2.Debits and credits: How are debits and credits used to change the balances in the different types of accounts?




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The terms debit (Dr.) and credit (Cr.) refer to the left and right sides of a general ledger account, respectively. These terms do not mean increase or decrease. They are used repeatedly in the recording process to describe where entries are made. For ex. the act of entering an amount on the left side of an account is called debiting the account and an entry on the right side is crediting the account. When the totals of the two sides are compared, an account will have a debit balance if the total of the debit amounts is more than the credits and an account will have a credit balance if the credit amounts exceed the debits.


3. Accounting equation (Balance sheet equation) : What are the basic and expanded accounting equations? What is a “double-entry” accounting system and how is it related to the accounting equation?


In a double-entry system, for every debit there must be a credit, and vice versa. The basic accounting equation: Assets = Liabilities + Shareholder"s EquityThe expanded accounting equation: Assets = Liabilities + Common Shares + Retained Earnings - Dividends + Revenues - ExpensesThe equality of debit and credits is the basis for the double-entry system of recording transactions (a.k.a. double-entry bookkeeping). Under the double-entry accounting system, which is used for accounting around the world, the two-sided (dual) effect of each transaction is recorded in appropriate accounts. This system gives a logical method for recording transactions. It also offers a way of proving the accuracy of the recorded amounts. Every transaction is recorded with total debits equal to total credits, so the sum of all the debits posted to the accounts must equal the sum of all the credits. Every time a transaction occurs, the elements in the equation change, but the basic equality of the two sides remains.


Asset and expense accounts are increased and decreased on which side? What about liability and revenue accounts?


All asset and expense accounts are increased on the left (or debit side) and decreased on the right (or credit side). Conversely, all liability and revenue accounts are increased on the right (or credit side) and decreased on the left (or debit side). Shareholder"s equity accounts, such as Common Shares, and Retained Earnings, are increased on the credit side, whereas Dividends is increased on the debit side.


4.Financial statements: How do revenues, expenses, dividends and other comprehensive income affect shareholders’ equity on the balance sheet? (Note: we will look at partnerships and proprietorships later in the course so don’t worry about these concepts right now.)


5.The Accounting Cycle: What are the steps in the accounting cycle? (Note: including order and which ones are optional).


1. Identification and measurement of transactions and other events. 2. Journalizing: General journal, Cash receipts journal, Cash disbursements journal, Purchases journal, Sales journal, Other special journals3. Posting: General ledger (usually monthly), Subsidiary ledgers (usually daily) 4. Trial balance preparation5. Adjustments: Accruals, Prepayments, Estimated items6. Adjusted trial balance7. Statement preparation: Income statement, Retained earnings, Balance sheet, Cash flows8. Closing (temporary accounts)9. Post-closing trial balance (optional) 10. Reversing entries (optional)When the steps have been completed, the sequence starts over again in the next accounting period. Statement preparation per Step 7 uses ASPE statement names (but it also applies under IFRS).


6.Identifying and recording transactions and other events: What factors are considered in determining what is recorded in the accounting records?An item should be recognized in the financial statements if? What should be done before preparing a journal entry?


The first step in the accounting cycle is to analyze transactions and other selected events. The problem is determining what to record. There are no simple rules for whether an event should be recorded. It is generally agreed that changes in personnel, changes in managerial policies, and the value of human resources, though important, should not be recorded in the accounts. On the other hand, when the company makes a cash sale or purchase - no matter how small - it should be recorded. An item should be recognized in the financial statements if it meets the definition of an element (such as a liability or asset), and is measurable. Where there is uncertainty about the future event occurring or not (such as the potential loss from a lawsuit), the entity must use all available information to make a neutral decision as to whether the liability/asset exists or not. A transaction analysis should be done before a journal entry. The purpose of transaction analysis is first to identify the type of account involved and then to determine whether a debit or a credit to the account is required.


6. Identifying and recording transactions and other events: There are two types of events, what are they? Many events have external and internal elements. Give an example. What other particular kind of external event is there?


