I.

Chapter 1 - Introduction to Accounting

A. The Purpose of Accounting: The purpose of accounting is to provide financial information
about a business to individuals and organizers.
B. The Accounting Process: The accounting process has 6 major steps which are analyzing,
recording, classifying, summarizing, reporting and interpreting.
1. Accounting: a system of gathering financial information about a business and reporting this
information to its users
2. Difference Between Accounting and Bookkeeping: Bookkeeping focuses on recording and
organizing financial data, including tasks such as invoicing, billing, payroll, and reconciling
transactions. Accounting is the interpretation and presentation of financial data, including aspects
such as tax returns, auditing and analyzing performance.
3. Steps in the Accounting Process: 6 steps
a. Analyzing: looking at events that have taken place and thinking about how they affect the
business.
b. Recording: entering financial information about events affecting the company into the
accounting system.
c. Classifying: sorting and grouping similar items together rather than merely keeping a simple
diary like record of numerous events.
d. Summarizing: bringing the various items of information together to determine a result.
e. Reporting: telling the results of the financial information.
f. Interpreting: deciding the meaning and importance of the information in various reports.
C. Generally Accepted Accounting Principles (GAAP): they are the rules that businesses must
follow when preparing financial statements.
D. Three Types of Business Ownership Structures
1. Sole Proprietorship: a type of ownership structure in which one person owns the business
2. Partnership: a type of ownership structure in which more than one person owns the business
3. Corporation: a type of ownership structure in which stockholders own the business. The
owner’s risk is usually limits to their initial investment and they usually have very little influence
on the business decisions
E. Types of Businesses
1. Service Business: a business that provides a service
2. Merchandising Business: a business that buys products to sell
3. Manufacturing Business: a business that makes a product to sell
F. Career Opportunities in Accounting: career opportunities in accounting include work in
public accounting, private accounting, and governmental accounting and not-for-profit
accounting.
1. Accounting Clerks: Records, sorts, and files accounting information
2. Bookkeepers and Para-Accountants: Bookkeepers generally supervise the work of an
accounting clerk, help with the daily accounting work, and summarize accounting information.
Para-accountants are paraprofessionals who provide many accounting, auditing, or tax services
under the direct supervision of an accountant.
3. Accountants: design the accounting information system and focusses on analyzing and
interpreting information
a. Budgeting: the process in which accountants help managers develop a financial plan.
b. Auditing: reviewing and testing to be certain that proper accounting policies and practices
have been followed.
c. Forensic Accounting: a specialized field that combines fraud detection, fraud prevention,
litigation support, expert witnessing , business valuables, and other investigative activities
4. Job Opportunities: Job growth in some areas will be much greater than in others.
Employment advertisements often indicate that accountants and accounting clerks are expected
to have computer skills. Computer skills definitely increase the opportunities available to you in
your career. Almost every business needs accountants, accounting clerks, and bookkeepers.
II. Chapter 2 - Analyzing Transactions: The
Accounting Equation
A. The Accounting Elements: Before the accounting process can begin, the entity to be
accounted for must be defined. A business entity is an individual, association, or organization
that engages in economic activities and controls specific economic resources. This definition
allows the personal and business finances of an owner to be accounted for separately.
Three basic accounting elements exist for every business entity: assets, liabilities, and owner’s
equity. These elements are defined below.
1. Assets: is an item that is owned by a business and will provide future benefits
a. Tangible Assets: those assets that can be appraised by value or seen or touched.
(1) Current Assets: items that can or will be converted into cash within one year
(a) Cash: coins, currency (paper money), checks, credit card receipts and money orders received
from others, as well as money deposited in the bank.
(b) Petty Cash Fund: a cash fund used to pay relatively small amounts
(c) Accounts Receivable: An amount owed to a business by its customers as a result of the sale
of goods or services. ;"on account" or "on credit"; must promise to pay sometime in the future.
(d) Prepaid Expenses: assets when acquired by expenses as they are consumed or expired
i) Supplies: assets that are consumed as used; if greater than 1 year/account. period, it is
equipment.
ii) Insurance: protection against a possible financial loss
(e) Inventory: items held for sale in the ordinary course of normal operations of the business
(f) Notes Receivable: A written promise that a customer will pay a fixed amount of principal
plus interest by a certain date in the future.
