Fundamental Accounting（18修订）

Fundamental Accounting
Instructor: WangNan
Tel:13770638264
E-mail :wn_jessica@nuist.edu.cn
Chapter 1
An Introduction to
Accounting
【 Learning Objectives 】
1. Describe the function of accounting
2. Prepare simple financial statements
3. List the main fields of accounting
4. Explain the accounting principles and
generally accepted accounting principles
(GAAP)
5. Explain the difference between a single
proprietorship, a partnership and a
corporation
6. Indicate the effects of transactions on the
accounting equation 3
Unit 1 the Nature of Accounting
Discussion Questions:
What is accounting? Please describe the

main functions of accounting.
What is difference between accounting and
bookkeeping?
What’s the meaning of stakeholders ?
4
Identify stakeholders
(Internal: managers, Assess
employees, etc. stakeholders’
External: Owners, informational
Customers, creditors, needs.
government, etc.)
Prepare Record economic Design the accounting

accounting data about information system to
reports for business activities meet stakeholders’
stakeholders. and events needs
Unit 2 Forms of Organization
Proprietorship
Partnership
Corporation
Differ three organization forms of

business.
6
Unit 3 the Framework for the Preparation
and Presentation of Financial Statements
International Accounting Standards Board
(IASB)
Established in 1973 to narrow the range of
differences in accounting standards.
Increase in international trade has motivated
the IASB to attempt to eliminate alternative
accounting treatments.
7
Who issue American Accounting Standards
FASB: Financial Accounting Standards Board

Set up in 1973 to replace Accounting
Principle Board (APB)
An independent, private organization
Standards issued recognized by SEC
Who issue American Accounting Standards
GAAP: Generally Accepted Accounting Standards
7 concept statements (principles)
e.g., No. 7 (February 2000) Using cash
flow information and present value in accounting
measurements
148 statements of standards (rules)

e.g., No. 1 (December 1973) Disclosure
of foreign currency translation information
The Conceptual Framework
Objectives of Financial Reporting

(SFAC No. 1)
Qualitative Characteristics Elements of

of Accounting Information Financial Statements
(SFAC No. 2) (SFAC No. 6)
Recognition and Measurement Criteria

(SFAC No. 5)
Environment Implementation Implementation
assumptions principles constraints
10
Conceptual Framework Objectives
To provide information:
Useful for decisions.
That helps predict cash flows.
About economic resources, claims to resources,
and changes in resources and claims.
Recognition and
Qualitative
Elements Measurement
Characteristics Concepts
Financial
Constraints Statements
Continued
Objectives
Recognition and
Elements Measurement
Qualitative Concepts
Characteristics Assets
Liabilities Assumptions
Understandability Equity Economic entity
Primary Investments by Owners Going concern
Relevance Distributions to owners Periodicity
Reliability Revenues Monetary unit
Expenses
Secondary Principles
Gains
Comparability Historical cost
Losses
Consistency Realization
Comprehensive Income
Matching
Full Disclosure
Financial Statements
Constraints Balance sheet
Cost effectiveness Income statement
Materiality Statement of cash flows
Conservatism Statement of shareholders’ equity
Related disclosures
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Qualitative Characteristics -Understandability
Decision Usefulness
Relevance Reliability
Predictive Feedback Representational

Timeliness Verifiability Neutrality
Value Value Faithfulness
Comparability Consistency
Accounting Assumptions(Concepts)
accounting entity assumption: An accounting

entity is any economic organization which
controls resources and engages in economic
activities.
14
going-concern assumption: An accounting

entity is assumed to continue in operation for
the foreseeable future.
What is the relationship between the
going-concern concept and the cost principle?
15
accounting period assumption: In order to

measure operating progress and changes in
economic position at relatively short term
intervals, accountants must divide the life of a
business into time periods of equal length.
What principle is based on the accounting

period assumption?
16
stable-money-unit assumption: It requires

that money be used as the basic measuring
unit for financial reporting.The purchasing
power remain unchanged, that is, accounting
recording generally doesn't consider the effect
of inflation or deflation.
Money is the sole measuring unit in
accounting system?
17
Accounting Principles
objectivity(reliability) principle: It requires that
accounting record should be based on objective
evidence rather than on subjective judgment.
cost principle:It states that assets should be
recorded at historical cost. The book value of
an asset reflects its worth on the date it is
acquired and subsequent changes are not
relevant to it.
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consistency principle: It requires that a
company should use the same accounting
method from one period to the other so that
the financial statements of different period are
comparable.
conservatism principle:It states that
accountant should be conservative in choosing
the one that has the least favorable impact on
net income when there are two or more
alternative accounting method.
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full-disclosure principle: It requires that
financial statements and their accompanying
financial notes include all relevant information
about the financial position, operations, and
cash flow of the entity.
materiality principle:It requires that
accountant are primarily concerned with the
important items of the financial statements.
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accrual-basis principle: It requires that

whenever a transaction happens
accountant should enter it into the
journal according some right or obligation
, whether or not cash has been received
or paid.
21
Accrual Accounting
Revenue: recognize whenever it is earned,
not when cash changes hands
Expense: recognize whenever it is incurred,

not when cash changes hands
matching principle:It requires that revenues
and expenses of the same period should be
matched each other so as to work out the net
income or net loss .
23
realization principle: It indicates that revenue
should be recognized and reported in the
income statement at the time the earnings
process is completed. In most cases, revenue
is earned when the business has delivered a
completed good or service to the customer.
24
Unit 4 Understanding of Financial
Statements
Relevant financial information is provided
primarily through financial statements and
related disclosure notes.
 Balance Sheet
 Income Statement
 Statement of Cash Flows
 Statement of Shareholders’ Equity
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Balance Sheet: at a point in time, i.e., December 31,
balance sheet measures how much asset the company
own, how much debt the company owe, and how much
equity shareholders have in the company
Assets = Liabilities + Equity
Income Statement: during the period ending on the

balance sheet date, i.e, during the year, how much
revenues the company generates, how much expenses
are used to generate the revenues, and the earnings
(Revenues – Expenses). Profits increase equity on
balance sheet, while losses decrease equity on balance
sheet.
Statement of Retained Earnings: Beginning equity +
Earnings – Dividends = Earnings equity (on balance sheet)
Statement of Cash Flows

Cash is king.
Three sections: Operating, Investing, Financing
Operating: cash flows related to the normal operation

of the firm
Investing: cash flows related to investment in assets
that generate operating cash flow in the future
Financing: cash flows from and to shareholders and
creditors
Financial Statement: Income Statement
Assets
Definition : probable future economic
benefits obtained or controlled by a
particular entity as a result of past
transactions or events; economic resources
owned by a business that are expected to
benefit future operations.
Kinds of assets:
current assets, fixed assets and intangible a
ssets
.
32
 Current assets: cash, accounts receivable,
inventories,
 Fixed assets: land, buildings,and equipment
 Intangible assets: patent, trademark and
brand name, copyright, franchise
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Liabilities
Definition: probable future sacrifices of
economic benefits arising from present
obligations of a particular entity to transfer
assets or provide services to other entities in
the future as a result of past transactions or
events.
Kinds of liabilities: current liabilities and long-
term liabilities
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 Current liabilities: short-term loans payable,
accounts payable, note payable , taxes
payable, advances from customers
 Long-term liabilities: long-term loans payable,
bonds payable, long-term accounts payable
35
Owner’s equity
Definition: the residual interest in the assets
of an entity that remains after deducting its
liabilities;it is the owner’s right to the assets
of the business.
Owner’s equity = assets – liabilities
Owner’s equity = net assets
Kinds of owner’s equity:paid-in capital and
retained earnings
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Revenues
Definition:the increases in owner’s equity as a
result of selling services or products.
Kinds of revenues: sales revenue, fees
earned, rent revenue, interest revenue, etc.
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Expenses
Definition: the results of using up assets or
consuming services in the process of
generating revenues
Kinds of expenses: cost of goods sold, selling
expense, wages expense, rent expense,
utilities expense, and miscellaneous expense,
etc.
38
SFAC No. 6
Assets and Liabilities
Assets: “Business resources that have
probable future economic benefits.”
Liabilities: “Probable future sacrifices of

economic benefits.”
SFAC No. 6
Equity
Residual interest in the assets of a
business entity is also known as net
assets.
SFAC No. 6
Revenues
“Inflows of assets or settlements of
liabilities during a particular accounting
period. Such inflows or settlements
stem from delivery or production of
goods or rendering of services.”
SFAC No. 6
Expenses
“Outflows of assets or incurrences of
liabilities during a particular accounting
period. Such outflows are necessary for
delivery or production of goods or
rendering of services.”
SFAC No. 6
Gains and Losses
Gains: “Increases in equity resulting from
incidental transactions not associated
with the company’s major business.”
Losses: “Decreases in equity resulting
from incidental transactions not
associated with the company’s major
business.”
SFAC No. 6
Investments and Distributions
Investments by owners: “Increases in
equity resulting from asset contribution
by other entities
(owners/stockholders).”
Distribution to owners: “Decreases in
equity resulting from the distribution of
assets to other entities.”
SFAC No. 6
Comprehensive Income
“The change in equity resulting from the
aggregate of all transactions reported in
a particular accounting period, except
for investments by and distributions to
owners.”
Unit 5 Accounting and its Profession
the fields of accounting
financial accounting
managerial accounting
tax accounting
the types of accountants
private accountant
public accountant
government agency accountant
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Financial Accounting
Providers of External
Financial Information User Groups
Investors
Creditors
Profit-oriented Relevant Employees
companies
Labor unions
Customers
Not-for-profit
Suppliers
entities Financial
Government
Information agencies
Households
Financial
intermediaries
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Unit 6 Accounting Elements and Using the
Accounting Equation
 Financial Position Equation
 financial position: economic resources
belonging to a company and the claims
(equities) against those resources at a point
in time.
 economic resources = equities
 Economic resources = creditor’s equity +
owner’s equity
 accounting equation:
 assets = liabilities + owner’s equity 48
 Operating Result Equation
Net Income( Net Loss)=Revenue – Expenses
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four types of transactions that affect owner’s
equity
Owner’s investments Owner’s withdrawals
Owner’s
equity
revenues expenses
 the full form of accounting equation:

Assets = Liabilities + Owner’s Equity +
Revenue – Expenses
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 the Effects of Business Transaction on the
Accounting Equation
A transaction is such an economic event or

condition that directly changes an entity’s
financial position or affects its operating
results.
All business transactions can be stated in
terms of changes in the elements of the
accounting equation.
51
The effect of every transaction is an increase or
a decrease in one or more of the accounting
equation elements.
All transactions can be categorized into two
kinds:
 The result of a transaction involves in the elements of two
sides of the equation, making assets and equity increase or
decrease at the same time.
 The result of a transaction only involves in the elements of one
side of the equation, making the contents of assets or equity
increase and decrease at the same time, but the total remain
unchanged.
 The two sides of the accounting equation are
always equal.
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Demonstration
1.The new business was begun on September 1,
when Roberts deposited $180,000 in a bank
account in the name of the business, Robert Real
Estate Company. The initial balance sheet of the
new business then appeared as follows:
ROBERTS REAL ESTATE COMPANY
Balance Sheet
September 1, 2001
Asset Liabilities and Owner’s Equity
Cash $180 000 James, Roberts, Capital  $180 000
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2. The next transaction entered into by Robert Real
Estate Company was the purchase of land suitable
as a site for an office. The price for the land was
$141,000 and payment was made in cash on Sep 3.
3. On Sep 5, an opportunity arose to buy from Kent
Company a complete office building which had to
permit the construction of a freeway. A price of
$36,000 was agreed upon, which included the cost
of moving the building and installing it upon the
Roberts Company’s lot. The terms provided for an
immediate cash payment of $15,000 and payment
of the balance of $21,000 within 90days.
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4. On Sep 10, Roberts Company sold a small, unused
corner of the lot to Carter’s Drugstore for a price of
$11,000. Since the sales price was computed at the
same amount per square foot as Roberts Company
had paid for the land, there was neither a profit nor
a loss on the sale. No down payment was required,
but it was agreed that the full price would be paid
within three months.
5. A complete set of office furniture and equipment
was purchased on credit from General Equipment,
Inc., on Sep 14 for $5,400.
55
6. On Sep 20, cash in the amount of $1,500 was
received as partial settlement of the account
receivable from Carter’s Drug Store.
7. On Sep 30, Robert Real Estate Company paid
$3,000 in cash to General Equipment, Inc.
Effect of Business transactions upon the Accounting
Transactions
1. Making an investment to start a business.
2. Purchase of an asset for cash.
3. Purchase of an asset and incurring of a liability
4. Sale of an asset.
5. Purchase of an asset on credit
6. Collection of an Account Receivable
7. Payment of a liability
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Assets = Liabilities + Owner’s Equity
Cash +Accounts +Land +Building+ Office = Accounts + James
Receivable Equipment Payable Roberts Capital
1.+180,000 +$180,000
2.- 141,000 +141,000
3. - 15,000 +36,000 +21,000