External events and internal events. >External events involve interaction between an entity and its environment, such as a transaction with another company, a change in the price of a product or service that a company buys or sells, or a flood or earthquake. >Internal events occur within an entity, such as using buildings and machinery in its operations, or transferring or consuming raw materials in production processes. Many events have external and internal elements. For example, acquiring the services of employees or others involves exchange transactions that are external events. The employee provides services and the pays the employee. Using those services (labour), is part of production, which is internal. Events may be initiated and controlled by an entity, such as the purchase of merchandise or the use of a machine, or they may be beyond its control, such as an interest rate change, a theft or vandalism, or a change in tax rates. As a particular kind of external event, a transaction can be an exchange in which each entity both receives and gives up value, such as a purchase or sale of goods or services. Alternatively, a transaction can be a transfer in one direction in which an entity incurs a liability or transfers an asset to another entity without directly receiving value in exchange. (In other words, the transaction is non-reciprocal.) Examples include distributions to owners, the payment of taxes, gifts, charitable contributions, uninsured losses, and thefts.


In short, most events that affect the enterprise"s financial position are recorded. Some events are not recorded because of tradition or because measuring them is too complex. The accounting profession in recent years has shown signs of breaking with age-old traditions and is more receptive than ever to measuring and reporting events and other items that were previously seen as too complex or immeasurable.


7.What is the purpose of a journal and a ledger? What is a T account? Why are transactions and other selected events not first recorded in the ledger? Why is the journal is referred to as the book of original entry? What is the simplest journal form?


Ledger: The effects of transactions on the basic business elements (assets, liabilities, and equities) are categorized and collected in accounts. The general ledger is a collection of all the asset, liability, shareholders" equity, revenue, and expense accounts. A T account is a convenient method for showing the effect of transactions on particular asset, liability, equity, revenue, and expense items. Journal:In practice, transactions and other selected events are not first recorded in the ledger. This is because each transaction affects two or more accounts, and since each account is on a different page in the ledger, it would be inconvenient to record each transaction this way. The risk of error would also be greater. To overcome this limitation and to have a complete record of each transaction or other selected event in one place, a journal (the book of original entry) is used. Transactions are first recorded in chronological order (i.e., by date) in a journal and then transferred to the accounts. For this reason, the journal is referred to as the book of original entry. The simplest journal form is a chronological listing of transactions and other events that expresses the transactions and events as debits and credits to particular accounts. This is called a general journal.


1. The accounts and amounts to be debited (Dr.)2. The accounts and amounts to be credited (Cr.)3. A date.4. An explanation. Businesses use special journals in addition to the general journal. Special journals summarize transactions that have a common characteristic (such as cash receipts, sales, purchases, and cash payments), which saves time in doing the various bookkeeping tasks.


Journalizing is the process of entering/recording all transactions data chronologically in a book called general journal or the book of original entry. Posting (part of the summarizing and classifying process) is when items entered in a general journal must be transferred to the general ledger. ~ We need to journalize first because it is more organized and results in the least of errors. Posting is done after to the general ledger which organizes all financial elements accounts in one place. ~


The numbers in the Ref. column of the general journal refer to the General Ledger accounts to which the items and its amount are posted.


When is the general journal posting completed?What two purposes does the number in the posting reference column serve?Provide one example of a numbering system practice that business enterprises use?


The general journal posting is completed when all the posting reference numbers have been recorded opposite account titles in the journal.(1) It indicates the ledger account number of the account involved, and (2) it indicates that the posting has been completed for the item.Each business enterprise chooses its own numbering system for its ledger accounts. One practice is to begin numbering with asset accounts and to follow with liabilities, shareholders equity, revenue, and expense accounts, in that order.


What is a trial balance and when is it prepared? How are the accounts ordered in a trial balance? What is the main purpose of a trial balance?