(2) Fixed Assets: Long-term assets that are relatively permanent such as land, buildings, or
equipment, automobile, furnishing
(a) Equipment
(b) Automobiles
(c) Furnishings
(d) Land and building
b. Intangible Assets: assets that do not have physical substance.
(1) Patent: claim for original creation
(2) Trademark: a symbol, word, or words legally registered or established by use as
representing a company or product.
(3) Copyright: the exclusive legal right given to an originator or an assignee to print, publish,
perform, film, or record literary, artistic, or musical material, and to authorize others to do the
same.
(4) Goodwill
2. Liabilities: Liabilities represent something owed to another business entity. The amount owed
represents a probable future outflow of assets as a result of a past event or transaction. Liabilities
are debts or obligations of the business that can be paid with cash, goods, or services.
a. Current Liabilities: liabilities due within a short time, usually within a year
(1) Accounts Payable: An unwritten promise to pay a supplier for assets purchased or services
received.
(2) Taxes Payable: is the actual amount owed in taxes based on the rules of the tax code. The
payable amount is recognized on the balance sheet as a liability until the company settles the tax
bill.
(3) Wages Payable: is the line item that records how much money is owed to workers but not
yet paid. It is a liability account. When a wage expense is recorded it is a debit to the wage
expenses account, which requires a credit to the wages payable account for the same amount
until the wage is paid to the worker.
b. Long-Term Liabilities: also called long-term debts, are debts a company owes third-party
creditors that are payable beyond 12 months. This distinguishes them from current liabilities,
which a company must pay within 12 months. On the balance sheet, long-term liabilities appear
along with current liabilities.
(1) Mortgage Payable: is an account on the balance sheet that represents a long-term or
noncurrent liability, specifically, the amount of a loan borrowed to purchase real estate that is yet
to be paid to the lender
(2) Notes Payable: A formal written promise to pay a supplier or lender a specified sum of
money at a definite future time.
(3) Bonds Payable: are a form of debt financing issued by corporations, governments, and other
entities in order to raise capital. As part of the financing arrangement, the issuer of the bonds is
obligated to pay periodic interest across the borrowing term and the principal amount on the date
of maturity.
3. Owner’s Equity (Net Worth, Capital): The amount by which the business assets exceed the
business liabilities.
B. The Accounting Equation: The accounting equation consists of the three basic accounting
elements:
1. Assets = Liabilities + Owner’s Equity: This equation reflects the fact that both outsiders and
insiders have an interest in the assets of a business.
Liabilities represent the outside interests of creditors.
Owner’s equity represents the inside interests of owners.
2. Assets - Liabilities = Owner’s Equity
3. Assets - Owner’s Equity = Liabilities
C. Analyzing Business Transactions: A business transaction is an economic event that has a
direct impact on the business. A business transaction almost always requires an exchange
between the business and another outside entity.
1. Account: A separate record used to summarize changes in each asset, liability, and owner’s
equity of a business.
2. Chart of Accounts: table of contents for accounts ; (COA) is a financial, organizational tool
that provides an index of every account in an accounting system. This provides an insight into all
the financial transactions of the company.
D. Effect of Transactions on the Accounting Equation
1. Expanding the Accounting Equation:
a. Revenues: The amount a business charges customers for products sold or services performed.
b. Expenses: The decrease in assets (or increase in liabilities) as a result of efforts to produce
revenues.
c. Withdrawals (Drawing): Reduce owner’s equity as a result of the owner taking cash or other
assets out of the business for personal use.
2. Effect of Revenue, Expense, and Withdrawal Transactions on the Accounting Equation
a. Expanded Accounting Equation
b. Assets = Liabilities + Owner’s Equity
[(Capital - Drawing) + (Revenues - Expenses)]
E. Financial Statements: Three financial statements commonly prepared by a business entity
are the income statement, statement of owner’s equity, and balance sheet. The transaction
information gathered and summarized in the accounting equation may be used to prepare these
financial statements.