4. +11,000 - 11,000
5. + 5,400 + 5,400
6.+ 1,500 -1,500
7. - 3,000 - 3,000
$22,500+$9,500+ $130,00 + $36,000 + $5,400 = $23,400 + $180,000
57
Unit 7 Ethics in Accounting
To be useful, accounting information must be
objective and reliable.
Management may be under pressure to report
desired results and ignore or bend existing
rules.
 Integrity
 Confidentiality
 Competence
 Objectivity
58
Chapter 2
Recording Transactions
1. Describe the nature of events and the
importance of business paper
2. Describe the use of accounts, the meaning
of debit and credit in T-accounts.
3. State the rules of debit and credit.
The total debits should equal the total credits
4. Record transactions in a General Journal,
describe balance column accounts and post
entries from the journal to the accounts.
5. Prepare and explain the use of trial
balance.
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The steps of recording business transactions:
Analyze transactions
Journalize transactions
Post to the ledger
61
Unit 1 Economic Events and Business
Documents
The accounting process starting by analyzing
economic events.
(1)Business transactions
(2)Other events
Analyze transactions: with the aid of source
document, and using the double-entry
accounting system.
62
Business documents—the starting point in
the accounting process.
 Source document: provide evidence of a
transaction and are the basis for analyzing
and recording the transaction, such as
checks, sales invoices, bank statements,
purchase orders, etc.
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UNIT 2 T- Account and Debit & Credit
Usefulness of an account
Why accounts are used to record and
summarize the effects of transactions on
financial statements?
——The increases and decreases in each
financial statement item are shown in a
separate record, this record is called an
account.
64
Characteristics of an account
An account, in its simplest form, has three
parts :
 A title—the name of the item recorded in the account
 A space for recording increases in the amount of the item
 A space for recording decreases in the amount of the item
Title
left side right side
debit credit
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Amounts entered on the left (right) side of an account
are called debits (credits).When debits (credits) are
entered in an account, the account is said to be
debited (credited).
Types of Accounts
asset accounts
liability accounts
Owner’s equity accounts
Revenue accounts
Expense accounts
66
Ledger
A group of accounts for a business entity is
called a ledger.
The accounts are normally listed in the order
in which they appear in the financial
statement.
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Double-Entry Bookkeeping
 1494.Luca Pacioli—Pioneer
 The system requires that each transaction
must be recorded in two or more accounts
simultaneously , in such way that the total
amounts of debits equal the total amounts of
credits.
The rules of debit and credit and the normal
balances of various types of accounts are
summarized as follows:
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Increase Decrease
(Normal balances)
Balance sheet accounts:
Asset Debit Credit
Liability Credit Debit
Owners’ Equity
Capital Credit Debit
Drawing Debit Credit
Income statement accounts:
Revenue Credit Debit
Expense Debit Credit
69
 Applying the double-entry system to analyze
transactions is summarized as follows:
1. Determine the types of accounts affected by
the transaction.
2. Determine which accounts increase /
decrease as a result of the transaction.
3. Determine whether each increase or
decrease should be recorded as a debit or a
credit.
70
UNIT 3 Journalizing and Posting Transactions
Journal: It is a history transactions by

date.The process of recording a transaction in
the journal is called journalizing. The form of
recording a transaction is called a journal
entry.
 General journal
 Special journal:cash receipts journal, cash
payments journal, sales journal, purchase
journal.
71
Ledger: A group of accounts for a business
entity. It is a history transactions by account.
The process of transferring the debits and
credits from the journal entries to the
accounts is called posting.
 General ledger: control account
 Subsidiary ledger:
Total of the ending balances of all subsidiary
accounts equal the ending balance of the
control account.
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CLASSROOM EXERCISES
1.Indicate below whether each account is an assets
(A), liabilities (L), or a part of owner’s equity (OE).
Cash
Salaries Payable
Accounts Receivable
Johnson, Capital
Land
Accounts Payable
Supplies
73
2.Identify the following transactions by type of
owner’s equity transaction by marking each as
either an owner’s investment (I), owner’s
withdrawal (W), revenue (R), expense (E) or
not an owner’s equity transaction (NOE).
a. Received cash for providing a service.

b. Took assets out of business from a
personal account.
C. Received cash from a customer previously
billed for a service.
74
d. Transferred assets to the business from a
personal account.
e. Paid service station for gasoline.
f. Performed a service and received a promise
of payment.
g. Paid cash to purchase equipment.
h. Paid cash to employee for services
performed.
75
3. Cecil Jamson,Attorney-at-Law,is a
proprietorship owned and operated by Cecil
Jamson.On July 1 of the current year, Cecil
Jamson ,Attorney-at-Law,has the following
assets and liabilities: cash,$1000; account
receivable,$3200; supplies,$850; land,$10000;
account payable,$1530;
office space and office equipment are currently
being rented,pending the construction of an
office complex on land purchased last
year.Business transactions during July are
summarized as follows:
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a.Received cash from clients for service,$3928
b.Paid creditor on account,$1055
c.Received cash from Cecil Jamson as an
additional investment,$3700.
d.Paid office rent for the month,$1200.
e.Charged clients for legal services on account,
$2025.
f.Purchased office supplies on account, $245
g.Received cash from clients on account,$3000.
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h.Received invoice for paralegal services from
Legal Aid Inc. for July (to be paid on August 10),
$1635.
i.Paid the following: wages expense,$850;
answering service expense,$250; utilities
expense,$325; and miscellaneous expense,$75.
j.Determined that the cost of office supplies on
hand was $980; therefore, the cost of supplies
used during the month was $115.
k.Jamson withdrew $1000 in cash from the
business for personal use.
78
Requirements:
Indicate the effect of each transaction and the
balances after each transaction,using the following
tabular headings:
Assets = Liabilities + Owner’s Equity
Cash+Accounts +Supplies = Accounts + Cecil Jamson
Receivable Payable ,Capital
Explain the nature of each increase and decrease in

owner’s equity by an appropriate notation at the
right of the amount.
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Differ:
 Receiving an amount on account is different
from receiving an amount for a revenue.The
receive of a revenue increases owner’s
equity,while receiving an amount on account
reduces an asset (account receivable).
 Paying an amount on account is different from
paying an amount for an expense.The payment
of an expense reduces owner’s equity,while
paying an amount on account reduces a liability
( account payable).
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Sell on credit
Account Receivable
Perform service on account
Receive an amount on account Reduce an asset

(account receivable)
c.f. Receive an amount for a revenue Revenue
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Buy/Purchase on account Account Payable
Pay an amount on account Reduce a liability
(account payable)
Pay an amount for an expense Expense
82
UNIT 4 Trial Balance
The equality of debits and credits in the
ledger is tested periodically by preparing a
trial balance, which lists the balance in each
ledger account after the posting process has
been completed.
83
Errors causing unequal trial balance:
Column incorrectly added
Trial balance
preparation Amount incorrectly entered on trial balance
errors
Balance entered in wrong column or omitted
Balance incorrectly computed

Account balance
errors
Balance entered in wrong column of account
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Wrong amount posted to an account
Posting errors Debit posted as credit, or vice versa
Debit or credit posting omitted
85
Limitation of trial balance:
Trial balance does not provide complete proof of the
accuracy of the ledger. It indicates only that the
debits and credits are equal.
 some errors which trial balance can not detect:
 Failure to record a transaction or to post a
transaction.
 Recording the same erroneous amount for both
the debit and the credit parts of a transaction.
86
Recording the same transaction more than
once.
Posting a part of a transaction correctly as
a debit or credit but to the wrong account.
87
UNIT 5 Practices in China
The processing of accounting in China is similar
to western style.However, it has its own devices.
Journal entries are made in vouchers.
Three types of vouchers: receipt vouchers
payment vouchers
transfer vouchers
88
UNIT 6 Using the Information---
the Debt Ratio
 the debt ratio is used to evaluated solvency
= Total Liabilities/ Total Assets
 financial leverage: trading on the equity
89
CLASSROOM EXERCISES
1. The following preliminary trial balance of Entrée Co., a sports
ticket agency, does not balance:
Entrée Co.
Trial Balance
December 31, 200x
Account Debit Credit
Cash 75,350
Account Receivable 23,600
Prepaid Insurance 3,300
Equipment 86,000
Account Payable 9,450
Unearned Rent 2,570
90
Account Debit Credit
Byron Reynolds, Capital 91,615
Byron Reynolds, Withdrawal 10,000
Fees earned 64,940
Wages Expense 33,400
Advertising Expense 5,200
Miscellaneous Expense 1,380
291,765 115,040
91
When the ledger and other records are reviewed, you discover
the following:
(1) The debits and credits in the cash account total $75,350
and $53,975, respectively
(2) a billing of $1,000 to a customer on account was not
posted to the account receivable account
(3) a payment of $1,500 made to a creditor on account was
not posted to the account payable account
(4) the balance of the unearned rent account is $2,750
(5) the correct balance of the equipment account is $68,000
(6) each account has a normal balance
Prepare a corrected trial balance.
92
2. The following errors occurred in posting from a two-column
journal:
(1) A debit of $750 to Accounts Payable was posted as a credit
(2) A credit of $350 to Cash was posted as $530
(3) A debit of $800 to Cash was posted to Miscellaneous
Expense
(4) A debit of $1050 to Supplies was posted twice
(5) A debit of $1575 to Wages Expense was posted as $5175
(6) A credit of $3175 to Accounts Payable was not posted
(7) An entry debiting Accounts Receivable and crediting Fees
Earned for $4500 was not posted.
93
Considering each case individually(assuming that no other
errors had occurred), indicate:
(a) by “yes”or “no” whether the trial balance would be out of
balance;
(b) if answer to (a) is “yes”, the amount by which the trial
balance totals would differ;
(c) whether the debit or credit column of the trial balance
would have the larger total.
Answers should be presented in the following form, with
error(1) given as an example:
(a) (b) (c)
Error Out of Balance Difference Larger Total
1. yes $1500 credit
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3. Indicate which of the following errors, each
considered individually, would cause the trial balance
totals to be unequal:
a. Payment of a cash withdrawal of $3,500 was
journalized and posted as a debit of $5,300 to Salary
Expense and a credit of $3,500 to Cash.
b. A payment of $6,100 for equipment purchased was
posted as a debit of $1,600 to Equipment and a credit
of $1,600 to Cash.
c. A fee of $1,850 earned and due from a client was
not debited to Accounts Receivable or credited to a
revenue account, because the cash had not been
received.
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d. A receipt of $325 from an account receivable was
journalized and posted as a debit of $325 to Cash and
a credit of $325 to Fees Earned.
e. A payment of $1,075 to a creditor was posted as a
debit of $1,075 to Account Payable and a credit of
$1,075 to Cash.
96
4. A company’s trial balance failed to agree, the totals being:
Debit $815,602
Credit $808,420
Which one of the following errors could fully account for
the difference?
A The omission from the trial balance of the balance on the
insurance expense account $7,182 debit
B Discount allowed $3,591 debited in error to the discount
received account
C No entries made in the records for cash sales totaling $7,182
D The returns outwards total of $3,591 was included in the trial
balance as a debit balance
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Illustrative Problem
The list below contains the transactions for the John.
Miller Advertising Agency for the month of January.
1. On January 1.John Miller invested $6000 in her own
adverting agency.
2. Rented an office, paying two months’ rent in
advance $500.
3. Purchased art equipment for $2200 cash.
4. Purchased office equipment from W. Equipment for
$1800, paying $750 in cash and agreeing to pay the
rest next month.
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5. Purchased on credit art supplies for $900 and office
supplies for $400 from T. Supply Company.
6. Paid T. Supply Company $500 of the amount owed.
7. Performed a service by placing advertisements for an
automobile dealer in the newspaper and collected a fee
of $800.
8. Paid $240 for one-year insurance policy.
9. Paid the secretary two weeks’ salary, $350.
10. Accepted $520 as an advance fee for art work to be
done for another agency
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11.Performed a service by placing several
advertisements for W. Department Store and A &A
Grocers. The earned fees of $700 and $900,respectively,
will be collected next month.
12. John. Miller withdrew $800 from the business for
personal living expenses.
13. Paid the secretary two more weeks’ salary $350.
14. Paid the utility bill, $50
15. Received a telephone bill, $350.
100
Required:
1. Prepare general journal entries to record John. Miller
Advertising Agency’s transactions.
2. Post the journal entries to the ledger accounts.
3. Prepare an unadjusted trial balance sheet as of Jan
31,200x.
4. Do adjusting entries below:
(1) At the beginning of the month, the John Miller
Advertising Agency Paid two month’ rent in advance. By
Jan 31,one-half had expired.
101
(2)John Miller did the art work for various clients during
the month using art supplies for $250,and his secretary
used office supplies for $100.
(3)Assume that the John Miller Advertising Agency
estimates the depreciation of art equipment for the
month as $35.
(4)Assume that, by the end of the month $200 of the
art work was done and accepted by the other agency.
(5)Assume that, by the end of Jan, the John Miller
Advertising Agency’s Secretary will have worked three
days beyond the last biweekly pay period. The salaries
for these three days are $105.
102
(6) Assume that the John Miller Advertising Agency
has placed an advertisement for M.T. Company that
appears on Jan.31.The fee of $100 for this
advertisement, which has been earned but not
recorded.
(7)This month, one-month insurance policy for $20
should be apportioned.
5. Prepare an adjusted trial balance sheet as of Jan
31,200x.
6. Journalize the closing entries and post them to the
ledger accounts.
103
7. Prepare a post-closing trial balance as of Jan
31,200x.
8. Prepare a balance sheet as of Jan 31,200x.
9. Prepare an income statement for the month of Jan
31,200x.
10. Prepare the statement of Retained Earnings for
the month of Jan 31,200x.
104
Chapter 3
Adjusting the Account,
Preparing the Statements
1. Describe the accounting periods and

