the trial balance there should never be a number in both the debit and the credit column for an account. The total in the debit column should always be equal to the total in the credit column. If the two are different then you have made a mistake somewhere. You will have to go back up to your t-‐accounts or to your journal entries to see where you made your mistake. After going back through to check where the mistake has occured; then check one more time to see if you have made any other mistakes. Then you should be ready to prepare for any adjusting that might come up before the end of your accounting period. Remember before moving forward to ensure that your total debits equal your total credits. Below is the unadjusted trial balance for sneaker world.
Account Title Cash Building Equipment Supplies Prepaid Utilities Prepaid insurance Accounts Receivable Unearned Rev Common Stock Retained Earnings Fees Earned Rent Expense Insurance Expense Wages Expense Miscellaneous Expense Totals
Sneaker World Unadjusted Trial Balance January 31, 2012 Unadjusted Trial Balance Debit Credit 730,225 150,000 3,450 3,725 10,000 0 7,800 0 800,000 0 110,500 1,000 2,000 2,100 200 910,500 910,500
the debit amounts and credit amounts are equal!
Step 5- Adjust Adjusting entries involve ADJUSTING an asset or liability account balance to its proper amount and updating the corresponding account. Adjusting entries are recorded in the general journal and then posted to the ledger. All adjusting entries are made at the end of the accounting period . After the adjusting entries have been made, the business prepares another trial balance. This trial balance is called the adjusted trial balance because it is prepared AFTER adjustments have been made to accounts. Calculating Depreciation is also apart of making adjustments. Depreciation is an expense account used to show the cost associated with an asset. Below, we have provided Sneaker Worlds adjusting transactions and adjusting entries. Adjusting Transactions 1. Sneaker World used $1,000 worth of its supplies 2. Sneaker World incurred $2,000 worth of its expenses 3. Sneaker World has cash registers that they purchased for $50,000 with a salvage value of $10,000 and a useful life of 4 years. 4. Sneaker World received payment from the Boston Celtics from a $3800 accounts receivable that took place during the period. 5. The New York Knicks paid $4000 from services rendered during the period on account. Depreciation = Cost – Salvage Value Useful Life
Date 1 2 3 4 5
Adjusting Entries Accounts Supplies Expense Supplies Utilities Expense Pre-‐paid utilities Depreciation Expense Accumulated Depreciation (Cash register) Cash Accounts Receivable Cash Accounts receivable
Amount $1,000 $1,000 $2,000 $2,000 $10,000 $10,000 $3,800 $3,800 $4,000 $4,000 14
Step 6- Preparing an adjusted trial balance The first trial balance prepared is the unadjusted trial balance; it is prepared before the adjustments are recorded. After the adjustments are recorded, the adjusted trial balance is prepared. After the adjusted trial balance is prepared, financial statements can be prepared directly from these numbers.
Account Title Cash Accounts Receivable Supplies Building Equipment Prepaid insurance Prepaid utilities Accumulated Depreciation Unearned Rev Common Stock Retained Earnings Service Revenue Fees Earned Depreciation expense Rent Expense Insurance Expense Wages Expense Supplies Expense Utilities Expense Miscellaneous Expense Totals
Sneaker World Adjusted Trial Balance January 31, 2012 Adjusted Trial Balance Debit Credit 738,025 0 2,725 150,000 3,450 0 8,000 10,000 0 800,000 0 0 110,500 10,000 3,000 2,000 2,100 1,000 2,000 200 922,500 922,500
check to make sure total debits are equal to total credits!!
Step 7- Prepare Statements The financial statements must be prepared in a very specific order. The order for the financial statements is: income statement, statement of retained earnings, and then the balance sheet. This order is important because information provided in the income statement is used in the statement of retained earnings, and information from the statement of retained earnings is used in the balance sheet. Remember to use the accounting equation from key concepts to assist you with these financial statements. Sneaker World Income Statement January 31, 2012 Income Statement Revenues Fees Earned 110,500 Total Revenue 110,500 Expenses Depreciation Expense 10,000 Rent Expense 1,000 Insurance Expense 2,000 Wage Expense 2,100 Supplies Expense 1,000 Utilities Expense 2,000 Misc. Expense 200 Total Expenses 18,300 Net Income 92,200 Remember Revenue less Expenses equals Net Income Sneaker World Statement of Retained Earnings January 31, 2012 Statement of Retained Earnings Retained Earnings, January 1……. Fees Earned……………………………….. Total Revenue…………………………. Expenses………………………………….