1. Heading
a. Fiscal Period
b. Calendar Year
c. Quarterly
2. Body
a. The Income Statement (Profit and Loss Statement, Operating Statement): Reports the
profitability of business operations for a specific period of time.
b. The Statement of Owner’s Equity: Reports beginning capital plus net income less
withdrawals to compute ending capital.
c. The Balance Sheet (Statement of Financial Position, Statement of Financial Condition):
balance sheet; Reports assets, liabilities, and owner’s equity on a specific date. It is called a
balance sheet because it confirms that the accounting equation is in balance.
statement of financial position/statement of financial condition; Another name for the
balance sheet, which reports assets, liabilities, and owner’s equity on a specific date.
F. Overview of the Accounting Process
1. Input: Business transactions provide the necessary input for the accounting information
system.
2. Processing: Recognizing the effect of transactions on the assets, liabilities, owner’s equity,
revenues, and expenses of a business.
3. Output: The financial statements are the output of the accounting information system.

III. Chapter 3 - The Double-Entry Framework

A. Double-Entry Accounting: A system in which each transaction has a dual effect on the
accounting elements.
1. Transaction: the interaction or exchange of buying or selling something, a business deal
2. Account: record or statement of financial expenditure and receipts relating to a particular
period or purpose
B. The T Account: The T account gets its name from the fact that it resembles the letter T. The
three major parts of an account are as follows: the title, the debit, or left side, and the credit, or
right side.
1. Debit: The debit side is always on the left
2. Credit: the credit side is always on the right
C. Balancing a T Account: To determine the balance of a T account at any time, simply total the
dollar amounts on the debit and credit sides. These totals are known as footings.
1. Footing: The total dollar amounts on the debit and credit sides of an account.
2. Account Balance: The difference between the footings of an account.
D. Effects of Debits and Credits on the Accounting Equation: To debit an account means to
enter an amount on the left or debit side of the account. To credit an account means to enter an
amount on the right or credit side of the account.
1. Assets: Assets are on the left side of the accounting equation. Therefore, increases are entered
on the left (debit) side of an asset account, and decreases are entered on the right (credit) side.
2. Liabilities and Owner’s Equity: Liabilities and owner’s equity are on the right side of the
equation. Therefore, increases are entered on the right (credit) side, and decreases are entered on
the left (debit) side.
3. The Owner’s Equity Umbrella: Owner’s equity includes four types of accounts: Owner’s
Capital, Revenues, Expenses, and Drawing. Expanding the accounting equation helps illustrate
the use of debits and credits. Since these accounts affect owner’s equity, they are shown under
the “umbrella” of owner’s equity in the accounting equation. It is helpful to think of the Owner’s
Capital account as hovering over the revenue, expense, and drawing accounts like an umbrella.
4. Owner’s Capital: The owner’s capital account reports the amount the owner has invested in
the business. These investments increase the owner’s equity and are credited to the owner’s
capital account.
5. Revenues: Revenues increase the owner’s equity. Revenues could be recorded directly on the
credit side of the owner’s capital account. Specific revenue accounts, like Delivery Fees, Sales,
and Service Fees, are used. These specific accounts are credited when revenue is earned.
6. Expenses: Expenses decrease the owner’s equity. specific expense accounts are maintained for
items like rent, wages, advertising, and utilities. These specific accounts are debited as expenses
are incurred.
7. Drawing: Withdrawals of cash and other assets by the owner for personal reasons decrease
owner’s equity
8. Normal Balances: is the side of an account that is used to increase the account.
debit balances: The normal balance of asset, expense, and drawing accounts.
credit balances: The normal balance of liability, owner’s equity, and revenue accounts.
E. Transaction Analysis
1. Accounting Equation Debits and Credits: Asset, Liability, and Owner’s Equity Accounts
2. Expanded Accounting Equation Debits and Credits: Including Revenues, Expenses, and
Drawing
3. Summary of Transactions: displays individual transactions that impacted the budget, by
account code, during a reporting period and is the online equivalent of the printed BAR.
F. The Trial Balance: A list of all accounts, showing the title and balance of each account, used
to prove that the sum of the debits equals the sum of the credits.