adjust entries at the end of each period.
2. Revenue recognition and matching
principles require adjustments and
accrual basis is preferred to cash basis.
3. Prepare adjusting entries.
4. Prepare financial statements from the
adjusted trial balance.
106
UINT 1 The Need for Adjustment
Why the end-of-period adjustments are
necessary? (why the preparation of
adjusting entries are necessary?)
107
accounting period concept
Using the accounting period assumption,
accountants must determine in which period
the revenues and expense of the business
should be reported. To determine the
appropriate period, accountants will use
either the cash-basis accounting or the
accrual-basis accounting.
108
Cash-basis accounting : revenues and
expenses are reported in the income
statement in the period in which cash is
received or paid.
Accrual-basis accounting: revenues and
expenses are reported in the income
statement in the period in which they are
earned. The principle that supports this
reporting of revenues is called the revenue
recognition principle.
109
revenue recognition principle (realization
principle ):It indicates that revenue should
be recognized and reported in the income
statement at the time the earnings process
is completed. In most cases, revenue is
earned when the business has delivered a
completed good or service to the customer.
110
Matching principle:under accrual basis,
expenses are reported in the same period
as the revenues to which they relate. So
this concept supports reporting revenues
and related expenses in the same period.
The accrual basis and its related matching
principle require an analysis and updating of
some accounts when financial statements
are prepared. This process is called the end-
of-period adjustment.
111
UNIT 2 Adjusting the Account
The characteristic of adjusting entries:
All adjusting entries affect at least one
income statement account and one balance
sheet account.
112
Four basic items require adjusting entries:
 The first two items are deferrals: deferrals are
created by recording a transaction in a way
that delays or defers the recognition of an
expense or a revenue.
 Deferred Expense or Prepaid Expense :are
items that have been initially recorded as
assets but are expected to become expenses
through the normal operations of the business.
e.g. prepaid insurance/ rent/ interest
113
 Deferred Revenues or Unearned Revenues :are
items that have been initially recorded as as
liabilities but are expected to become revenues
through the normal operations of the business.
e.g. Advances on service revenue
Advances from customers
 The second two items are accruals: accruals
are created by an unrecorded expense that has
been incurred or an unrecorded revenue that
has been earned.
114
 Accrued Expenses or Accrued Liabilities:are
expenses that have been incurred but have
not been recorded in the accounts.
e.g. accrued wages owed to employees
accrued interest on notes payable
accrued taxes
 Accrued Revenues or Accrued Assets: are
revenues that have been earned but have
not been recorded in the accounts.
e.g. perform a service on account
accrued interests on note receivable
115
CURRENT ACCOUNTING PERIOD FUTURE ACCOUNTING PERIOD
Deferrals
Revenue earned or
Cash received or paid
expense incurred
Accruals
Revenue earned or
Cash received or paid
expense incurred
Adjusting
entries to
record current
period revenue
or expense
116
Recording adjusting entries:
 Deferred Expense [Prepaid Expense]
Apportioning recorded costs to periods benefited
将已入账的成本摊配于应受益的各会计期间
A cost that will benefit more than one
accounting period usually is recorded by
debiting an asset account. In each period that
benefits from the use of this asset, an adjusting
entry is made to allocate a portion of the
asset’s cost to expense.
117
For example:
(1) Prepaid Expense
 paid in advance (3.1)  apportioned (3.31)
Dr: Prepaid Insurance Dr: Insurance Expense
Cr: Cash Cr: Prepaid Insurance
(2) the consumption of office supplies
 purchased (3.1)  apportioned (3.31)
Dr: Office Supplies Dr: Office Supplies Expense
Cr: Cash Cr: Office Supplies
After the adjustment has been recorded and posted, the prepaid
insurance account ( supplies account ) has a debit balance which
represents an asset that will become an expense in a future period.
118
(3) the operation of fixed assets
Fixed assets are a type of long-term deferred
expense. Unlike supplies, there is no visible reduction
in the quantity of the equipment. Instead, as time
passes, the equipment loses its ability to provide
useful service. This decrease in usefulness is called
depreciation. Depreciation allocates the cost of a
fixed asset to expense over its estimated life.
The adjusting entry to record depreciation is to
debit Depreciation Expense and credit Accumulated
Depreciation( contra account).
contra account: will be deducted from the related asset
accounts on the balance sheet.
119
 purchased (3.1)
Dr: Building
Cr: Cash
 apportioned (3.31)
Dr: Depreciation Expense, Building
Cr: Accumulated Depreciation, Building
the difference between accumulated depreciation account and
the related fixed asset account is the cost that has not yet been
depreciated. This amount is called the book value of the asset
( or net asset).
120
 Deferred Revenues [Unearned Revenues]
Apportioning recorded revenue to period in
which it is earned.
将已入账的收入摊配于应获取的各会计期间
A business may collect in advance for
services to be rendered to its customers in
future accounting periods. In the period in
which services are rendered, an adjusting entry
is made to record the portion of the revenue
earned during the period.
121
For example: Unearned Revenue
 collected in advance for services/goods to be
rendered in future
Dr: Cash
Cr: Unearned revenue
 determine the revenue earned during the period
Dr: Unearned revenue
Cr: Service revenue
Fees Earned
After the adjustment has been recorded and posted, the balance
of unearned revenue account which is a liability represents a
deferral that will become revenue in a future period.
122
 Accrued Expense [Accrued Liabilities]
Recording unrecorded expenses incurred
记录未入账但已发生的费用
An expense may be incurred in the
current accounting period even though no bill
has been received and payment will not
occur until a future period.The amount of
such an accrued but unpaid item at the end
of the accounting period is both an expense
and a liability.
123
For example:
Unrecorded Expenses (Accrued Expenses)
—— recognize the expense in the current accounting
period
 Dr: Interest Expense
Cr: Interest Payable
 Dr: Income Taxes Expense
Cr: Income Taxes Payable
 Dr: Salaries Expense
Cr: Salaries Payable
124
Accrued Revenue [Accrued Assets]
Recording unrecorded revenue earned
记录未入账但已获取的收入
Revenue may be earned during the current
period, but not yet billed to customers or
recorded in the accounting records. The amount
of the revenue should be recorded by debiting
an asset account and crediting a revenue
account.
125
For example:
Unrecorded Revenue (Accrued Revenue)
—— recognize the revenue in the current accounting
period
Dr: Accounts Receivable
Cr: Fees Earned
Sales Revenue
126
UNIT 3 Adjusted Trial Balance
and Preparation of Financial Statements
Adjusted trial balance
the purpose of preparing the adjusted trial
balance is to verify the equality of the total
debit balances and total debit balances and
total credit balances before we prepare the
financial statements.
127
The adjusted trial balance is an aid in
preparing the financial statements
 Income Statement—— A summary of the revenue
and expenses for a specific period of time.
 Statement of Owner’s Equity——A summary of the
changes in the owner’s equity that have occurred
during a specific period of time.
 Balance Sheet——A list of the assets, liabilities, and
owner’s equity as of a specific date.
128
CLASSROOM EXERCISES
1. Classify the following items as (a) deferred expense( prepaid
expense), (b) deferred revenue( unearned revenue), (c)
accrued expense( accrued liability), (d) accrued
revenue( accrued asset).
(1) Fees earned but not yet received
(2) Taxes owed but payable in the following period
(3) Salary owed but not yet paid
(4) Supplies on hand
(5) Fees received but not yet earned
(6) Utilities owed but not yet paid
(7) A two-year premium paid on a fire insurance policy
(8) Subscriptions received in advance by a magazine publisher
129
2. The following accounts were taken from the unadjusted trial
balance of O’ Neil Co., a congressional lobbying firm. Indicate
whether or not each account would normally require an
adjusting entry. If the account normally requires an adjusting
entry, use the following notation to indicate the type of
adjustment:
AE——Accrued Expense
AR——Accrued Revenue
DR——Deferred Revenue
DE——Deferred Expense
To illustrate, the answers for the first two accounts are
shown below:
130
Account Answer
Tip Perkey, Drawing …………………. Does not normally require adjustment
Account Receivable…………………….. Normally requires adjustment ( AR )
Accumulated Depreciation
Cash
Interest Payable
Interest Receivable
Land
Office Equipment
Prepaid Insurance
Supplies Expense
Unearned Fees
Wages Expense
131
3. The balance in the supplies account, before
adjustment at the end of the year, is $1,475.
Journalize the adjusting entry required if the amount
of supplies on hand at the end of the year is $241.
4. At December 31, the end of of the first month of
operations, the usual adjusting entry transferring
supplies used to an expense account is omitted.
Which items will be incorrectly stated, because of the
error, on (a) the income statement for December and
(b) the balance sheet as of December 31?Also indicate
whether the item in error will be overstated or
understated.
132
5. The prepaid insurance account had a balance of $3,600 at
the beginning of the year.The account was debited for
$1,200 for premiums on polices purchased during the
year.Journalize the adjusting entry required at the end of
the year for each of the following situation: (a) the amount
of unexpired insurance applicable to future periods is
$3,450 (b)the amount of insurance expired during the year
is $1,875.
6. At the end of the current year, $7,260 of fees have been
earned but have not been billed to clients.
a. Journalize the adjusting entry to record the accrued fees
b. If the cash basis rather than the accrual basis had been
used, would an adjusting entry have been necessary?
Explain.
133
7. The accountant for Maxim Medical Co., a medical services
consulting firm, mistakenly omitted adjusting entries for (a)
unearned revenue ($10,390) and (b) accrued wages
($2,440). Indicate the effect of each error, considered
individually, on the income statement for the current year
ended December 31.
8.The balance in the equipment account is $518,500, and the
balance in the accumulated depreciation——equipment
account is $120,750.
a. What is the book value of the equipment?
b. Does the balance in the accumulated depreciation account
mean that the equipment’s loss of value is $120,750?
134
9. The unadjusted and adjusted trial balances for Medico
Service Co. on December 31, 2003, are show below:
Medico Service Co.
Trial balance
December 31, 2003
unadjusted Adjusted
Cash 8 8
Account Receivable 19 21
Supplies 6 2
Prepaid Insurance 10 6
Land 13 13
Equipment 20 20
Accumulated Depr. － Equipment 4 5
135
unadjusted Adjusted
Accounts Payable 13 13
Wages Payable 0 1
Brain Stuart, Capital 46 46
Brain Stuart, Drawing 4 4
Fees Earned 37 39
Wages Expense 12 13
Rent Expense 4 4
Insurance Expense 0 4
Utilities Expense 2 2
Depreciation Expense 0 1
Supplies Expense 0 4
Miscellaneous Expense 2 2
Totals 100 100 104 104
136
Required:
Journalize the five entries that adjusted the
accounts at December 31,2003. None of the accounts
were affected by more than one adjusting entry.
137
10. The accountant for St.Elmo Laundry prepared the following
unadjusted and adjusted trial balances. Assume that all balances in
the unadjusted trial balance and the amounts of the adjustments are
correct. How many errors can you find in the accountant’s adjusting
entries?
St.Elmo Laundry
Trial balance
October 31, 2003
unadjusted Adjusted
Cash 3,790 3,790
Account Receivable 8,000 12,500
Laundry Supplies 3,750 5,660
Prepaid Insurance 2,825 1,325
Prepaid Rent 7,200 7,200
Laundry Equipment 85,600 80,880
Accumulated Depreciation 55,700 55,700
138
unadjusted Adjusted
Accounts Payable 4,950 4,950
Wages Payable 850
Nicole Chun, Capital 23,900 23,900
Nicole Chun, Drawing 800 800
Laundry Revenue 76,900 76,900
Wages Expense 24,500 24,500
Rent Expense 15,575 15,575
Utilities Expense 8,500 8,500
Depreciation Expense 4,720
Laundry Supplies Expense 1,910
Insurance Expense 0 500
Miscellaneous Expense 910 910
Totals 161,450 161,450 168,770 162,300
139
Chapter 4
Completing the
Accounting Cycle
1. Prepare a work sheet.

2. Prepare closing entries to close the
temporary accounts.
3. Prepare a post-closing trial balance.
4. List the steps in accounting cycle.
5. Prepare a classified balance sheet.
141
UINT 1 Using the Work Sheet
The significance of work sheet
The work sheet is a working paper that
accountants can use to summarize adjusting
entries and the account balances for the
financial statements, but it is not considered
a part of the formal accounting records.
142
How to prepare a work sheet?
 Entering the unadjusted trial balance directly in
the Trial Balance columns.
 Entering the adjustments in the Adjustments
Debit and Credit column.
 The Trial Balance amounts plus or minus the
adjustments are extended to the Adjusted Trial
Balance columns.
 The work sheet is completed by extending the
adjusted trial balance amounts to the Income
Statement and Balance Sheet columns.
143
1) the adjusted trial balance amounts of
assets, liabilities, owner’s capital, and
withdrawing are extended to the Balance
Sheet columns.
2) the adjusted trial balance amounts of
revenues and expenses are extended to the
Income Statement columns.
3) the net income (or net loss) for the period is
entered on the work sheet in the Income
Statement Debit (or Credit) column and the
Balance Sheet Credit (or Debit) column.
144
UINT 2 Closing Entries
real account (permanent account): their
balances are carried forward from one
accounting period to the next. Such as, asset
account, liability account.
nominal account( temporary account): their
balances are not carried forward from one
accounting period to the next, these accounts
report amounts for only one period. Such as,
revenue accounts, expense accounts,
withdrawal account.
145
The purpose of closing the accounts
 To report amounts for only one period,
temporary accounts should have zero
balances at the beginning of the next
period.How are these balances converted to
zero?
—— their balances are closed to owner’s
equity account.
 The purpose is to prepare the accounts for
the next period.
146
Closing Process
Expenses are Revenues are

2 transferred to INCOME SUMMARY 1 transferred to
income summary income summary
3 Net Income or Net Loss is

transferred to Owner’s Capital
OWNER’S CAPITAL
4 Withdrawal are transferred to

Owner’s Capital
147
Note:
 the revenues and expenses are transferred to
owner’s equity through a closing account called
Income Summary. Because Income Summary has
the effect of clearing the revenue and expense
accounts of their balances, so it is also called a
clearing account.
 For corporations, in the step 3 and 4, transferring
the balance of Income Summary and Withdrawal to
Retained Earnings
148
Journalizing and Posting Closing Entries
 If a work sheet is used, the data for the first
two entries of the step 1 and 2 appear in the
Income Statement columns. The amount for
the third entry is the net income or net loss
appearing at the bottom of the work sheet.
The amount of the last entry is the
Withdrawals balance that appears in the
Balance Sheet Debit column of the work
sheet.
149
 closing entries:
1) Dr: Fees Earned
Sales Revenue
Rent Revenue
Cr: Income Summary
2) Dr: Income Summary
Cr: Wages Expense
Rent Expense
Depreciation Expense
Utilities Expense
Supplies Expense
Miscellaneous Expense
150
3) Dr: Income Summary
Cr: Capital / Retained Earning
4) Dr: Capital / Retained Earning
Cr: Withdrawal
The balance in the capital account or retained
earning account will agree with the amount
reported on the statement of owner’s equity
and on the balance sheet. The revenue,
expense, and withdrawal accounts will have
zero balances.
151
UINT 3 Post-Closing Trial Balance
The last accounting procedure for a period is
to prepare a trial balance after the closing
entries have been posted. The purpose of the
post-closing trial balance is to make sure that
the ledger is in balance at the beginning of
the next period. The accounts and amounts
should agree exactly with the accounts and
amounts listed on the balance sheet at end
of the period.
152
UINT 4 Accounting Cycle
The meaning of accounting cycle
 The process that begins with analyzing and
journalizing transactions and ends with the
post-closing trial balance is called the
accounting cycle.
 The most important output of the accounting
cycle is the financial statements.
153
The contents of accounting cycle:


Source Documents Journal 
 Ledger


Post-closing
Work Sheet
Trial Balance
 
154
 Transactions are analyzed and recorded in the
journal.
 Transactions are posted to the ledger.
 A trial balance is prepared, adjustment data are
assembled, and the work sheet is completed.
 Financial statements are prepared.
 Adjusting entries are journalized and posted to the
ledger.
 Closing entries are journalized and posted to the
ledger.
 A post-closing trial balance is prepared.
155
UINT 5 Practices in China
In China, the accounting cycle is called
bookkeeping procedures .
Four types of bookkeeping procedures in
practice:
 Vouchers
 Summarized Vouchers
 Categorized Accounts Summary
 Columnar Journal
156
UINT 6 Classification of
Balance Sheet Items
Asset:
Current assets Long-term Investments
Plant and equipment Intangible assets
Liabilities: Stockholder’s Equity:
Current liabilities Contributed capital
Long-term liabilities Retained earnings
157
UNIT 7 Using the Information---
the Current Ratio
 the current ratio is used to evaluated liquidity
= Current Assets/ Current Liabilities
 be readily convertible into the cash
be readily sold for the cash
158
CLASSROOM EXERCISES
1. Francesca Service Co. offers cleaning services to business
client.
Francesca Service Co
Work Sheet
For the Year Ended December 31, 2003
Adjusted Income Balance
Trial Balance Statement Sheet
Account Title Dr. Cr. Dr. Cr. Dr. Cr.
Cash 4
Accounts Receivable 28
Supplies 1
Prepaid Insurance 1
Land 25
Equipment 16
Accm. Depr. － Equip. 3 159
Adjusted Income Balance
Trial Balance Statement Sheet
Account Title Dr. Cr. Dr. Cr. Dr. Cr.
Wages Payable 1
Pamela Latham, Capital 56
Pamela Latham, Drawing 4
Fees Earned 33
Wages Expense 9
Rent Expense 4
Insurance Expense 5
Utilities Expense 2
Depreciation Expense 2
Supplies Expense 3
Miscellaneous Expense 2
Total 106 106
Net Income(Loss) 160
Required:
(1) Complete the following work sheet for Francesca
Service Co.
(2) Based on the data in the work sheet , prepare an
income statement, statement of owner’s equity, and
balance sheet .
(3) Based on the data in the work sheet , prepare the
adjusting entries .
(4) Based on the data in the work sheet , prepare the
closing entries .
(5) Prepare a post-closing trial balance.
161
2. Greenhorn Service Co. offers its services to new arrivals in
the Belgrade area. Selected accounts from the ledger of
Greenhorn Service Co. for the current fiscal year ended July
31, 2003, are as follows:
Jone Bozeman, Capital Jone Bozeman, Withdrawal
July.31 11,000 Aug. 1 183,750 Oct.30 2,000 July 31 11,000
July.31 44, 250 Jan.31 2,000
Apr.30 2,000
July.31 5,000
Income Summary
July.31 577,150 July 31 621,400
31 44, 250
Prepare a statement of owner’s equity for the year. 162

3. Prior to its closing, Income Summary had total debits
of $631, 335 and total credits of $812,575.
Briefly explain the purpose served by the income
summary account and the nature of the entries that
resulted in the $ 631, 335 and the $812,575.
163
4. An accountant prepared the following post-closing
trial balance
Buchanan Repairs Co.
Post-Closing Trial Balance
July 31, 2003
Cash 5,125
Accounts Receivable 18,500
Supplies 1,100
Equipment 35,000
Accm. Depr. － Equip. 11,100
Accounts Payable 6,250
Salaries Payable 1,500
Unearned Rent 3,000
Sydney Buchanan, Capital 37,875
81,850 37,600
164
Required:
Prepare a corrected post-closing trial balance. Assume
that all accounts have normal balances and that the
amounts shown are correct.
5. The Breakthrough Company is an investigation
services firm that is owned and operated by Chandra
Domir. On April 30, 2003, the end of the current fiscal
year, the accountant for the Breakthrough Company
prepared a work sheet, a part of which is shown
below:
165
The Breakthrough Company
Work Sheet( Partial )
April 30, 2003
Income Statement Balance Sheet
Cash 4,325
Accounts Receivable 18,600
Supplies 1,610
Prepaid Insurance 1,350
Equipment 80,750
Accm. Depr. － Equip. 23,995
Accounts Payable 6,230
Salaries Payable 2,480
Taxes Payable 1,200
Unearned Rent 1,500
Chandra Domir, Capital 64,715
166
Income Statement Balance Sheet
Fees Earned 175,900
Rent Revenue 3,000
Salary Expense 129,865
Rent Expense 16,000
Supplies Expense 4,310
Depreciation Expense 3,500
Utilities Expense 3,460
Taxes Expense 3,115
Insurance Expense 2,925
Miscellaneous Expense 1,710
164,885 178,900 114,135 100,120
Net Income 14,015 14,015
178,900 178,900 114,135 114,135
167
Required:
(1) Journalize the entries that were required to close the
accounts at April 30.
(2) Prepare a statement of owner’s equity for the fiscal
year ended April 30, 2003. There were no additional
investments during the year.
(3) If Chandra Domir, Capital decreased $20,000 after
the closing entries were posted, what was the
amount of net income or net loss?
168
Chapter 5
Accounting for Cash, Trading
Securities and Receivable
1. Explain the concept of Liquidity and the

difference between cash and cash equivalents.
2. Why internal control procedures are needed
and the broad principles of internal control.
3. The internal control procedures used to cash
receipts and cash disbursements.
4. Explain the operation of a petty cash fund and
prepare journal entries to record petty cash
fund transactions.
5. Prepare a bank reconciliation.
170
6. Account for trading securities and L-C-M in
marketable securities.
7. Account for transactions with credit customers.
Accounting for bad debts under the allowance
method and the direct write-off method.
8. Calculate the interest on promissory notes and
record the receipt of notes and their payment
or dishonor.
9. Calculate the discount and proceeds on
discounted notes receivable and record the
discounting of notes receivable.
171
UNIT 1 Cash, Cash Equivalents
and Liquidity
Liquidity: the liquidity of an asset refers to
how easily the asset can be converted into
other types of assets or be used to buy
services or satisfy obligations.
Cash: cash include not only currency and
coins but also amounts on deposit in bank
accounts(checking accounts and saving
accounts), and customer’s checks.
172
Cash equivalents: short-term, highly liquid
investments that satisfy two criteria:
(1) The investment must be readily convertible to a known
amount of cash.
(2) The investment must be sufficiently close to its
maturity date and relatively insensitive to interest rate
changes.
 Generally, only investments that are purchased

within three months of their maturity dates satisfy
these criteria.
 Examples of cash equivalents:
U.S. treasury bills, commercial paper, and money
market funds.
173
UNIT 2 Internal Control over Cash
The effects of internal control system
1. Encourage adherence to prescribed managerial
policies.
2. Promote operational efficiencies.
3. Protect the business assets from waste, fraud,
and theft.
4. Ensure that accurate and reliable accounting
data are produced.
174
The broad principles of internal control
1. Clearly establish responsibilities.
2. Maintain adequate records.
3. Insure assets and bond employees.
4. Separate record-keeping and custody over
assets.
5. Divide responsibilities for related transactions.
6. Use mechanical devices whenever practicable.
7. Perform regular and independent reviews.
175
Internal Control for Cash
A good system of internal control for cash
should provide adequate procedures for
protecting both cash receipts and cash
disbursements. In designing this, three
basic guidelines should be observed.
176
 Three basic guidelines:
1. Duties should be separated so that people
responsible for actually handling cash are not
also responsible for keeping the cash records.
2. All cash receipts should be deposited in the
bank, intact, each day.
3. All cash payments should be made by check.
Small payments should be made in cash from
a petty cash fund.
177
UNIT 3 The Petty Cash Fund
A business establishes a petty cash fund

and uses the money in this fund to make
small payments.
Steps in establishing a petty cash fund:
1. Estimating the total amount of small payments
likely to be paid during a short period.
178
2. The cashier’s office draw a check for an amount
slightly in excess of the estimate.
3. The check is cashed, and the currency is turned

over to a member of the office staff designated as
the petty cashier.
4. As each disbursement is made, the person

receiving payment signs a petty cash receipt. The
receipt is then placed in the petty cash box with
the remaining money.
179
5. When the cash is nearly gone, the fund should
be reimbursed. The petty cashier presents the
receipts to the company cashier. The company
cashier stamps all receipts paid so that they can
not be reused, retains them, and gives the petty
cashier a check for their sum.
6. When the check is cashed and the proceeds

returned to the cashbox, the money in the box is
restored to its original amount.
180
Journalizing the petty fund
(1) Establishing the petty cash fund
Dr: Petty Cash
Cr: Cash
(2) Making disbursements from the petty cash fund
(3) Replenishing the petty cash fund
Dr: Transportation In
Office Expenses
Postage Expenses
Cr: Cash
181
UNIT 4 Reconciling the Bank Balance
Bank accounts as a control over cash

 Based on the system of internal control over
cash, there is a double record of cash
transaction—one by the business and the
other by the bank.
182
At least once every month, banks send
depositors a bank statement, including the
following items:
1. The depositor’s beginning balance.
2. Deposits and other added amounts.
3. Checks and other deducted amounts.
4. The end balance.
183
Need for reconciling the bank balance
1. Outstanding checks
2. Unrecorded deposits
3. Charges for uncollectible items and for
service
4. Credits for collections and for interest
5. Errors
184
Steps in reconciling the bank balance
Left side:
1. Start with the bank balance of the cash account.
2. Identify and list any unrecorded deposits and
any bank errors that understated the bank
balance. Add them to the bank balance.
3. Identify and list any outstanding checks and any
bank errors that overstated the bank balance.
Subtract them from the bank balance.
4. Compute the adjusted balance.
185
right side:
1. Start with the book balance of the cash account.
2. Identify and list any unrecorded credit memoranda
from the bank, interest earned, and any errors that
understated the book balance. Add them to the
book balance.
3. Identify and list any unrecorded debit memoranda
from the bank, service charges, and any errors that
overstated the book balance. Subtract them from
the book balance.
4. Compute the reconciled balance.
186
Bank Reconciliation
Cash balance according bank statement
Add: Additions by depositor not on bank statement
( Deposits in transit)
Bank errors
Deduct: Deduction by depositor not on bank
statement
( Outstanding check)
Bank errors
Adjusted Balance
187
Cash balance according depositor’s record
Add: Additions by bank not recorded by depositor
( Interest earned, Note receivable collected by
bank for depositor)
Depositor errors
Deduct: Deduction by bank not recorded by depositor
( NSF check, Service charge, Collection fee)
Depositor errors
Adjusted Balance
188
The bank statement for Power Networking Company shows a
balance of $9143.11 as of June 30. The cash balance in
Power Networking’s ledger as of the same date is
$4526.25.
The following reconciling items are revealed:
a. The bank had collected for Power Networking Company
$1030 on a note left for collection. The face of the note
was $1,000.
b. A deposit of $1852.21, representing receipts of June 30,
had been made too late to appear on the bank statement.
c. Outstanding check totaled $5265.27
d. A check drawn for $139 had been incorrectly charged by
the bank as $157. 189
e. A check for $30 returned with the statement had been
recorded in the depositor’s records as $240. The check
was for the payment of an obligation to Avery Equipment
Company for the purchase of office supplies on account.
f. Bank service charges for June amounted to $18.20.
Required:
1. Prepare a bank reconciliation for June.
2. Journalize the entries that should be made by Power
Networking Company.
190
UNIT 5 Trading Securities
Definition:
a current asset which servers a similar
purpose as cash equivalents. They can be
converted into cash easily and are held as
a source of cash to satisfy the needs of
current operations. Management usually
expects to convert them into cash within
one year.
191
Classification:
 Debt securities:
government or corporate debt obligations
 Equity securities:
stock
192
Accounting for Trading Securities
1. Purchase : When short-term investments are
purchased, they should be recorded at cost. To
determine the cost, any commissions paid are
included.
Dr: Trading Investment
Cr: Cash
2. Mature : credit the interest to a revenue account.
Cr: Interest Revenue
193
3. Dividends : credit the dividend to a revenue
account.
Cr: Interest Revenue
4. Sell : the difference between cost and cash
proceeds is recorded as a gain or loss.
Dr: Cash
Loss on Sale of Short-term Investment
Cr: Trading Investment
Gain on Sale of Short-term Investment
194
Balance Sheet Presentation
Market Value Method:

Year-end adjustment is made to current market
value
Dr: Security Fair Value Adjustment (trading)
Cr: Unrealized Holding Gain of Loss
(income statement)
195
UINT 6 Credit Sales and Bad Debts
Design internal controls for receivables
 Maintaining a separate for each credit
customer
 Matching bad debt expenses with sales
 Bad debts expense (Uncollectible accounts
expense, doubtful accounts expense):
a kind of operating expense incurred because of
the failure to collect receivables.
196
 Matching the expenses for bad debt losses with
the credit sales requires the company to estimate
its unknown amount at the end of the year.
 There are two methods of accounting for
receivables that appear to be uncollectible.
The one is the allowance method, another is the
direct write-off method.
 The allowance method of accounting for bad
debts is used to accomplish this matching
requirement.
197
Allowance Method of Accounting for Bad Debts
 The advantages for allowance method:

1. The estimated expense is charged to the
period in which the revenue is recognized,
thus net income won’t be overstated for the
period.
2. The accounts receivable are reported on the
balance sheet at the amount of cash proceeds
that is expected form their collection, thus
asset won’t be overstated for the period.
198
 Recording the estimated bad debts expense
 Estimating is based on the experience of similar
business or compared to the previous period.
 Allowance for Doubtful Accounts: a contra asset
account which must be credited integrate instead
of credit Accounts Receivable directly.
Dr: Bad Debt Expenses
Cr: Allowance for Doubtful Accounts
Allowance for Doubtful Accounts
1, Dec.31 1,500
199
 Reporting bad debts in the Financial
Statements
 Bad debts expense normally appears on the
income statement as an administrative expense
rather than a selling expense.
 Allowance for doubtful accounts is subtracted
from the accounts receivable to show the net
realizable value of the accounts.
200
Writing off a bad debt
When a customer’s account is identified as
uncollectible, it is written off against the allowance
account as follows:
Dr: Allowance for Doubtful Accounts
Cr: Accounts Receivable
As expense has been recorded previously and the
estimated realizable value of the accounts won’t be
affected by the write-off, neither total asset nor net
income are affected.
1, Dec.31 1,500
2, Jan.23 100
201
Bad Debt Recoveries
An account receivable that has been written
off against the allowance account may later
be collected, the write-off entry should be
reversed.
1. Reverse the original write-off.
2. Record the collection of the reinstated account.
1, Dec.31 1,500
2, Jan.23 100
2, Aug.15 100
202
Cr: Allowance for Doubtful Accounts
Dr: Cash
( To reinstate account written off earlier in the year)
203
Estimating the amount of bad debts expense
 Estimating bad debts by focusing on the income
statement — the income statement method
1. Based on the idea that some particular percentage
of a company’s credit sales for the period will
become uncollectible.
2. Allowance for Doubtful Accounts is not likely to be
zero.
3.This method emphasizes the matching of
uncollectible accounts expense with the related
sales of the period. Thus, it places more emphasis
on the income statement than on the balance sheet.
204
 Estimating bad debts by focusing on the balance
sheet—the balance sheet method
This method emphasizes the current net
realizable value of the receivables. Thus, it places
more emphasis on the balance sheet than on the
income statement.
1. The simplified balance sheet approach
A company estimates that a certain percentage
of its outstanding receivables will prove to be
uncollectible.
205
2. Aging accounts receivable approach
 The receivables are classified in terms of how
long they have been outstanding, then, estimates
of uncollectible amounts are made under the
assumption that the longer an amount is
outstanding, the more likely it will be
uncollectible. This process is called aging the
receivable. An aging schedule is prepared by
classifying each receivable by its due date.
206
 The estimate based on receivables is compared
to the balance in the allowance account to
determine the amount of the adjusting entry.
Q: Before the year-end adjustment, Allowance for Doubtful
Accounts has a debit balance of $3,000. Using the aging-
of-receivable method, the desired balance of the Allowance
for Doubtful Accounts is estimated as $55,000.The
accounts receivable balance before adjustment is
$290,000. What are (1) the uncollectible expense for the
period, (2) the balance of Allowance for Doubtful Accounts
after adjustment, and (3) the net realizable value of the
receivable after adjustment?
207
Direct Write-Off Method of Accounting for Bad
Debts
 No attempt is made to estimate uncollectible
accounts or bad debts expense at the end of each
period.
 Directly write the uncollectible accounts to Bad Debts
Expense .
 Direct write-off method mismatches revenues and
expenses.
208
Dr: Bad Debt Expenses
( To write off the uncollectible account)

Cr: Bad Debt Expenses
Dr: Cash
( To reinstate account written off earlier in the year)
209
Credit Card Sales
 For example
VISA, MasterCard, American Express
 Reasons for using credit cards
1.Evaluation for each customer is not necessary.
2.the risk of failure payment is extended to credit
card company.
3. Sooner of cash receipts from credit card
company than from customers.
210
 Dealing with credit card
(1) Credit card issued by bank:
 Deposit a copy of each credit card sales receipt in
its bank account.
 Receive a credit to its checking account
immediately.
(2) Credit card issued by credit card company :
 Send the appropriate copy of each receipt to the
credit card company.
 Wait until paid by the credit card company.
(3) Credit card expense:
a fee ranging from 2% to 5% of credit card sales.
211
UINT 7 Promissory Notes
Characteristics of Notes Receivable
 A promissory note is a written promise to
pay a sum of money or at a definite time.
 two parties:
(1) the maker :the one making the promise
(2) the payee: the one holding the note
212
 Due Date( maturity date ): the date a note is
to be paid
 Interest: A note normally specifies that
interest be paid for the period between the
issuance date and the due date.
Interest =
Principle Annual Time of the
of the × rate of × note expressed
note interest in years
 Maturity Value: The amount is the sum of

the face amount and the interest.
213
Accounting for Notes Receivable
 Receiving a note to replace an account
receivable
Dr: Notes Receivable
 Receiving principal and interests on
matured note
Dr: Cash
Cr: Notes Receivable
Interest Earned
214
 To record dishonored note and interest
If the maker of a note fails to pay the debt on the
due date, the note is a dishonored note receivable.
Charge it back to an account receivable from its
maker:
Cr: Notes Receivable
Interest Earned
215
 Adjusting entry for accrued interest
Dr: Interest Receivable
Cr: Interest Earned
The interest revenue account is closed at the end
each accounting period. The amount of interest
revenue is normally reported in the Other Income
section of the income statement.
216
Discounting Notes Receivable
 Definition
The owner of the note endorses and delivers the note

to the bank in exchange for cash. The bank transfers
cash ( the proceeds) to the company after deducting
a discount ( interest) that is computed on the
maturity value for the discount period and holds the
note to maturity and then collects its maturity value
from the original maker.
217
 Calculation:
make discount maturity
1. Maturity value of the note

=Principal + interest
2. Discounts charged by the bank
=maturity value ×discount interest rate
×discount period
3. Proceeds from discounting the note
=maturity value - discounts
218
Recording the discounting of notes receivable
Dr: Cash ( proceeds)
Cr: Notes Receivable ( face value of note)
Interest Earned
The endorser of a note that has been
discounted has a contingent liability until the
due date, because it is possible that the maker
dishonors the note.
219
Contingent Liability
 Definition
Contingent liability is a potential liability that will

become an actual liability only if certain events occur.
Discounted notes, possible additional tax
assessments, debts of other parties guaranteed by
the company, pending lawsuits against the company.
In case of discounted notes:
The dishonoring of the note by its maker.
 Disclosure of contingent liability:
in a footnote to the balance sheet.
220
Full-Disclosure Principle
 Definition
Full-disclosure principle requires a concern’s financial
statements to contain all relevant information about
the operations and financial position of the entity.
Any data that are important enough to affect a
statement reader’s evaluation should be reported.
221
 Examples of items:
Contingent liabilities:
Discounted notes, possible additional tax
assessments, debts of other parties guaranteed by
the company, pending lawsuits against the
company.
Long-term commitments under contracts
long-term lease contract, pledged asset as
security for a loan.
Accounting methods used
especially when the choice of methods can
materially affect reported net income.
222
UINT 8 Converting Receivable into Cash
Selling Accounts Receivable
Pledging Accounts receivable
223
UINT 9 Using the information
— Accounts Receivable Turnover
Accounts Receivable Turnover =
Net sales on account
Average accounts receivable
Note: The indicator measures how frequently during
the years the accounts receivable are being
converted into cash.
224
Chapter 6
Inventories and
Cost of Goods Sold
1. Identify cost to be included in inventories.
2. Determine inventory quantities under periodic
system and perpetual system.
3. Determine the cost of inventory purchased
4. Computer cost of goods sold and ending
inventories under the four kinds of cost flow
assumption.
5. Valuate inventory using lower of cost or
market method
6. Estimate the cost of ending inventory by using
gross profit method and retail method
226
UINT 1 Cost to Be Included in
Inventories
Contents of Inventories
Inventory is used to indicate (1)
merchandise held for sale in the normal
course of business and (2) materials in the
process of production or held for production.
227
Ownership of Inventories
Goods in transit
With the terms of FOB shipping point, ownership of the
goods changes hands when the goods are originally
shipped, because the buyer is paying the shipping costs by
himself.
With the term of FOB Destination, ownership of the goods
changes hands when the reach their destination, because
the seller is paying the shipping costs on the behalf of the
buyer and thus owns the inventory until it is delivered.
228
Ownership of Inventories
Consignments
The owner of goods( the consignor) transfers goods to a

retailer (the consignee). The consignee will sell the goods
on the owner’s behalf but does not hold title to the goods.
Therefore, the consignor includes these goods in inventory
rather than the consignee.
229
UINT 2 Inventory System
Two accounting system for inventory
 Perpetual inventory system: each purchase and sale
of merchandise is recorded in an inventory account.
The amount of goods available for sale and the
amount sold are continuously ( perpetually) disclosed
in the inventory records.
230
Two accounting system for inventory
 Periodic inventory system: the inventory records do
not show the amount available for sale or sold during
the period. Instead, a detailed listing of physical
inventory at the end of the accounting period is
prepared.
 the system waits until the end of an accounting
period to make the calculation:
1) count the inventory on hand. (called taking a physical
inventory)
Ending inventory
=Σ counted quantity of each type of goods ×@cost
2) determine the cost of goods sold during the period.
231
UINT 3 Purchase, Discount, Return
and Allowance
Cost of merchandise purchased
=( invoice price- purchase discounts-
purchase return and allowance)
+ transportation-in
Note: we do not consider the relative tax
232
(1) Trade Discounts: a reduction below a list
price ( catalogue price ), the actual price is
determined by deducting the trade discount
from the list price.
A seller offered a 30% trade discount on an item listed in
its catalog for $2,400. At what amount would the buyer
record the purchase?
233
(2) Purchase Returns and Allowance
When merchandise is returned ( purchases return)
or a price adjustment is requested ( purchase
allowance), the buyer (debtor) usually sends the seller
a letter of a debit memorandum which informs the
seller of the amount the buyer proposes to debit
Account Payable.
Dr: Accounts Payable
Cr: Merchandise Inventory
Ennis Co. purchases merchandise of $8,000 on terms
2/10,n/30.Ennis pays the original invoice, less a return
of $2,500, within the discount period. How much did
Ennis Co. pay?
234
(3) Purchase Discounts
when the buyer purchase inventory on credit, discounts
offered by the supplier to encourage prompt payment.
credit term: the terms of a purchase are normally indicated
on the invoice that the seller sends to buyer.
“n/30” “n/10 EOM” “2/10,n/60”
Dr: Accounts Payable

Cr: Cash
Merchandise Inventory
If an invoice date Nov. 22 has credit term 2/10,n/30,
what is (a) the last day the invoice may be paid within
the discount period and (b) the last day of credit period if
the discount is not taken?
235
(4) Transportation-in
 FOB destination: invoice price includes the
transportation costs
invoice price=CIF price 到岸价格
 FOB shipping point: invoice price does not include
the transportation costs, the buyer records the
shipping charges
invoice price=FOB price 离岸价格
236
Martin Co. sells $4,000 of goods to Oblinger Co. on
account on terms 2/10, n/30, FOB shipping point. As a
convenience to Oblinger, Martin Co. pays transportation
costs of $ 250 and adds those costs to the invoice. (a) How
much will Martin Co. bill Oblinger? (b) In Oblinger Co. pays
within the discount period, what amount will Oblinger pay
Martin?
237
UINT 4 Inventory Cost Flow Assumptions
Inventory Cost Flow Assumptions
— When identical units of inventory are
acquired at different unit costs during a period,
how to determine the unit cost when an item is
sold or used?
 Specific identification method
To determine the cost of the unit sold or used
with a specific purchase, calculate the amount of
inventory items one by one at their actual cost.
238
 Three common cost flow assumptions
( inventory costing method):
1. Cost flow is in the order in which the costs
were incurred —First-in, first-out ( FIFO)
the ending inventory is made up of the most recent
costs
2. Cost flow is in the reverse order in which the
costs were incurred —Last-in, first-out ( LIFO)
the ending inventory is made up of the earliest costs
3. Cost flow is an average of the costs
—Average cost
the cost of the units in inventory is an average of the
purchase costs
239
 Compare and contrast the use of the three
inventory costing method
Each method normally yields different
amounts for (1) the cost of goods sold (2)
the ending inventory (3) the gross profit (and
the net income) for the period.
During periods of inflation, the LIFO method
yields the highest amount for the cost of
goods sold, the lowest amount for gross
profit, and the lowest amount for the ending
inventory.
240
Summary of Merchandising Cost Flows
Three kinds of information:
(1)the cost of the merchandise on hand at the
beginning of the period.
(2)the cost of the merchandise purchased during
the period.
(3)the cost of unsold goods on hand at the end of
the period.
Dr: Merchandise inventory(ending)
Cost of goods sold
Cr: Purchase
Merchandise inventory(beginning) 241
UINT 5 Revenue from Sales and Cost of
Goods Sold
----Perpetual Inventory System
the two components of gross profit
sales revenue and cost of goods sold.
Net Sales Revenue – Cost of Goods Sold
= Gross Profit
Gross Profit – Operating Expenses
= Net Income
242
Revenue from sales
= gross proceeds – returns, allowance, discounts
 Gross sales = cash sales + credit sales
 Sales returns and allowance
When buyer returns an unsatisfactory merchandise or
is given an amount off the sales price to keep the
goods, the seller usually issues the buyer a credit
memorandum.
Dr: Sales Returns and Allowance
Dr: Merchandise Inventory
Cr: Cost of Goods Sold
243
 Sales discounts
cash discount for early payment as a part of credit
terms that a seller offer the buyer
Dr: Cash
Sales Discount
 Sales Taxes
Cr: Sales Revenue
Sales Taxes Payable
244
Merchandise Inventory: Merchandise on
hand (not sold) at the end of an accounting
period. It is reported as a current asset on
the balance sheet.
sales, cost of goods sold

gross profit income statement
Merchandise inventory balance sheet
245
Merchandise Inventory Shrinkage
Under the perpetual inventory system, the counted
physical inventory at the end of the accounting
period may differ from the amount of inventory
shown in the Merchandise Inventory account.
Dr: Cost of Goods Sold
Cr: Merchandise Inventory
246
Each merchandising transaction affects a buyer
and a seller. In this example, the seller is Scully
Co. and the buyer is Burton Co.
1. July 1. Scully Co. sold merchandise on account to
Burton Co., $7,500, terms FOB shipping
point,n/45. The cost of the merchandise sold was
$4,500.
2. July 2. Burton Co. paid transportation charges of
$150 on July 1 purchase from Scully Co.
247
3. July 5. Scully Co. sold merchandise on account to
Burton Co., $5,000, terms FOB destination,n/30.
The cost of the merchandise sold was $3,500.
4. July 7. Sully Co. paid transportation costs of $250
for delivery of merchandise sold to Burton Co. on
July 5.
5. July 13. Sully Co. issued Burton Co. a credit
memorandum for merchandise returned, $1,000.
The merchandise had been purchased by Burton
Co. on account on July 5. The cost of the
merchandise returned was $700.
248
6. July 15 Scully Co. received payment from Burton
Co. for purchase of July 5.
7. July 18 Scully Co. sold merchandise on account
to Burton Co., $12,000, terms FOB shipping point,
2/10,n/eom. Sully Co. prepaid transportation
costs of $500, which were added to the invoice.
The cost of the merchandise sold was $7,200.
8. July 28. Scully Co. received payment from Burton
Co. for purchase of July 18, less discount.
Required:
Journalized the entries for merchandise
transactions for both the buyer and the seller.
249
UINT 6 Valuation Using LCM Method
Ending Valuation of Inventory
 Lower-of-Cost-or-Market ( LCM ) Method
If the market price of an item of inventory is
lower than its cost, the lower market price is
used to compute the value of the item. It is
possible to apply the lower of cost or market
to each item in the inventory, to major
categories, or to the inventory as a whole.
250
 Net Realizable Value (NRV)
Merchandise that can be sold only at prices
below cost should be valued at net realizable
value, which is the estimated selling price
less any direct cost of disposal.
251
UINT 7 Inventory Estimation Method
Gross Profit Method