A trial balance is a list of general ledger accounts and their balances at a specific time. Customarily, a trial balance is prepared at the end of an accounting period. The accounts are listed in the order in which they appear in the general ledger. The main purpose of a trial balance is to prove the mathematical equality of debits and credits after posting. Under the double-entry system, this equality will occur when the sum of the debit account balances equals the sum of the credit account balances. A trial balance also uncovers errors in journalizing and posting. In addition, it is useful when preparing financial statements.


1. Listing the account titles and their balances2. Totalling the debit and credit column3. proving the equality of the two columns.


A trial balance does not prove that all transactions have been recorded or that the ledger is correct. Even though the totals in the trial balance columns agree, there can still be many errors. What are some examples that the trial balance may still balance in error?


When 1. a transaction is not journalized. 2. a correct journal entry is not posted.3. a journal entry is posted twice4. incorrect accounts are used in journalizing or posting, or5. offsetting errors are made in recording a transaction amount. In other words, as long as equal debits and credits are posted, even to the wrong account or in the wrong amount, the total debits will equal the total credits.


In order for revenues to be recorded in the period in which they are earned, and for expenses to be recognized in the period in which they are incurred, adjusting entries are made at the end of the accounting period. In short, adjustments are needed to ensure that the revenue recognition principle is followed and that proper matching occurs.


The use of adjusting entries makes it possible to report on the statement of financial position the appropriate assets, liabilities, and owners" equity at the statement date and to report on the statement of comprehensive income the proper net income (or loss) and comprehensive income for the period.


The trial balance - the first pulling together of the transaction data - may not contain up-to-date and complete data because:1. Some events are not journalized daily because it is not efficient to do so. Examples are the consumption of supplies and the earning of wages by employees. 2. Some costs are not journalized during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transactions. Examples of such costs are building and equipment deterioration, rent, and insurance. 3. Some items may be unrecorded. An example is a utility service bill that will not be received until the next accounting period.


Adjusting entries are required every time financial statements are prepared. The starting point is to analyze each trial balance account to determine whether it is complete and up to date for financial statement purposes. The analysis requires a thorough understanding of the company"s operations and the relationships between its accounts. In accumulating the adjustment data, the company may need to take inventory counts of supplies and repair parts. It may also be desirable to prepare supporting schedules of insurance policies, rental agreements, and other contractual commitments. Adjustments are often prepared after the end of the period, but the entries are dated as at the statement of financial position date.


Adjusting entries can be classified as prepayments, accruals, or estimated items (including fair value estimates). Prepayments include:1. Prepaid Expenses which are expenses paid in cash and recorded as assets before they are used or consumed. 2. Unearned Revenues which are revenues received in cash and recorded as liabilities before they are earned. Accruals include: 3. Accrued Revenues which are revenues earned but not yet received in cash or recorded.4. Accrued Expenses which are expenses incurred but not yet paid in cash or recorded. Estimated Items:5. Bad Debts are expenses for impaired accounts receivable estimated in the period the related revenue is earned. 6. Unrealized Holding Gain or Loss is a gain (or loss) on fair value - NI investments is estimated at the end of an accounting period and recorded as an increase (or decrease) to the investment account with a corresponding gain (or loss) in the Statement of Comprehensive Income. 7. Unrealized Holding Gain or Loss - OCI is a gain (or loss) on fair value- OCI investments estimated at the end of an accounting period and recorded as an increase (or decrease) to the investment account with a corresponding gain (or loss) in OCI on the Statement of Comprehensive Income.


10.Adjusting entries for prepayments: What are prepaid expenses and what factors are considered in creating an adjusting entry for a prepayment?


Expenses that have been paid in cash and recorded as assets before they are used or consumed are identified as prepaid expenses. When a cost is incurred, an asset account is debited to show the service or benefit that will be received in the future. Prepayments often occur for such things as insurance, supplies, advertising, and rent.


When do prepaid expenses expire? Does it require an entry each day with each expiration of these costs? Are assets overstated or understated before adjustment and what is the prepaid expense adjusting entry?