IV. Chapter 4 - Journalizing and Posting

Transactions
A. Flow of Data
1. Transaction Analysis: involves documenting every transaction that has an impact on your
company's finances. This recordkeeping step is very important in the accounting process and
helps to show how your business transactions impact your assets, liabilities, and equity.
2. Journalizing: Journalizing in accounting is the system by which all business transactions are
recorded for your financial records. A business transaction is first recorded in a journal, also
called a Book of Original Entry
3. Posting: Posting in accounting refers to moving a transaction entry from a journal to a general
ledger, which contains all of a company's financial accounts. A journal's entries are chronological
while a ledger compiles its transactions by accounts, such as assets or liabilities.
4. Trial Balance: is a financial report of credit entries and debit entries that businesses use to
internally audit their double-entry accounting systems. The goal is to confirm that the sum of all
debits equals the sum of all credits and identify whether any entries have been recorded in the
wrong account.
B. Source Documents: Any document that provides information about a business transaction.
1. Check Stub: is the part of a check that is kept by the payee with information such as the check
number, date, and amount. If you accurately record on your check stubs what you have paid out,
you should build up a very accurate account of your finances.
2. Invoice: is a document issued by a seller to the buyer that indicates the quantities and costs of
the products or services provider by the seller. An invoice specifies what a buyer must pay the
seller according to the seller's payment terms.
a. Sales Invoice: is an accounting document sent by a provider of goods/services to a purchaser.
It records services rendered, items provided, the amount owed by the customer, and how they
can make payment. Invoices create legally binding agreements between companies and buyers,
especially for larger purchases.
b. Purchase Invoice: A purchase invoice is a document that specifies the products or services
purchased by a customer and the corresponding cost. The invoice is sent to the buyer after the
purchase has been made and is matched to the corresponding purchase order before payment is
issued.
3. Sales Ticket: The term "ticket" refers to a customer's purchase in one visit but does not
necessarily involve paper or cardboard slips like concert, plane, or theater tickets. The average
ticket size measurement helps businesses understand sales trends and their overall profitability
4. Cash Register Tape: contain information that clearly identifies the merchant. This usually is
located at the top of the receipt and appears before anything else. Typical listings include the
name of the merchant, the business address and the phone number.
5. ATM/POS Receipts: A PoS (Point of Sale) machine is an electronic device through which a
customer can make payment to merchant in exchange for goods or after provision of a service
through debit/credit/prepaid cards or QR scanning. Merchant may issue a printed receipt / e-
receipt for successful transaction. Types of PoS
C. The Chart of Accounts: A list of all accounts used by a business.
D. The General Journal: is a book of raw business transactions recorded in chronological order
by date. It is the first place a transaction is recorded. The amounts are then posted to the
appropriate accounts such as accounts receivables, cash accounts or asset accounts.
1. Journalizing: Entering the transactions in a journal.
2. Steps to Entering Transactions in General Journal:
a. Enter the Date
b. Enter the Debit(s)
c. Enter the Credit(s)
d. Enter the Explanation
E. The General Ledger: A complete set of all the accounts used by a business. The general
ledger accumulates a complete record of the debits and credits made to each account as a result
of entries made in the journal.
1. General Ledger Accounts: An account with columns for the debit or credit transaction and
columns for the debit or credit running balance.
2. Posting to the General Ledger: Copying the debits and credits from the journal to the ledger
accounts.
a. Account Balance: is the amount of money present in a financial repository during the current
accounting period. It is the net difference between the credits and debits posted in any given
accounting cycle, added to the balance carried forward from the previous month.
b. Running Balance: refers to the cumulative total of all transactions in an account over a
specific period. It is a dynamic figure that continuously changes as new transactions are added or
removed. The running balance reflects the net effect of all deposits, withdrawals, transfers, and
fees associated with an account.
3. Cross-Reference: The information in the Posting Reference columns of the journal and ledger
that provides a link between the journal and ledger.
4. The Trial Balance: A list used to prove that the totals of the debit and credit balances in the
ledger accounts are equal.