Using a gross profit percentage to estimate
the cost of goods sold and inventory
balance
Retail Inventory Method
Using a cost-to-retail percentage to
estimate ending inventory at cost
252
UINT 8 Using the information
— Merchandise Turnover
 Inventory turnover
= Cost of goods sold / Average inventory
 Number of Day’s Sales in Inventory
= Inventory, end of year/ Average daily
cost of goods sold
Note: These two indicators are also useful for
evaluating the management of inventory.
253
Acid-test ratio = Quick assets/ Current
liabilities
Gross margin ratio = Gross margin/ net sales
Ratio of net sales to assets = Net sales /
Average total assets
It can measure how effectively a business
is using its assets to generate sales. A high
ratio indicates an effective use of assets.
254
CLASSROOM EXERCISES
1. Determine the amount to be paid in full settlement of each
of the following invoices, assuming that credit for returns
and allowances was received prior to payment and that all
invoices were paid within the discount period.
Merchandise Transportation Returns and
Paid by Seller Allowances
a. $4,000 — FOB shipping point, 1/10,n/30 $1,200

b. 1,500 $50 FOB shipping point, 2/10,n/30 700
c. 9,500 — FOB destination, n/30 400
d. 2,500 75 FOB shipping point, 1/10,n/30 600
e. 5,000 — FOB destination, 2/10,n/30 —
255
2. How many errors can you find in the following income
statement?
The Functor Company
Income Statement
For the Year Ended July 31, 2005
Revenue from sales:
Sales $ 3,000,000
Add: Sales returns and allowances $ 58,000
Sales discounts 14,500 72,500
Gross sales $ 3,072,500
Cost of merchandise sold 1,495,000
Income from operations $ 1,577,500

Operating expenses:
Selling expenses $ 145,000
Transportation Out 5,300
Administrative expenses 87,200
Total operating expenses 237,500
$ 1,340,000
Other expenses:
Interest revenue 47,500
256
Chapter 7
Investments, Fixed Assets
and Intangible Assets
UINT 1 Long-Term Investment
Classification
 Debt Security: issued bonds
stable income stream and low risk
 Equity Security: common stock
There are two methods of accounting for long-term
investments in stock: (1) the cost method
(2) the equity method
258
The method used depends on whether the investor
(the buyer of the stock) has a significant influence
on the operating and financing activities of the
company whose stock is owned (investee).
Cost Method
 The cost of the stocks is debited to an investment
account.
 Cash dividends are recorded as a debit to Cash and
a credit to Dividend Revenue.
259
Equity Method
 A stock purchase is recorded in the same manner
as the cost method.
 The investor’s share of the periodic net income of
the investee is recorded as an increase in the
investment account and as revenue for the period.
Likewise, the investor’s share of the periodic net
loss of the investee is recorded as an decrease in
the investment account and as a loss for the period.
 The investor’s share of cash dividends from the
investee is recorded as an increase in the cash
account and a decrease in the investment account.
260
UINT 2 Fixed Assets
Nature of Fixed Assets
Fixed assets are long-term or relatively
permanent assets. They are owned and used
by the business and are not offered for sale
as part of normal operations. Such assets
must by capable of providing repeated use or
benefit and are normally expected to last
more than a year.
261
Acquisition of Fixed Assets
 Acquisition for Cash
 Acquisition through Leasing
 Acquisition via Exchange
 Acquisition with a Basket Purchase
 Acquisition from Donation
 Acquisition through Self- Construction
262
Nature of Depreciation
It represents a decline in the ability of a fixed
asset to provide services. It is also a process
of transferring the cost of a fixed asset to
expense.
Physical depreciation: wear and tear
Functional depreciation: advances in
technology
263
Accounting for Depreciation
 Three factors:(1) the fixed asset’s initial cost (2)
its expected useful life (3) residual value( scrap
value)
initial cost – residual value = depreciable cost
 Three methods :
(1) Straight-Line Method
(2) Units-of-Production Method
(3) Declining-Balance Method: the rate of declining-
balance rate is double the straight-line rate
264
Revision of Estimated Depreciation
—— prospective method
When the estimates of the residual value and the
useful life are revised, they are used to
determine the depreciation expense in future
periods. They do not affect the amounts of
depreciation expense recorded in earlier years.
265
Capital and Revenue Expenditures
 The costs of acquiring fixed assets, adding
to a fixed asset, improving a fixed asset, or
extending a fixed asset’s useful life are
called capital expenditures. Costs that
benefit only the current period or costs
incurred for normal maintenance and repairs
are called revenue expenditures.
266
 Types of Capital Expenditures
(1) Additions: the cost of an addition to a fixed asset
should be debited to the related fixed asset.
(2) Betterments: an expenditure that improves a
fixed asset’s operating efficiency or capacity for its
remaining useful life
(3) Extraordinary Repairs: an expenditure that
increases the useful life of an asset beyond its
original estimate
267
Disposal of Fixed Assets
 Discarding fixed assets
When fixed assets are no longer useful to the
business and have no residual or market value, they
are discarded.
Dr: Accumulated Depreciation
Loss on Disposal of Fixed Assets
Cr: Equipment
Gain on Disposal of Fixed Assets
268
 Selling fixed assets
the entry to record the disposal of a fixed asset
removes the cost of asset and its accumulated
depreciation from the accounts.
Dr ： Cash
Accumulated Depreciation
Loss on Disposal of Fixed Assets
Cr: Equipment
Gain on Disposal of Fixed Assets
269
Leasing Fixed Assets
 Capital lease: it is accounted for as if the
lessee has purchased the asset.
 Operating lease
270
UINT 3 Intangible Assets
Contents of Intangible Assets
Patent
Copyright
Trademarks
Franchise
Goodwill
271
Amortization of intangible assets
 amortization period: beneficial period
effective period
 amortization method: straight-line
Dr: Amortization Expense—Patents
Cr: Patents
272
UINT 4 Assets Impairment
Impairment of a fixed asset occurs when
the recoverable amount of the long-term
asset is less than its carrying amount.
273
Chapter 8
Current
and Long-Term Liabilities
1. Understand the nature of liabilities and
distinguish the debt between equity.
2. Define and give examples of current liability.
3. Understand determinable current liabilities.
4. Understand current liabilities dependent on
operating results.
5. Understand contingency, contingent assets and
contingent liability.
6. Describe the characteristics of bonds.
7. Compute the present value of bonds payable.
8. Journalize entries for bonds payable.
275
UNIT 1 the Nature of Liabilities
Definition:
probable future sacrifices of economic
benefits arising from present obligations of
a particular entity to transfer assets or
provide services to other entities in the
future as a result of past transactions or
events.
276
Distinction between Debt and Equity
the claims of creditors are clearly
distinguished from the claims of owners.
277
UNIT 2 Determinable Current Liabilities
Accounts Payable
Notes Payable
Advances from Customers
Current Maturities of Long-Term
Obligations
Dividend Payable
Third-Party Collections
278
UNIT 3 Current Liabilities Dependent on
Operating Results
Income Taxes Payable
the Difference between pretax financial
income and taxable income
 Temporary difference: taxable or deductible
 Permanent difference
279
UNIT 4 Contingencies
Contingent Asset
Contingent Liability
280
UNIT 5 Bonds Payable
Characteristics of Bonds Payable
A corporation that issues bonds enters into
a contract, called a bond indenture or trust
indenture, with the bondholders.
281
Classification of Bonds
 registered and coupon
 term and serial
 convertible and callable
 secured and debenture
282
Accounting for Bonds Payable
Bonds Issued at Face Amount/ Discount/ Premium
 Dr: Cash
Cr: Bonds Payable
 Dr: Cash
Discount on Bonds Payable
Cr: Bonds Payable
 Dr: Cash
Cr: Bonds Payable
Premium on Bonds Payable
283
Amortization of Discount/ Premium
 Dr: Interest Expense
Cr: Discount on Bonds Payable
Cash
 Dr: Interest Expense
Cr: Cash
There are two methods of amortizing a bond
discount or premium:
(1) the straight-line method
(2) The effective interest rate method
( interest method)
284
 Retirement or Redemption of Bonds
 Dr: Bonds Payable
Cash
Loss on Redemption of Bonds
Cr: Cash
Cr: Gain on Redemption of Bonds
Cash
285
Chapter 9
Owner’s Equity
1. Describe the nature of the corporate form of
organization.
2. List the two main sources of stockholders’ equity.
3. List the major sources of paid-in capital, including
the various classes of stock.
4. Journalize the entries for issuing stock .
5. Journalize the entries for treasury stock transaction.
6. Prepare an income statement reporting earnings per
share (EPS).
7. Journalize the entries for cash dividends and stock
dividends.
8. State the effect of stock splits on financial
statement. 287
UINT 1 Nature of a Corporation
Characteristics of a Corporation
A corporation is a legal entity, distinct and
separate from the individuals who create
and operate it.
As a legal entity, it can sell shares of
ownership, called stock, without affecting its
operation or continued existence. The
stockholders own the corporation and have
limited liability.
288
Organization Structure of a Corporation
Stockholders
Board of Directors
Officers
Employees
289
Rights of Stockholders
1. The right to vote in matters concerning the
corporation.
2. The right to share in distributions of
earnings.
3. The right to share in assets on liquidation.
290
UINT 2 Stockholders’ Equity
Two main sources of stockholders’ equity
stockholders’ equity
Paid-in Retained
Capital Earnings
Stockholder investments Reinvested Earnings
291
 Paid-in Capital ( Contributed Capital)
Capital contributed to the corporation by the
stockholders and others. If there is only one class
of stock, the account is entitled Capital Stock or
Common Stock.
 Retained Earnings
It is generated from operations. Net income
increases it while dividends decreases it. Retained
earnings represents a corporation’s accumulated
net income that has not been distributed to
stockholders as dividends.
292
UINT 3 Source of Paid-in Capital
Stock
 Authorized Stock, Issued Stock, and
Outstanding Stock
AUTHORIZED
ISSUED
OUTSTANDING
293
 Common Stock and Preferred Stock
 Rights of Common Stockholders
1. The right to vote in matters concerning the
corporation.
2. The right to share in distributions of
earnings.
3. The right to share in assets on liquidation.
4. The right to share in any new issues of stock
of the same class ( preemptive right )
294
 Rights of Preferred Stockholders
1. The preferred right to receive regular
dividends .
2. The preferred right to receive a certain
amount in the corporation liquidates.
 Cumulative Preferred Stock
 Nonparticipating Preferred Stock
295
 Issuing Stock
 Issuing stock at par for cash
Dr: Cash
Cr: Common Stock
Preferred Stock
 Issuing stock at a premium
Dr: Cash
Cr: Common/Preferred Stock
Paid-in Capital in Excess of Par-Value
296
Other Sources of Paid-in Capital
----- Donated Capital
Dr: Land
Cr: Donated Capital
297
UINT 4 Treasury Stock
Treasury Stock
Such stock that a corporation has once
issued and then reacquires is called treasury
stock.
 Purchase treasury stock
 Reissue treasury stock
298
UINT 5 Retained Earnings
the balance of Retained Earnings
The balance of retained earnings account at
the end of the fiscal year is created by
closing entries. First, the balance in the
income summary account (the net income or
net loss) is transferred to Retained Earnings.
Second, the balance of the dividends
account is transferred to Retained Earnings.
299
Prior Period Adjustments
 the correction of material accounting errors
 Events occurring after the balance sheet
date
Restricted Retained Earnings
 legal reserve
 secret reserve
300
UINT 6 Comprehensive Income
the meaning of comprehensive income
Comprehensive income is defined as all
changes in stockholders’ equity during a
period except those resulting from
dividends and stockholders’ investments.
comprehensive income
= traditional net income +(-)
other comprehensive income items
301
the comprehensive income statement
 net income
 other comprehensive income statement:
foreign currency items
pension liability adjustment
unrealized gains and losses on investments
 comprehensive income per share
302
UINT 7 Dividends and Stock Split
Cash Dividend
There are three conditions that a corporation
must meet to pay a cash dividend:
1. Sufficient retained earnings
2. Sufficient cash
3. Formal action by the board of directors
303
Dividend Date
 the date of declaration
Dr: Cash Dividend
Cr: Cash Dividend Payable
 the date of record: no entry
 the date of payment
Dr: Cash Dividend Payable
Cr: Cash
304
Stock Dividend
the effect of a stock dividend on the stockholders’
equity of the issuing corporation is to transfer
retained earnings to paid-in capital.
 Declare the stock dividend
Dr: Stock Dividends
Cr: Stock Dividends Distributable
Paid-in Capital in Excess of Par-Common Stock
 Issue stock for the stock dividends
Dr: Stock Dividends Distributable
Cr: Common Stock
305
Stock Split
 Corporations reduce the par of stated value of
their common stock and issue a proportionate
number of additional shares.
 A major objective of a stock split is to reduce the
market price per share of the stock.
 A stock split changes only the par or state value
and the number of shares outstanding, it is not
recorded by a journal entry.
306
Chapter 10
1 understand the four basic financial

