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ECONOMIC EVENTS
A = L + OE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase
Double Entry Accounting
The Equality of Debits and Credits
•The rule of debts and credits are designed so that every
transaction is recorded by equal amounts of debits and credits.
•This is due to the relationship of the rule of debits and
credits with the accounting equation.
A = L + OE
Debit
balances = Credit
balances
GENERAL JOURNAL
General Ledger
Cash
Date Debit Credit Balance
2007
May 1 8,000 8,000
Posting Journal Entries to the Ledger
Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2007
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.
General Ledger
Capital Stock
Date Debit Credit Balance
2007
May 1 8,000 8,000
Posting Journal Entries to the Ledger
Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2007
May 2 Tools & Equipment 2,500
Cash 2,500
Purchased office equipment.
A = L + OE
Increase Decrease Increase
Either (or both) of these effects occur . . . but this is what “net
as net income is earned . . . income” really means.
Retained Earnings
A = L + OE
Capital Retained
Stock Earnings
The Realization Principle: When To
Record Revenue
Realization Principle
Revenue should be recognized at the time goods are sold and
services are rendered. At this point the business transaction has
completed its earning process.
Assume that ABC company has taken a contract on September
2016 to render service to Z company. ABC company
performed the service on October 2016 and will receive
$2000 from Z company on November 20, 2016.
In which month ABC company should recognize the revenue
earned?
The Matching Principle:
When To Record Expenses
Matching Principle
According to Matching principle, Expenses should be recorded in the
period in which they are used up to generate revenue.
In measuring Net income for the period, revenue should offset by all
the expenses incurred in producing that revenue.
This concept of offsetting expenses against revenue on a basis of
cause and effect is called Matching principle.
Expenses are the cost of the goods and services used up in
the process of earning revenue.
An expenses always causes a decrease in owner’s equity.
The result of change of an expense transaction in the
accounting equation can be either a decrease in assets or a
increase in liabilities.
...
Adjusting Entry
Recognizes portion
Transaction
of asset consumed
Paid cash in advance
as expense, and
of incurring expense
Reduces balance of
(creates an asset).
asset account.
When an adjusting entry is used to convert an asset to expense, a transaction took place
in a prior period that involved the advance payment of an expense.
The adjusting entry is made at the end of the current period to recognize the converting
of the prepaid asset into an expense. The asset account is reduced and the expense
account is increased. Examples for adjusting entries.doc
4-42
2. Converting Liabilities to Revenue
End of Current Period
Prior Periods Current Period Future Periods
Adjusting Entry
Recognizes portion earned as
Transaction revenue,
Collect cash in advance of earning and
revenue (creates a liability). Reduces balance of liability
account.
The adjusting entry is necessary when cash has been collected in advance of earning revenue.
At the end of the accounting period, an adjusting entry will need to be recorded to recognize
the revenue earned during the period and to reduce the liability account.
3. Accruing Unpaid Expenses
End of Current Period
Prior Periods Current Period Future Periods
One of the keys to understanding the accrual of expenses is to realize that an expense has been
incurred in the current accounting period but will not be paid until the following accounting
period should be recorded in the current period.
If Companies cannot follow this practice, current expenses would be recorded in the wrong
accounting period and this violate the matching principle.
4. Accruing Uncollected Revenue
End of Current Period
Adjusting Entry
Transaction
Recognizes revenue earned but
Collect cash in settlement
not yet recorded, and
of receivable.
Records receivable.
A revenue accrual is necessary when revenue has been earned in the current accounting
period but the cash will not be collected until the next period.
In the adjusting entry we will be record as receivable, an asset account, and recognize the
revenue earned as revenue.
Adjusting Entries and Accounting Principles
Costs are matched with revenue in two ways:
The Unadjusted
Trial Balance The adjusted Trial
Balance 50
Financial Statements
Abeba Care Service
Income Statement
For The Month Ended May 31, 2005
Revenue:
Sales Revenue $750
Expenses:
Gasoline expense $ 50
Accu. Dep. Exp. Tool & equip. 50
Accu. Dep. truck expense 250
Total expenses 350
Net income $ 400
Bal. 50 50
Retained Earnings
Dep. Expense: Truk
200 400
Bal. 250 250
Debit Income Summary for the Debit each revenue account for the
Dividends
total expenses and credit each amount of its balance and credit
expense account for its balance. 200 Income summary for the total
revenue.
Debit the capital account /retained Debit Income Summary for the amount
earning for the balance of the drawing of its balance (in this case, the net
account/ dividend and credit income) and credit Retained Earnings
drawing/dividend for the same the capital account.
Post-closing Trial Balance
Abeba Care Service
Post-Closing Trial Balance
May 31, 2005
Cash 3925
Accounts Receivable 75
Tools & equipment 2650
Accumulated Dep. Tools & Equip. 50 2600
Turk 15000
Accumulated Dep.: Turk 250 14750
Notes Payable 13000
Accounts Payable 150
Capital stock 8000
Retained Earnings 200
21350 21350
59
Reversing Entries
After the accounting records have been adjusted and closed at the
end of an accounting period, reversing entries may be made on the
first day of the next accounting period.
The purpose of the reversing entries is to simplify the recording of
routine transactions by disposing of the accrued items (assets and
liabilities), which were entered in the balance sheet accounts
through adjusting entries.
General guidelines for reversing entries when requires
1. When adjusting entry create an assets or liability account which
normally is not used during the accounting period, reversing
entry is required.
2. When an adjusting entry adjusts an asset or liability account
which normally is used to record transactions during the period,
no reversing entry is required.
Exercise
Mr X began his working career in the accounting department of ABC
company. Although Mr. X had taken some formal course of study in
accounting, he gradually developed a thorough knowledge of accounting
policies and eventually he was promoted to the position of chief
accountant.
While attending a regional meeting of accounting executives, Mr X
puzzled by a statement made in a group discussion. The statement was:
“Reversing entries are frequently very helpful in accounting for business
transactions; however they are seldom, if ever, essential to the record-
keeping function.” Mr X was concerned because reversing entries had
been used regularly by ABC company and he had always considered
them essential.
Instructions:-
1.Explain why reversing entries are not essential but why they may be
helpful. Your answer should include an explanation as to when reversing
entries are appropriate and when they should not be used.
2. Using the data below, demonstrate with journal entries
how reversing entries may be used or ignored. The
accounting policy is to debit supplies Expense for all
supplies purchased. The value of supplies on hand on
December 31, year 4 was determined by count to be
Birr 1,150. The balance in the asset account, Inventory
of supplies, in the ledger was zero. The following
adjusting entry was made:
Inventory of supplies 1,150
Supplies expense 1,150
To record inventory of supplies on December 31, year 4.
Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.