F. Finding and Correcting Entry Method: An entry to correct an incorrect entry that has been
journalized and posted to the wrong Correcting Errors in the Trial Balance
1. Ruling Method account.

V. Chapter 5 - Adjusting Entries and the Work

Sheet
A. End-of-Period Adjustments: Throughout the accounting period, business transactions are
entered in the accounting system. These transactions are based on exchanges between the
business and other companies and individuals. During the accounting period, other changes
occur that affect the business’s financial condition.
adjusting entries: Journal entries made at the end of an accounting period to reflect changes in
account balances that are not the direct result of an exchange with an outside party.
1. Supplies: Since these supplies were expected to provide future benefits, Supplies, an asset,
was debited at the time of the purchase
2. Prepaid Insurance: Prepaid Insurance, an asset, was debited because the insurance policy is
expected to provide future benefits in the form of insurance coverage, or a cash refund if the
policy is canceled.
3. Wages Expense and Wages Payable: Since the employees have not been paid, Wages
Payable, a liability, should be established
4. Depreciation of Fixed Assets and Depreciation Expense: Depreciation is a method of
matching an asset’s original cost against the revenues produced over its useful life. There are
many depreciation methods
a. Straight-Line Method of Depreciation: A depreciation method in which the depreciable cost
is divided by the estimated useful life.
(1) Original Cost Basis: is the original value of an asset for tax purposes, usually, the purchase
price, adjusted for stock splits, dividends, and return of capital distributions. This value is used to
determine the capital gain, which is equal to the difference between the asset's cost basis and the
current market value.
(2) Salvage Value: The expected market value of an asset at the end of its useful life.
(3) Market Value: The amount an item can be sold for under normal economic conditions.
(4) Useful Life: The period of time that an asset is expected to help produce revenues.
(5) Depreciable Cost: The cost of an asset that is subject to depreciation.
(6) Accumulated Depreciation: refers to the accumulated reduction in the value of an asset over
time. When an asset is first purchased, it's typically assigned a value reflecting its expected
lifespan, gradually reducing over time. Accumulated depreciation is the total of this depreciation
to date.
(7) Depreciation Expense: is the cost of an asset that has been depreciated for a single period,
and shows how much of the asset's value has been used up in that year. Accumulated
depreciation is the total amount of depreciation expense that has been allocated for an asset since
the asset was put into use.
b. Calculation of Depreciation: Formula: (Cost of asset – Scrap value of asset) / Useful life of
asset = Depreciation expense. Most often used for: Equipment that loses value steadily over time.
Pros: It spreads the expense evenly over each accounting period.
(1) Straight-Line: is an accounting process that spreads the cost of a fixed asset over the period
an organization expects to benefit from its use. Depreciation impacts a company's income
statement, balance sheet, profitability and net assets, so it's important for it to be correct.
(2) Sum-of-the-Years’-Digits: (SYD) method allows depreciation to be recorded based on a
reversed scale of the total of digits for the years of useful life. Where: YD = n(n + 1)/2 reflects
the summation over the depreciable life of n years
(3) Double-Declining Balance: is a form of accelerated depreciation that doubles the regular
depreciation approach. It is frequently used to depreciate fixed assets more heavily in the early
years, which allows the company to defer income taxes to later years.
(4) Modified Accelerated Cost Recovery System: MACRS stands for modified accelerated cost
recovery system. It is the tax depreciation system used in the United States to calculate asset
depreciation. This system replaced the Accelerated Cost Recovery System (ACRS) in 1986 and
applies to property placed into service after 1986.
c. Adjusting Entry for Deprecation Expenses: is a journal entry made at the end of a period to
reflect the expense in the income statement and the decrease in value of the fixed asset on the
balance sheet. The entry generally involves debiting depreciation expense and crediting
accumulated depreciation
(1) Contra Account: An account with a credit balance that is deducted from the related asset
account on the balance sheet.
(2) Book Value (Undepreciated Cost): The difference between the asset account and its related
accumulated depreciation account. The value reflected by the accounting records.
5. Expanded Chart of Accounts: Several new accounts were needed to make the adjusting
entries. New accounts are easily added to the chart of accounts
B. Posting Adjusting Entries: Adjusting entries are posted to the general ledger in the same
manner as all other entries, except that “Adjusting” is written in the Item column of the general
ledger.
C. The Work Sheet: A form used to pull together all of the information needed to enter adjusting
entries and prepare the financial statements.