Prepaid expenses expire with the passage of time (such as rent and insurance) or by being used and consumed (such as supplies). The expiration of these costs does not require an entry each day, which would be unnecessary and impractical. Instead, it is customary to postpone the recognition of such cost expirations until financial statements are prepared. At each statement date, adjusting entries are made to record the expenses that apply to the current accounting period and to show the remaining unexpired costs in the asset accounts. Before adjustment, assets are overstated and expenses are understated. Thus, the prepaid expense adjusting entry results in a debit to an expense account and a credit to an asset account.


What supplies are used in business and how is the account recorded when acquired? When is recognition for used-up supplies supposed to be? Explain supplies in an adjusting entry.


Several different types of supplies are used in business. For example, a CA firm will have office supplies such as stationery, envelopes, and paper. In contrast, an advertising firm will have advertising supplies such as graph paper colour ink cartridges, and poster paper. Supplies are generally debited to an asset account when they are acquired. During the course of operations, supplies are partly or entirely consumed. However, recognition of the used-up supplies is deferred until the adjustment process when a physical inventory (a count) of supplies is taken. The difference between the balance in the Supplies account (the asset) and the cost of supplies on hand represents the supplies used up for the period (the expense).


If the adjusting entry is not made for supplies, expenses will be understated and net income overstated. Moreover, both assets and shareholder"s equity will be overstated on the statement of financial position.


Most companies have fire and theft insurance on inventory and equipment, personal liability insurance for accidents suffered by customers, and automobile insurance on company cars and trucks. The cost of insurance protection is the amount paid as insurance premiums. The term (duration) and coverage (what the company is insured against) are specified in the insurance policy. The minimum term is usually one year, but three-to five-year terms may be available and offer lower annual premiums. Insurance premiums are normally charged to the asset account Prepaid Insurance when they are paid. At the financial statement date, it is necessary to debit Insurance Expense and credit Prepaid Insurance for the cost that has expired during the period. If adjustment is not made, expenses for that month will be understated by $A and net income overstated by $A. Moreover, both assets and owners" equity also will be overstated by $A on the statement of financial position date.


Depreciation/Amortization:What kind of productive facilities typically own? What is the term of service commonly referred to as?


Companies typically own a variety of productive facilities such as buildings, equipment and motor vehicles. These assets provide a service for many years. The term of service is commonly referred to as the asset"s useful life. Because an asset such as a building is expected to provide service for many years, it is recorded as an asset, rather than an expense, in the year it is acquired. Such assets are recorded at cost, as required by the cost principle.


Depreciation/Amortization:In order to match the cost of the asset with the revenues that it is generating, what should be done? What is depreciation/amortization? From an accounting standpoint, when productive facilities are acquired, the transaction is viewed as?


In order to match the cost of the asset with the revenues that it is generating, a portion of the cost of a long-lived asset should be reported as an expense during each period of the asset"s useful life. Depreciation/amortization is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. From an accounting standpoint, when productive facilities are acquired, the transaction is viewed essentially as a long-term prepayment for services. Periodic adjusting entries for depreciation are therefore needed for the same reasons described earlier for other prepaid expenses. In other words, it is necessary to recognize the cost that has expired during the period (the expense) and to report the unexpired cost at the end of the period (the asset).


Depreciation/Amortization:In order to match the cost of the asset with the revenues that it is generating, what should be done? What is depreciation/amortization?


In order to match the cost of the asset with the revenues that it is generating, a portion of the cost of a long-lived asset should be reported as an expense during each period of the asset"s useful life. Depreciation/amortization is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner.


Depreciation/Amortization:In determining a productive facility"s useful life, there are three main causes of depreciation. What are they?


1. Actual use2. Deterioration due to the elements3. ObsolescenceWhen an asset is acquired, the effects of these factors cannot be known with certainty, so they must instead be estimated. Thus, depreciation is an estimate rather than an exact measurement of the cost that has expired. A common procedure in calculating depreciation expense is to divide the asset"s cost by its useful life. For example, if the cost is $10,000 and the useful life is expected to be 10 years, annual depreciation is $1,000.




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