statements and relationship among them.
2 Command the contents and structure of
balance sheet and its financial analysis or
interpretation.
3 Identify two different formats of income
statement and its major financial analysis or
interpretation.
308
4 .Explain why the statement of cash flows is

one of the basic financial statement.
5 Summarize the types of cash flow and
activities reported in the statement of cash
flows.
6 Prepare a statement of cash flows, using the
direct method and indirect method.
7 Calculate and interpret the free cash flow.
309
UINT 1 Introduction to Financial
Statements
The significance of financial statements
Financial statements are used to evaluate
the current financial condition of a business
and to predict its future operating results
and cash flows. From the theory of
“decision-making “, the purpose of financial
accounting is to provide useful information
for decision-makers by the aid of financial
statements.
310
The relationship of the financial statement
 In the statement of owner’s equity (or
retained earnings) , Net Income comes
directly from the Income Statement, and
the Owner’s Equity (or Retained Earnings)
at the end of the period is the same as that
in the balance sheet.
 Cash at the end of the period in the
statement of cash flows is equal to the cash
item in the balance sheet.
311
UINT 2 Balance Sheet
The balance sheet lists all the assets,
liabilities, and owner’s equity of an entity as
of a specific date. It represents the financial
position of a business, so it is also called the
statement of financial position.
The formats of balance sheet:
 the account format:
Assets = Liabilities+Owner’s Equity
 The report format:
Assets – Liabilities = Owner’s Equity
312
The contents of balance sheet:( for a corporation)
 Assets:
 Cash
 Marketable securities
 Accounts receivable
 Inventories: raw materials, goods in process,
finished goods, supplies, etc.
 Prepaid: prepaid rent/ insurance
 Long-term investment
 Property, plant and equipment
 Land
 Intangible assets: trademark, copyright, patents,
goodwill 313
 Liabilities:
 Payables: accounts payable, notes payable, wages
payable, taxes payable, interest payable,etc.
 Unearned revenue
 Bonds payable
 Owner’s Equity:
 Paid-in capital: preferred stock, common stock,
paid-in capital in excess of par value (additional
paid-in capital)
 Retained earnings
314
Financial analysis and interpretation—
Solvency Analysis
Solvency analysis focuses on the ability of a
business to pay its current and noncurrent
liabilities. It is normally assessed by
examining balance sheet relationships.
 Current Position Analysis:to evaluate short-
term solvency
 Working capital
=Current assets – Current Liabilities
315
 Current ratio (Working capital ratio)
= Current assets / Current Liabilities
Note: Current ratio is more useful than working capital in making
comparisons across companies and with industry averages.
 Quick ratio (Acid-test ratio)
= Quick assets / Current Liabilities
Note:Quick ratio measure the “instant” debt-paying ability of a
business.Quick assets are cash, cash equivalents, and
receivables that can quickly be converted into cash. It is often
considered desirable to have a quick ratio exceeding 1.
316
 Accounts Receivable Analysis
 Accounts receivable turnover
= Net sales on account / Average account receivable
Note:The indicator measures how frequently during the years
the accounts receivable are being converted into cash.
 Number of Day’s Sales in Receivables
= Account receivable,end of year/ Average daily sales
on account
Note:The indicator is an estimate of the length of time the
accounts receivable have been outstanding.
 An improvement in the efficiency in collecting accounts
receivable is indicated when the accounts receivable turnover
increases and the number of day’s sales in receivables
decreases. 317
 Inventory Analysis
 Inventory turnover
= Cost of goods sold / Average inventory
 Number of Day’s Sales in Inventory
= Inventory,end of year/ Average daily
cost of goods sold
Note:These two indicators are also useful for evaluating the
management of inventory.
318
 Ratio of Fixed Assets to Long-Term Liabilities
= Fixed assets(net) / Long-term liabilities
Note: Long-term notes and bonds are often secured by
mortgages on fixed assets. The indicator is a solvency measure
that indicates the margin of safety of the noteholders or
bondholders. It also indicates the ability of the business to
borrow additional funds on a long-term basis.
 Ratio of Liabilities to owner’s equity
= Total liabilities / Total owner’s equity
Note:The indicator presents the relationship between the total
claims of the credits and owners. It is a solvency measure that
indicates the margin of safety for creditor and the ability of the
business to withstand adverse business conditions.
319
 Number of Times Interest Charges Earned
= (Income before income tax+Interest Expense) /
Interest Expense
Note:The amount available to meet interest charges is not
affected by income taxes. This is because interest is
deductible in determining taxable income. The higher the
ratio, the lower the risk that interest payments will not be
made if earnings decrease.
320
UINT 3 Income Statement
The income statement presents a summary
of the revenues and expenses of an entity
for a specific period of time. Its output is
the net income which represents the
operating results of a business.
The formats of income statement:
 Single-step format
 Multiple-step format: the gross profit,
operating income, and the net income
should be calculated in a series of steps.
321
The contents of income statement:
 Revenues:
 Sale revenue: for a manufacturing/merchandising
business
 Fees earned: for a service business
 Other income (Non-operating revenues):
dividend revenue, interest revenue,
gain on sale of land/plant/equipment/investment
322
 Expenses:
 Cost of goods sold
 Operating expenses:
 selling expenses :delivery, advertising,
sales commissions, etc.
 administrative expenses: office salaries, office
supply expenses, insurance, depreciation expenses
of equipment and buildings, uncollectible accounts
expense,etc.
 Other expenses (Non-operating expenses):
interest expenses, income taxes expenses
323
A frame of multiple-step income statement:
Sales Revenues
Less: Sales Returns and Allowances
Sales Discounts
Net Sales
Fees Earned
Cost of Goods Sold
Gross Profit
Operating Expenses:
Selling Expenses
Administrative Expenses
Total Operating Expenses
Operating Income ( Income from
Operation)
324
Other Revenue:
Interest Earned
Dividend Income
Gain on sale of land
Other Expense:
Interest Expense
Income before Income Taxes
Income Taxes Expense
Net Income
325
Financial analysis and interpretation—
Profitability Analysis
Profitability analysis focuses on the relationship
between operating results as reported in the
income statement and resources available to
the business as reported in the balance sheet.
 Ratio of net sales to assets
= Net sales / Average total assets
Note: The ratio measures how effectively a business is using its
assets to generate sales. A high ratio indicates a better use of
assets.
326
 Rate Earned on Total Assets
= (Net income+ Interest expense)/ Average total assets
Note:The ratio measures the profitability of total assets, without
considering how the assets are financed. Adding interest
expense to net income eliminates the effect of whether the
assets are financed by debt or equity.
 rate of income from operations to total assets
= income from operation/Average total assets
In this case, any assets related to the nonoperating revenue
and expense items should be excluded from total assets . Using
income from operation has the advantage of eliminating the
effects of any changes in the tax.
327
 Rate Earned on Stockholders’ Equity
= Net income / Average total stockholders’ equity
Note:This ratio emphasizes the rate of income earned on the amount
invested by the stockholders. The difference in the rate on
stockholders’ equity and the rate on total assets is called leverage.
Funds from creditor can be used to increase the return on the
stockholders’ equity.
 Rate Earned on Common Stockholders’ Equity
= ( Net income – Preferred dividend) / Average total common
stockholders’ equity
Note: The ratio focuses only on the rate of profits earned on the amount
invested by the common stockholders. The concept of leverage, can
also be applied to the use of funds from the preferred stock as well as
borrowing. Funds from both sources can be used in an attempt to
increase the return on common stockholders’ equity.
328
 Earnings per Share on Common Stock (EPS)
= ( Net income – Preferred stock dividends)/ Number of
common shares outstanding
Note:It is the net income per share of common stock
outstanding during a period. When the number of common
shares outstanding has changed during the period, a
weighted average number of shares outstanding is used.
 Price-Earnings Ratio ( P/E )
= Market price per share of common stock / Earnings per share
of common stock
Note:It indicates how much the market is willing to pay per
dollar of a company’s earnings. It assesses a company’s
growth potential and future earnings prospects. P/E ratio that
are much higher than the market averages are generally
associated with companies with fast-growing profits.
329
 Dividends per Share and Dividend Yield
 Dividends per Share
= Total common stock dividends/ Number of common shares
outstanding
Note:dividends per share and earnings per common share are
usually used by investor in assessing alternative stock
investments. These two ratios can commonly indicate the
relationship between dividends and earnings.
 Dividend Yield
= Dividends per share of common stock / Market price per
share of common stock
Note: It shows the rate of return to common stockholders in
terms of cash dividends. It is of special interest to investors
whose main investment objective is to receive current returns
rather than an increase in the market price of the investment.
330
UNIT 4 Statement of Owner’s Equity
Single proprietorships and partners prepare
the statement of owner’s equity. However
corporations prepare a similar statement
called the statement of retained earnings.
The statement of owner’s equity reports
the changes in the owner’s equity for a
period of time.
331
It is prepared after the income statement
because the net income or net loss for the
period must be reported in this statement.
Similarly, it is prepared before the balance
sheet, since the amount of owner’s equity
at the end of the period must be reported
on the balance sheet. So it is viewed as the
connecting link between the income
statement and the balance sheet.
332
UNIT 5 Statement of Cash Flows
Purpose of the statement of cash flows
The statement of cash flows reports a
company’s major cash inflows and outflows
during a certain period.
It is useful to managers in evaluating past
operations and in planning future investing and
financing activities. It is useful to investors,
creditors,and other stakeholders in assessing a
company’s profit potential. In addition, it is a basis
for evaluate the solvency of a business (why?).
333
The concept of “cash”
“cash” includes cash, bank deposits and cash
equivalents.
cash equivalents refer to those highly liquid
short-term investments, such as Treasury Bill,
commercial instruments (notes issued by major
corporation).
334
Reporting cash flows
Cash flows are reported by three types of
activities:
 Cash flows from operating activities
this kind of cash flows comes from transactions
that affect net income.
e,g. the purchase and sale of merchandise
But it normally differ from the amount of net
income. This difference occurs because
revenues and expenses may not be recorded at
the same time that cash is received or paid.
335
 Cash flows from investing activities
that affect the investment in noncurrent assets.
e.g. the sale and acquisition of fixed asset
 Cash flows from financing activities

that affect the equity and debt of the business.
e.g. the issuing or retiring equity and debt
securities.
336
Cash Flows
Increase in Cash Decrease in Cash
OPERATING OPERATING
(receipt from (payments for
revenues) expenses)
INVESTING INVESTING
(receipt from sales of (payments for acquiring
noncurrent assets) noncurrent assets)
FINANCIING FINANCIING
(receipt from issuing equity (payments for treasury
and debt securities) stock, dividends, and
redemption of debt
securities)
337
 Noncash Investing and Financing Activities
some investing and financing activities do
not directly involve cash, such as, the issue
of common stock to retire long-term debt.
This kind of transaction does not have a
direct effect on cash. However it does not
eliminate the need for future cash payment
to pay interest and retire the bonds.
Because of the future effect on cash flows,
such transactions usually appear at the
bottom of the statement of cash flows.
338
Two alternative methods for reporting cash
flows from operating activities.
 In the direct method, the cash flows from
operating activities are disclosed by the
original cash receipts or payments.
 Its advantage is that it reports the sources
and uses of cash directly.
 Its disadvantage is that the necessary data
may not be readily available and may be
costly to gather.
339
 In the indirect method, the cash flows from
operating activities are disclosed by adjusting
the net income. The disclosure begins with the
net income and lists all the adjustments (do not
involve the receipt or payment of cash)
necessary to convert the accrual net income to
the net cash flows from operating activities.
 Its major advantage is that the data are readily
available, so it is normally less costly and
efficient to prepare than the direct method.
340
Direct method
 Corporation
Statement of Cash Flow
For the year ended Dec.31.200
Items Amounts
Cash Flows from Operating Activities 
Cash Receipts
From Customers
From Interest and Dividends
Cash Payments
To Suppliers
For Operating Expenses
For Interest Payments
For Income Taxes
Net Cash Flows from Operating Activities
341
Cash Flows from Investing Activities
Cash Receipts
Sales of Investment
Sales of Plant Assets
Cash Payments
Purchase of Investment
Purchase of Plant Assets
Purchase of Intangible Assets
Net Cash Flows from Investing Activities
342
Cash Flows from Financing Activities
Cash Receipts
Issue of common stock
Proceeds from borrowing
Cash Payments
Repayment of amount borrowed
Repayment of bonds
Dividends paid to stockholders
Net Cash Flows from Financing Activities
Net Increase in cash
Cash at the beginning of the period
Cash at the end of the period
343
Explanations:
1.Cash Receipts from Customers = Sales Revenues
+ Decrease in Accounts Receivable
- Increase in Accounts Receivable
2. Cash Receipts from Interest and Dividends
 虽然收到的利息和股利是与投资活动联系到一起的。但
IASC 和 FASB 都把它们归入经营活动产生的现金流量。
344
3. Cash Payments to Suppliers
1) Suppliers are those entities that provide the business with its
inventory and essential services. Cash Payments to Suppliers
refers to the payments for purchases of inventory or service.
2) Cash Payments for Purchases
First, Net Purchases( 购货净额 ) = Cost of Goods Sold +
Increase in Inventory - Decrease in Inventory
以销售成本为基础结合存货的变动调整计算购货净额。
Second, Cash Payments for Purchases
= Net Purchase + Decrease in Accounts Payable
- Increase in Accounts Payable
以购货净额为基础调整应付账款的变化计算出购货的现金支付额。
345
4. Cash Payments for Operating Expenses
Generally, the cash payments for operating expenses are
determined after three adjustments.
 Prepaid Expenses, such as Prepaid Rent
 Accrued/Unrecorded Expenses, such as Accrued Wages
 Non-cash Expenses, such as Depreciation
Expenses 、 Amortization Expenses
Cash Payments for Operating Expenses =
Operating Expenses + Increase in Prepaid Expense
- Decrease in Prepaid Expenses
+ Decrease in Accrued Expense
- Increase in Accrued Expenses
- Non-cash Operating Expenses
346
5. Cash Payments for Interest Payments
 在中国，偿付利息属于筹资活动。
6. Cash Payments for Income Taxes =
Income Taxes Expense
+ Decrease in Income Taxes Payable
- Increase in Income Taxes Payable
347
Indirect method
Adjustment Items
 items for expenses that affect noncurrent accounts
but not cash — depreciation, the amortization of
intangible assets
 items for revenues and expenses that affect current
assets and current liabilities but not cash flows.
 Current assets (receivables, inventories, prepaid
expenses)
 Current liabilities (payables, accrued liabilities)
 items that are connected with investing or financing
activities — disposal of fixed assets or investments
348
Cash Flows from Operating Activities
Net Income
Adjustments to Reconcile Net Income to Net Cash Flows from
Operating Activities
Depreciation and amortization of intangible assets (+)
Gain or Loss on Sale of Investments
Gain or Loss on Sale of Plant Assets gain(-) ； loss(+)
Increase or Decrease in Account Receivable In(-) ； De(+)
Increase or Decrease in Inventory In(-) ； De(+)
Increase or Decrease in Prepaid Expenses In(-) ； De(+)
Increase or Decrease in Account Payable In(+) ； De(-)
Increase or Decrease in Accrued Liabilities In(+) ； De(-)
Increase or Decrease in Income Taxes Payable In(+) ； De(-)
Other Items
Total Adjustments
Cash Flows from Operating Activities
349
Example: The Balance Sheet —— With Changes of Each Item
ABC Corporation
The Balance Sheets
Dec 31, 1999 and 2000
ITEMS 2000 1999 CHANGES (I or D)

