978-1259722660 Chapter 2 Lecture Note

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CHAPTER 2

REVIEW OF THE ACCOUNTING PROCESS

Overview

Chapter 1 explained that the primary means of conveying financial information to investors,

creditors, and other external users is through financial statements and related notes. The purpose of

this chapter is to review the fundamental accounting process used to produce the financial

statements. This review establishes a framework for the study of the concepts covered in

intermediate accounting.

Actual accounting systems differ significantly from company to company. This chapter focuses on

the many features that tend to be common to any accounting system.

Learning Objectives

LO2–1 Analyze routine economic events—transactions—and record their effects on a company’s

financial position using the accounting equation format.

LO2–2 Record transactions using the general journal format.

LO2–3 Post the effects of journal entries to general ledger accounts and prepare an unadjusted trial

balance.

LO2–4 Identify and describe the different types of adjusting journal entries.

LO2–5 Record adjusting journal entries in general journal format, post entries, and prepare an

adjusted trial balance.

LO2–6 Describe the basic financial statements.

LO2–7 Explain the closing process.

LO2–8 Convert from cash basis net income to accrual basis net income.

Lecture Outline

I. The Basic Model

A. External events involve an exchange between the company and another entity; internal

transactions do not involve an exchange transaction but do affect financial position.

B. The accounting equation underlies the process used to capture the effect of economic

events (transactions):

Assets = Liabilities + Owners’ Equity

C. Each transaction has a dual effect on the accounting equation.

D. Owners’ equity for a corporation, called shareholders’ equity, is classified by source as

either paid-in capital or retained earnings.

E. The double-entry system is used to process transactions.

1. Elements of the accounting equation are represented by accounts in a general ledger.

2. In the double-entry system, debit means left side of an account, and credit means right

side of an account.

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3. Asset increases are entered on the debit side of accounts and decreases are entered on

the credit side. Liability and equity account increases are credits and decreases are

debits.

II. The Accounting Processing Cycle

A. Step 1. Obtain information about transactions from source documents.

B. Step 2. Transaction analysis is the process of reviewing source documents to determine

the dual effect on the accounting equation and the specific elements involved.

C. Step 3. Record the transaction in a journal. For most external transactions,

special journals (discussed in Appendix 2C) are used to capture the dual effect

of the transaction in debit/credit form.

D. Step 4. Post from the journal to the general ledger accounts. In addition to

general ledger control accounts, a subsidiary ledger (discussed in Appendix 2C)

contains a group of subsidiary accounts associated with particular general

ledger control accounts.

E. Step 5. Prepare an unadjusted trial balance. A worksheet (discussed in

Appendix 2A) can be used as a tool after and instead of step 5 in the

processing cycle.

III. Adjusting Entries

A. Step 6. Record adjusting entries and post to the ledger accounts.

B. Prepayments are transactions in which the cash flow precedes expense of revenue

recognition.

1. Prepaid expenses represent assets recorded when a cash disbursement creates benefits

beyond the current reporting period.

2. Deferred revenues represent liabilities recorded when cash is received from

customers in advance of providing a good or service.

C. Accruals involve transactions where the cash outflow or inflow takes place in a period

subsequent to expense or revenue recognition.

1. Accrued liabilities represent liabilities recorded when an expense has been incurred

prior to cash payment.

2. Accrued receivables involve situations when the revenue is recognized in a period

prior to the cash receipt.

D. Estimates often are made to comply with the accrual accounting model.

1. Most estimates involve either prepayments or accruals.

2. One situation involving an estimate that does not fit neatly into either the prepayment

or accrual classification is accounting for bad debts.

E. Step 7. Preparation of an adjusted trial balance.

F. Accountants sometimes use reversing entries (discussed in Appendix 2B) in conjunction

with adjusting entries.

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IV. Step 8. Prepare Financial Statements

A. The income statement

B. The statement of comprehensive income

C. The balance sheet

D. The statement of cash flows

E. The statement of shareholders’ equity

V. Step 9. Close the Temporary Accounts

A. Close the revenue accounts to income summary.

B. Close the expense accounts to income summary.

C. Close the income summary account to retained earnings.

D. Step 10. Prepare a post-closing trial balance.

VI. Conversion from Cash Basis to Accrual Basis

A. Add (deduct) increases (decreases) in assets. For example, an increase in accounts

receivable means that the company recognized more revenue than cash collected.

B. Add (deduct) decreases (increases) in accrued liabilities. For example, a decrease in

interest payable means that the company incurred less interest expense than the cash

interest paid, requiring the addition to cash basis-income.

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PowerPoint Slides

Three PowerPoint presentations of the chapter are available in the Connect Library:

1. With “Concept Checks” useful for classroom presentation, permitting the

instructor to intersperse in the presentation short exercises students can be asked

to solve individually or in small groups before the solution is “revealed” by the

instructor. {These are available only within Instructor Resources.}

2. Without the “Concept Checks” so students don’t have the solutions before being

asked to solve individually or in small groups.

3. Accessible PowerPoint Presentations. Accessibility is becoming even more

important in the education marketplace. Students and instructors with

disabilities use many different assistive technologies, and McGraw-Hill

Education is working to increase compatibility and access that will not only

help those with disabilities achieve better learning outcomes, but also serve the

institutions that are teaching these students. Accessible PowerPoint allows slide

content to be read by a screen reader and provides alternative text descriptions

for any image files used that enrich the learning experience. Accessible

PowerPoint is also designed with high-contrast color palettes and uses texture

when possible, instead of color to denote different aspects of the imagery used

within the slide.