1. The 10-Column Work Sheet: Although a work sheet can take several forms, a common
format has a column for account titles and 10 amount columns grouped into five pairs of debits
and credits.
2. Preparing the Work Sheet: five steps required for the preparation of a work sheet
a. Prepare the Trial Balance: the first pair of amount columns is for the trial balance. The trial
balance assures the equality of the debits and credits before the adjustment process begins. The
columns should be double ruled to show that they are equal.
b. Prepare the Adjustments: the second pair of amount columns is used to prepare the adjusting
entries. Enter the adjustments directly in these columns. When an account is debited or credited,
the amount is entered on the same line as the name of the account and in the appropriate
Adjustments Debit or Credit column. A small letter in parentheses identifies each adjusting entry
made on the work sheet.
c. Prepare the Adjusted Trial Balance: The third pair of amount columns on the work sheet.
They are used to prove the equality of the debits and credits in the general ledger accounts after
making all end-of-period adjustments.
d. Extend Adjusted Balances to the Income Statement and Balance Sheet Columns: each
account listed in the Adjusted Trial Balance must be extended to either the Income Statement or
Balance Sheet columns. The Income Statement columns show the amounts that will be reported
in the income statement. All revenue accounts are extended to the Income Statement Credit
column and expense accounts are extended to the Income Statement Debit column.
e. Complete the Work Sheet: To complete the work sheet, first total the Income Statement
columns. If the total of the credits (revenues) exceeds the total of the debits (expenses), the
difference represents net income. If the total of the debits exceeds the total of the credits, the
difference represents a net loss.
D. Finding Errors on the Work Sheet: If any of the columns on the work sheet do not balance,
you must find the error before you continue. Once you are confident that the work sheet is
accurate, you are ready to journalize the adjusting entries and prepare financial statements.
E. Journalizing Adjusting Entries from the Work Sheet: Writing the adjustments on the work
sheet has no effect on the ledger accounts in the accounting system. The only way to change the
balance of a ledger account is to make a journal entry. Once the work sheet has been completed,
simply copy the adjustments from the work sheet to the journal.
F. Methods of Accounting for a Personal Service Enterprise:
1. Cash Basis of Accounting: A method of accounting under which revenues are recorded when
cash is received and expenses are recorded when cash is paid.
2. Modified Cash Basis of Accounting: A method of accounting that combines aspects of the
cash and accrual methods. It uses the cash basis for recording revenues and most expenses.
Exceptions are made when cash is paid for assets with useful lives greater than one accounting
period.
3. Accrual Basis of Accounting: A method of accounting under which revenues are recorded
when earned and expenses are recorded when incurred.

G. APPENDIX: Depreciation Methods

1. Straight-Line Method: Under the straight-line depreciation method, an equal amount of
depreciation will be taken each period. First, compute the depreciable cost by subtracting the
salvage value from the cost of the asset
2. Sum-of-the-Years’-Digits: Under the sum-of-the-years’-digits depreciation method,
depreciation is determined by multiplying the depreciable cost by a schedule of fractions. The
numerator of the fraction for a specific year is the number of years of remaining useful life for
the asset, measured from the beginning of the year. The denominator for all fractions is
determined by adding the digits that represent the years of the estimated life of the asset.
3. Double-Declining-Balance Method: Under the double-declining-balance depreciation
method, the book value is multiplied by a fixed rate, often double the straight-line rate. The van
has a five-year life, so the straight-line rate is 1 ÷ 5, or 20%. Double the straight-line rate is 2 ×
20%, or 40%.
4. Modified Accelerated Cost Recovery System: For assets purchased since 1986, many firms
use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. Under this
method, the Internal Revenue Service (IRS) classifies various assets according to useful life and
sets depreciation rates for each year of the asset’s life. These rates are then multiplied by the cost
of the asset.