0 92,200 92,200 0 92,200
Sneaker World Balance Sheet January 31, 2012 Assets Cash Accounts Receivable Supplies Building Equipment Prepaid Utilities Prepaid insurance Less Accumulated Depreciation Total Assets
738,025 0 2,725 150,000 3,450 8,000 0 10,000 892,200 Liabilities
Accounts Payable Total Liabilities
0 0 Equity
Common Stock Retained Earnings Total Equity Total liabilities and equity
800,000 92,200 892,200 892,200
Step 8- Close The closing process occurs after the financial statements have been completed. This process is important because all temporary accounts for the ending accounting period must be closed out before the start of the next accounting period. These temporary accounts include revenues, expenses, and dividends. Why is that? The revenue, expenses, and dividends for the period will be shown in retained earnings. Remember revenue and expense accounts are found on the income statement which is for a PERIOD in time. Since this is true, revenue and expense accounts have to be closed at the end of each period. In order to close these accounts, Income summary is the account that is used. This account is only used for the closing process. After revenue and expense accounts are closed to income summary, income summary is then closed to retained earnings. Remember to close and account you record the account as the opposite of its normal balance. For example, Sales has a normal credit balance and to close it you would debit the account to decrease it. All revenue, expense, and dividend account will have a 0 balance after the closing process. Sneaker World’s closing entries are listed below:
Date 1 2
Closing Entries Accounts Fees Earned Income Summary Income Summary Wages Expense Insurance Expense Rent Expense Misc. Expense Supplies Expense Utilities Expense Depreciation Expense Income Summary Retained Earnings
Amount $110,500 $110,500 $18,300 $2,100 $2,000 $1,000 $200 $1,000 $2,000 $10,000 $92,200 $92,200
Step 9-Preparing post-closing trial balance When the closing entries are completed, the post-‐closing trial balance will need to be prepared. The post-‐closing trial balance lists all permanent accounts and their balances after all the adjustments have been made and the closing entries have been posted. It includes assets, liabilities, and equity. Remember not to list any revenue, expense, or dividend accounts because they are closed. A post-‐ closing trial balance should only contain the debit and credit balance for permanent accounts, because these are the only accounts that are remaining after the closing process have concluded. The purpose of this trial balance is to ensure that the debits equal the credits for permanent accounts. For many companies this is the last step in the accounting cycle. Below, the post-‐closing trial balance for Sneaker World is listed. Sneaker World Post-‐Closing Trial Balance January 31, 2012 Post-‐Closing Trial Balance Cash Accounts Receivable Building Equipment Supplies Prepaid Utilities Less Accumulated Depreciation Prepaid insurance Accounts Payable Unearned Revenue Common Stock Retained Earnings Totals
738,025 0 150,000 3,450 2,725 8,000 10,000 0 0 0 800,000 92,200 892,200 892,200
This concludes our workshop for today. We hope that we have equipped you with a better understanding of accounting concepts and the accounting cycle. Remember to follow the instructions that are listed below to download our accounting application on your smartphone.
Application Set-‐up If you would like to download our app
Our app has our presentation from today’s seminar
The app also features our twitter page
The GAAP principle just an case you forget
Visit us on our YouTube Channel
And you can call us anytime 9-‐5 Mon-‐ Fri
Team Members Contributions
Justin Ruffin-‐ My contribution was the detailed chart of accounts, the explanation of key concepts, and the statements for each step of the accounting cycle. I really enjoyed working with this group! There were no slackers and everyone contributed to the project. Each member attended the group meetings and came to work. We had a few obstacles but we persisted through them and completed the project.
Miranda Wilson-‐ My contribution to this project was the discussion of the purpose and approach along with the introduction to address the audience. I also contributed to the detail of the project as well as recording the steps in the accounting cycle on to the project itself.
Benjamin Bailey-‐ My contribution to this project was to explain the steps in the accounting cycle. I also came up with the idea for the mobile application to give to our seminar participates. I really liked working with this group because we came to work every meeting. We also had good time explain the accounting cycle. 22