Note: The slides are intended to provide comprehensive coverage of the chapter, but

they can be easily edited to allow instructors to change numbers and content in

illustrations or to delete slides pertaining to topics they choose to omit or

deemphasize. (Using your students’ names for company names in the Concept

Checks or Illustrations can be fun.)

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Suggestions for Class Activities

1. Spreadsheet Activities

In addition to Exercise 2–20 and Problem 2–13, the requirements for Problems 2–2, 2–4, 2–6, 2–8,

and 2–10 can be modified to include the use of software such as Excel.

2. Professional Skills Development Activities

The following are suggested assignments from the end-of-chapter material that will help your

students develop their communication, analysis and judgment skills.

Communication Skills. In addition to Communication Case 2–3, Judgment Cases 2–1 and 2–2

can be adapted to ask students to write a memo. These Judgment Cases also do well as group

assignments and create good class discussions.

Analysis Skills. The “Broaden Your Perspective” section includes Analysis Cases that direct

students to gather, assemble, organize, process, or interpret data to provide options for making

business and investment decisions. Exercises 2–15, 2–18 and Problems 2–7, 2–9 provide

opportunities to develop and sharpen analytical skills.

Judgment Skills. The “Broaden Your Perspective” section includes Judgment Cases that require

students to critically analyze issues to apply concepts learned to business situations in order to

evaluate options for decision-making and provide an appropriate conclusion. This chapter

includes Judgment Cases 2–1 and 2–2.

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Assignment Chart

Learning Est. time

Questions Objective(s) Topic (min.)

2–1 1 External and internal events 5

2–2 1 Dual effect of transactions on financial position 5

2–3 2,3 Purpose of journal and ledger 5

2–4 3 Permanent and temporary accounts 5

2–5 2,3 Debits and credits 5

2–6 2,3 Debits and credits 5

2–7 1,2,3 Accounting processing cycle 5

2–8 1,2,3 Transaction analysis 5

2–9 3 Posting 5

2–10 2 Journal entries 5

2–11 3,5 Trial balance 5

2–12 4 Adjusting entries 5

2–13 7 Closing entries 5

2–14 4 Adjusting entries—prepaid expenses 5

2–15 4 Adjusting entries—deferred revenue 5

2–16 4 Adjusting entries—accrued liabilities 5

2–17 6 Financial statements 5

2–18 A Worksheet [Based on Appendix 2A] 5

2–19 B Reversing entries [Based on Appendix 2B] 5

2–20 C Special journals [Based on Appendix 2C] 5

2–21 C Subsidiary ledger [Based on Appendix 2C] 5

Brief Learning Est. time

Exercises Objective(s) Topic (min.)

2–1 1 Transaction analysis 10

2–2 2 Journal entries 10

2–3 3 T-accounts 15

2–4 2 Journal entries 15

2–5 5 Adjusting entries 15

2–6 4,5 Adjusting entries; income determination 15

2–7 5 Adjusting entries 15

2–8 4 Income determination 15

2–9 5 Adjusting entries 10

2–10 6 Financial statements 10

2–11 6 Financial statements 10

2–12 7 Closing entries 10

2–13 8 Cash versus accrual accounting 15

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Learning Est. time

Exercises Objective(s) Topic (min.)

2–1 1 Transaction analysis 15

2–2 2 Journal entries 15

2–3 3 T-accounts and trial balance 15

2–4 2 Journal entries 20

2–5 2,3,4,5,6,7 The accounting processing cycle 15

2–6 2 Debits and credits 15

2–7 2 Transaction analysis; debits and credits 15

2–8 5 Adjusting entries 15

2–9 5 Adjusting entries 15

2–10 4,5 Adjusting entries; solving for unknowns 15

2–11 5 Adjusting entries 15

2–12 6,7 Financial statements and closing entries 20

2–13 7 Closing entries 10

2–14 7 Closing entries 10

2–15 4,5,8 Cash versus accrual accounting; adjusting entries 15

2–16 2,5 External transactions and adjusting entries 15

2–17 4,8 Accrual accounting income determination 15

2–18 8 Cash versus accrual accounting 20

2–19 8 Cash versus accrual accounting 20

2–20 A Worksheet [Based on Appendix 2A] 35

2–21 B Reversing entries [Based on Appendix 2B] 10

2–22 B Reversing entries [Based on Appendix 2B] 10

2–23 B Reversing entries [Based on Appendix 2B] 10

2–24 C Special journals [Based on Appendix 2C] 15

2–25 C Special journals [Based on Appendix 2C] 15

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Learning Est. time

Problems Objective(s) Topic (min.)

2–1 2,3 Accounting cycle through unadjusted trial

balance

2–2 2,3 Accounting cycle through unadjusted trial

balance

2–3 5 Adjusting entries 20

2–4 3,5,6,7 Accounting cycle; adjusting entries through

post-closing trial balance

2–5 5 Adjusting entries 20

2–6 2,3,4,5,6,7 Accounting cycle 75

2–7 2,5 Adjusting entries and income effects 20

2–8 5 Adjusting entries 20

2–9 3,5,7 Accounting cycle; unadjusted trial balance

through closing

2–10 4,6,8 Accrual accounting; financial statements 30

2–11 8 Cash versus accrual accounting 15

2–12 8 Cash versus accrual accounting 40

2–13 A Worksheet [Based on Appendix 2A] 40

 Star Problems

Learning Est. time

Cases Objective(s) Topic (min.)

Judgment Case 2–1 4,8 Cash versus accrual accounting; adjusting entries 20

Judgment Case 2–2 8 Cash versus accrual accounting 30

Communication Case 2–3 4 Adjusting entries 20

Target Case 4,6 Target 30

Air France–KLM Case 9IFRS; Air France–KLM 30

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