VI. Chapter 6 - Financial Statements and the

Closing Process
A. The Financial Statements
1. The Income Statement: Multiple columns are used on the financial statements to make them
easier to read. There are no debit or credit columns on the financial statements.
a. Heading
b. Body
(1) Revenues
(2) Expenses
(3) Net Income or Net Loss
(a) Net Income: refers to the amount an individual or business makes after deducting costs,
allowances and taxes. In commerce, net income is what the business has left over after all
expenses, including salary and wages, cost of goods or raw material and taxes
(b) Net Loss: occurs when the sum total of expenses exceeds the total income or revenue
generated by a business, project, transaction, or investment. Businesses would report a net loss
on the income statement, effectively as a negative net profit
2. The Statement of Owner’s Equity: The Balance Sheet columns of the work sheet provide
most of the information needed to prepare a statement of owner’s equity.
a. Heading
b. Body
(1) Beginning Capital: This is the year-end balance of the capital accounts from the previous
statement of owner's equity, which should also equal the balance on the previous balance sheet
(2) Change in Capital: refers to a modification of a company's capital structure — the
percentage of debt and equity used to finance operations and growth. Debt includes bond issues
or loans, while equity mainly consists of common stock, preferred stock, and retained earnings.
(a) Net Income or Net Loss
(b) Withdrawals
(3) Ending Capital
3. The Balance Sheet: the work sheet and the statement of owner’s equity are used to prepare
the balance sheet. The asset and liability amounts can be found in the Balance Sheet columns of
the work sheet.
a. Heading
b. Body
(1) Assets
(2) Liabilities
(3) Owner’s Equity
c. Report Form of Balance Sheet: A balance sheet in which the liabilities and the owner’s
equity sections are shown below the assets section.
d. Account Form of Balance Sheet: A balance sheet in which the assets are on the left and the
liabilities and the owner’s equity sections are on the right.
e. Classified Balance Sheet: A balance sheet with separate categories for current assets;
property, plant, and equipment; current liabilities; and long-term liabilities.
4. Additional Investments by the Owner (Revisited): If the owner of a business made
additional investments during the accounting period, the owner’s capital reported in the Balance
Sheet columns of the work sheet represents the beginning balance plus any additional
investments made during the accounting period.
B. The Closing Process: Assets, liabilities, and the owner’s capital account accumulate
information across accounting periods.
1. Steps in the Closing Process: The process of giving zero balances to the temporary accounts
so that they can accumulate information for the next accounting period.
a. Permanent Accounts: Accounts that accumulate information across accounting periods; all
accounts reported on the balance sheet.
b. Temporary Accounts: Accounts that do not accumulate information across accounting
periods but are closed, such as the drawing account and all income statement accounts.
c. Income Summary Account: A temporary account used in the closing process to summarize
the effects of all revenue and expense accounts.
2. Journalize Closing Entries
a. Close Revenue Accounts to Income Summary Account: Revenues have credit balances and
increase the owner’s equity. Therefore, the revenue account is debited to create a zero balance.
Income Summary is credited for the same amount.
b. Close Expense Accounts to Income Summary Account: Expenses have debit balances and
reduce owner’s equity. Therefore, the expense accounts are credited to create a zero balance.
Income Summary must be debited for the total of the expenses.
c. Close Income Summary Account to Capital Account: The balance in Income Summary
represents the net income (credit balance) or net loss (debit balance). If net income has been
earned, the Income Summary is debited to create a zero balance, and the owner’s capital account
is credited. If a net loss has been incurred, the owner’s capital account is debited and Income
Summary is credited to create a zero balance.
d. Close Drawing Account to Capital Account: Drawing has a debit balance and reduces
owner’s equity. Therefore, it is credited to create a zero balance. The owner’s capital account is
debited.
3. Post the Closing Entries:
C. Post-Closing Trial Balance: Prepared after posting the closing entries to prove the equality
of the debit and credit balances in the general ledger accounts.
D. The Accounting Cycle: The steps involved in accounting for all of the business activities
during an accounting period.
1. Steps in the Accounting Cycle: Properly analyzing and journalizing transactions is very
important. A mistake made in step 1 is carried through the entire accounting cycle.
a. During Accounting Period
(1) Analyze Source Documents
(2) Journalize Transactions in the General Journal
(3) Post to the General Ledger Accounts
b. End of Accounting Period
(1) Prepare a Trial Balance
(2) Journalize and Post Adjusting Entries
(3) Prepare an Adjusted Trial Balance
(4) Prepare the Financial Statements
(5) Journalize and Post Closing Entries
(6) Prepare a Post-Closing Trial Balance
2. Preparing for New Fiscal Period and Reversing Entries
E. APPENDIX: Statement of Cash Flows
1. Types of Business Activities: cash flows is a measure of how much cash a business brought
in or spent in total over a period of time. Cash flow is typically broken down into cash flow from
operating activities, investing activities, and financing activities on the statement of cash flows, a
common financial statement.