Current Assets
Cash $115 920 $37 800 $78 120(I)
Account Receivable 118 440 138 600 -20 160(D)
Inventory 362 880 277 220 85 680(I)
Prepaid Expenses 2 520 12 600 - 10 080(D)
Total Current Assets 599 760 466 200
350
Long-term Assets
Investment 289 800 320 040 -30 240(D)
Plant Assets 1 489 400 1 262 600 226 800(I)
Accumulated Depreciation (259 560) (171 360) (88 200)(I)
Total Plant Assets 1 229 840 1 091 240
Intangible Assets 312 400 10 000 302 400(I)
Total Assets 2 431 800 1 887 480
Current Liabilities
Accounts Payables 126 000 108 360 17 640(I)
Accrued Expenses 20 240 10 680 9 560(I)
Salary Payable 10 000 12 000 -2 000(D)
Income Taxes Payable 7 560 12 600 -5 040(D)
Total Current Liabilities 163 800 143 640
351
Long-term Liabilities
Bond Payable 743 400 617 400 126 000(I)
Total Liabilities 907 200 761 040
Stockholder’s Equity
Capital Stock 695 520 504 000 19 520(I)
Paid-in Capital in Excess 476 280 289 800 186 480(I)
Of Par Value
Retained Earnings 352 800 332 640 20 160(I)
Total Stockholder’s Equity 1 524 600 1 126 440
Total Liabilities and
Stockholder’s Equity 2 431 800 1 887 480
352
The Income Statement
ABC Corporation
The Income Statement
For Year Ended Dec 31, 2000
ITENS AMOUNTS
Sales Revenue $1 758 960
Cost of Goods Sold 1 310 400
Gross Profit 448 560
Salary Expenses 100 000
Operating Expenses
(Including depreciation expenses $93 240) 270 440
Operating Income 78 120
353
Other Income or Expenses
Interest Expense $(57 960)
Interest Income 15120
Gain on Sale of Investment 30 240
Loss on Sale of Plant Assets (7 560)
Total Other Income or Expense ( 20 160 )
Income Before Taxes $57 960

Income Taxes 17 640
Net Income 40 320
354
Apart from the balance sheet and the income
statement, there are other transactions recorded in
relating accounts as follows:
(1) Purchased other company’s stocks in the amount
of $ 196 560.
(2) Sold long-term government bonds, the price is $
257 040, and the cost is $ 226 800.
(3) Sold some plant assets, the price is $12 600, the
original cost is $ 25 200, the accumulated depreciation
is $ 5 040.
(4) Purchased intangible assets in the amount of $
302 400.
355
(5) Issued $ 252 000 of bonds at face value in a non-
cash exchange for plant assets.
(6) Repaid $ 126 000 of bonds at face value at
maturity.
(7) Issued common stock for $ 378 000, the face value
is $ 378 000, the face value is $ 191 520, and the paid-
in capital in excess of par value is $ 186 480.
(8) Paid cash dividends in the amount of $ 20 160.
Required:
Prepare the statement of cash flows for the 2000 of
ABC Corporation, using direct method and indirect
method.
356
Financial analysis and interpretation
 free cash flow: a measure of operating cash
flow available for corporate purpose after
providing sufficient fixed assets additions to
maintain current productive capacity and
dividends. It is a valuable tool for evaluating
the cash position of a business.
Cash flow from operating activities
Less: Cash used to purchase fixed assets to maintain productive
capacity used up in producing income during the period
Less: Cash used for dividends
Free cash flow
357
Doomsday ratio: the ratio of cash to current
liabilities. It is more useful than working
capital and current ratio in assessing short-
term solvency especially when a company that
is in financial distress may have difficulty
converting its receivables, inventory, and
prepaid assets to cash on a timely basis.
Doomsday ratio
= Cash and cash equivalents/ Current liabilities
358
CLASSROOM EXERCISES
1. State the effect (cash receipt or payment and amount ) of
each of the following transactions ,considering
individually, on cash flows:
a. Purchases a building by paying $30,000 cash and issuing
a $90,000 mortgage note payable.
b. Retired $500,000 of bonds, on which there was $2,500 of
unamortized discount, for $501,000.
c. Paid dividends of $1.50 per share.There were 30,000
shares issued and 5,000 shares of treasury stock.
d. Sold a new issue of $100,000 of bonds at 101.
e. Purchased 5,000 shares of $30 par common stock as
treasury stock at $50 per share.
359
f. Purchased land for $120,000 cash.
g. Sold equipment with a book value of $42,500 for $41,000.
h. Sold 5,000 shares of $30 par common stock for $45 per share.
2. On the basis of the following stockholder’s equity accounts,
indicate the items, exclusive of net income, to be reported on
the statement of cash flows. There were no unpaid dividends at
either the beginning or the end of the year.
ACCOUNT Common Stock, $10 Par
Balance
Date Item Debit Credit Debit Credit
2003
Jan 1 Balance, 50,000 shares 500,000
Feb 11 6,000 shares issued for cash 60,000 560,000
June 30 2,750-share stock dividend 27,500 587,500
360
ACCOUNT Paid-in Capital in Excess of Par- Common Stock
Balance
2003
Jan 1 Balance 90,000
Feb 11 6,000 shares issued for cash 240,000 330,000
June 30 Stock dividend 137,500 467,500
ACCOUNT Retained Earnings

Balance
2003
Jan 1 Balance 475,000
June 30 Stock dividend 165,000 310,000
Dec 30 Cash dividend 180,000 130,000
31 Net income 450,000 580,000
361
3. Selected data derived from the income statement and
balance sheet of Intel Corp. for a recent year are as follows:
Income Statement Data (dollars in millions)
Net earnings $6,068
Depreciation 2,807
Loss on sale of property, plant, and equipment 282
Other noncash expenses 242
Balance Sheet Data (dollars in millions)
Increase in accounts receivable $ 38
Decrease in inventories 167
Decrease in other operating assets 37
Decrease in accounts payable and accrued expenses 163
Decrease in income tax payable 211
362
Prepare the cash flows from operating activities section of the
statement of cash flows ( using the indirect method) for Intel
Corp., for the year.
4. The comparative balance sheet of Maria’s Memories Inc. for
December 31, 2003 and 2002, is as follows:
Dec 31, 2003 Dec 31, 2002
Assets
Cash $ 54 $ 34
Accounts receivable (net) 23 27
Inventories 16 14
Land 20 30
Equipment 26 12
Accumulated Depreciation—equipment (8) (5)
Total $ 131 $ 112
363
Liabilities and Stockholder’s Equity
Accounts payable ( merchandise creditors) $ 17 $ 18
Dividend payable 8 6
Common stock, $1 par 3 2
Paid-in capital in excess of par—common stock 15 10
Retained earnings 88 76
Total $ 131 $ 112
The following additional information is taken from the records:
a. Land was sold for $ 17.
b. Equipment was acquired for cash.
c. There were no disposals of equipment during the year.
d. The common stock was issued for cash.
e. There was a $25 credit to Retained Earnings for net income.
f. There was a $13 debit to Retained Earnings for cash dividend declared.
364
Prepare a statement of cash flow, using the indirect method
of presenting cash flows from operating activities.
5. The income statement of Tender Memories Greeting Card
Company for the current year ended June 30 is as follows:
Sales $ 358,000
Cost of merchandise sold 163,400

Gross profit 194,600
Operating expenses:
Depreciation expense $ 32,500
Other operating expense 142,600
Income before income tax 19,500
Income tax expense 7,300
Net income 12,200 365
Changes in the balances of selected accounts from the
beginning to the end of the current year are as follows:
Increase ( Decrease*)
Account receivable (net) $ 17,000*
Inventories 5,300
Prepaid expenses 3,100*
Accounts payable ( merchandise creditors) 13,600*
Accrued expenses (operating expenses) 8,300
Income tax payable 2,400*
Required:
Prepare the cash flows from operating activities section of the
statement of cash flows, using the direct method.
366
6. The comparative balance sheet of Dowling Company for December 31, 2004
and 2003, is as follows:
Dowling Company
Comparative Balance Sheet
December 31, 2004 and 2003
2004 2003
Assets
Cash $ 140,350 $ 95,900
Account receivable (net) 95,300 102,300
Inventories 165,200 157,900
Prepaid expenses 6,240 5,860
Investments (long-term) 35,700 84,700
Land 75,000 90,000
Buildings 375,000 260,000
Accumulated depreciation—buildings (71,300) (58,300)
Machinery and equipment 428,300 428,300
Accumulated depreciation—Machinery and equipment (148,500) (138,500)
Patents 58,000 65,000
Total 1,159,290 1,093,660
367
Liabilities and Stockholder’s Equity
Accounts payable ( merchandise creditors) $ 43,500 $ 46,700
Accrued expenses (operating expenses) 14,000 12,500
Income taxes payable 7,900 8,400
Dividend payable 14,000 10,000
Mortgage note payable, due 2004 40,000 0
Bonds payable 150,000 250,000
Common stock, $30 par 450,000 375,000
Paid-in capital in excess of par—common stock 66,250 41,250
Retained earnings 313,640 349,810
total 1,159,290 1,093,660

The income statement for Dowling Company is shown below:
368
Dowling Company
Income Statement
For the Year Ended December 31, 2004
Sales $ 1,100,000
Cost of merchandise sold 710,000

Gross profit 390,000
Operating expenses:
Depreciation expense 23,500
Patent amortization 7,000
Other operating expense 196,000
Income from operations 163,500
Other income:
Gain on sale of investment 11,000
Other expense:
Interest expenses 26,000 (15,000)
Income before income tax 148,500
Income tax expense 5,000
Net income 98,500 369
An examination of the accounting records revealed the
following additional information applicable to 2004:
a. Land costing $15,000 was sold for $ 15,000.
b. A mortgage note was issued for $40,000.
c. A building costing $115,000 was constructed.
d. 2,500 shares of common stock were issued at 40 in exchange
for the bonds payable.
e. Cash dividends declared were $74,670.
Required:
1. Prepare a statement of cash flows, using the indirect method
of reporting cash flows from operating activities.
2. Prepare a statement of cash flows, using the direct method of
reporting cash flows from operating activities.
370
7. The financial statements for Dowling Company are
presented in exercise 6.
a. From Dowling Company’s statement of cash flows,
determine the free cash flow for 2004. Assume that 40% of
the acquisition of property and equipment and 20% of the
acquisition of technology licenses are used to maintain
productive capacity.
b. What conclusion can you draw from your analysis?
371

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Fundamental Accounting

What is accounting? Please describe the

Prepare Record economic Design the accounting

Differ three organization forms of

FASB: Financial Accounting Standards Board

148 statements of standards (rules)

Objectives of Financial Reporting

Qualitative Characteristics Elements of

Recognition and Measurement Criteria

Predictive Feedback Representational

accounting entity assumption: An accounting

going-concern assumption: An accounting

accounting period assumption: In order to

What principle is based on the accounting

stable-money-unit assumption: It requires

accrual-basis principle: It requires that

Expense: recognize whenever it is incurred,

Income Statement: during the period ending on the

Statement of Cash Flows

Operating: cash flows related to the normal operation

Liabilities: “Probable future sacrifices of

 the full form of accounting equation:

A transaction is such an economic event or

3. - 15,000 +36,000 +21,000

Post to the ledger

Journal: It is a history transactions by

a. Received cash for providing a service.

Explain the nature of each increase and decrease in

Receive an amount on account Reduce an asset

Balance incorrectly computed

Posting errors Debit posted as credit, or vice versa

Debit or credit posting omitted

1. Describe the accounting periods and

1. Prepare a work sheet.

Expenses are Revenues are

3 Net Income or Net Loss is

4 Withdrawal are transferred to

 Categorized Accounts Summary

Prepare a statement of owner’s equity for the year. 162

1. Explain the concept of Liquidity and the

 Generally, only investments that are purchased

A business establishes a petty cash fund

3. The check is cashed, and the currency is turned

4. As each disbursement is made, the person

6. When the check is cashed and the proceeds

Bank accounts as a control over cash

Market Value Method:

 The advantages for allowance method:

Dr: Accounts Receivable

 Maturity Value: The amount is the sum of

The owner of the note endorses and delivers the note

make discount maturity

1. Maturity value of the note

Contingent liability is a potential liability that will

The owner of goods( the consignor) transfers goods to a

Dr: Accounts Payable

sales, cost of goods sold

Gross Profit Method

a. $4,000 — FOB shipping point, 1/10,n/30 $1,200