2. Preparing the Statement of Cash Flows: is a financial statement that summarizes the
amount of cash flowing into and out of a company. This includes all cash inflows a company
receives from its ongoing operations and external investment sources.

VII. Chapter 7 - Accounting for Cash

A. Cash: coins, currency (paper money) , checks, credit card receipts and money orders received
from others, as well as money deposited in the bank
B. Records of Cash receipts and Disbursements
C. Banking Procedures and the Checking Account
1. Opening a Checking Account
a. Signature Card: A card that is completed and signed by each person authorized to sign
checks.
b. Joint Account: is a bank or brokerage account shared by two or more individuals. Joint
account holders have equal access to funds but also share equal responsibility for any fees or
charges incurred. Transactions conducted through a joint account may require the signature of all
parties or just one.
2. Making Deposits
a. Deposit Ticket: a bank form which list those cash items ( currency and coin) and individual
checks to be deposited
b. Checks: a piece of commercial paper drawn on funds in a bank account and payable on
demand
3. Endorsements: the signature of the payee or other holder placed on the back of a check or
other negotiable instrument
a. Blank Endorsement: the handwritten signature of the payee on the back of the check
b. Restrictive Endorsement: An endorsement where the payee adds words such as “Pay to the
order of (specific) bank” or “For deposit only” to restrict the payment of the check.
c. Qualified Endorsement: A signature on the back of a negotiable instrument transferring the
amount to some other party but that includes wording that limits the endorser's liability.
d. Special Endorsement: refers to the signing by the payee at the back of a check specifying the
person's name to whom the check can be paid on presentation. It restricts check usage against
fraudulent encasing, aids transaction fluidity in businesses, and secures fund transfers to the
designated person.
4. Automated Teller Machines: Atm machine used by depositors to make withdrawals or
deposits at any time.
5. Writing Checks: A check is a document ordering a bank to pay cash from a depositor’s
account. There are three parties to every check.
a. Drawer: DEPOSITOR; a person who signs a check, ordering a payment to be made
b. Drawee: a person or concern , usually a bank, that has been ordered to make a payment on a
check or draft
c. Payee: a person or company who will receive payment on a promissory note, check, draft or
money order
d. Endorser: a person or company whose name is written on the back of a check
e. Holder: is the bank
6. Bank Statement: an itemized listing prepared by the bank of additions to the subtractions
from a depositors account
7. Miscellaneous Banking Terms
a. Stop Payment Order: is a formal request made to a financial institution to cancel a check or
payment that has not yet been processed. A stop payment order is issued by the account holder
and can only be enacted if the check or payment has not already been processed by the recipient.
b. N.S.F. and U.C.F. Checks: Not sufficient funds. B. UCF - Uncollected funds hold.
c. Overdraft Protection: is an agreement with the bank or financial institution to cover
overdrafts on a checking account. This service typically involves a fee and is generally limited to
a preset maximum amount.
d. Transposition Error: an amount written with the digits in incorrect order
D. Reconciling the Bank Statement: bank reconciliation: A report used to bring the book and
bank balances into agreement.; On any given day, the balance in the cash account on the
depositor’s books (the book balance) is unlikely to be the same as that on the bank’s books (the
bank balance). This difference can be due to errors, but it usually is caused by timing.
Transactions generally are recorded by the business at a time that is different from when the bank
records them.
1. Deposits: is a sum of money that is held in an account. It may be secured in a bank for
safekeeping or to secure goods for renting or purchase. Many different kinds of business
transactions involve the use of a deposit. During daily operations, your business may pay regular
deposits and receive deposits from customers.
2. Cash Payments: money and money substitutes paid
3. Reasons for Differences Between Bank and Book Balances: Differences between the bank
balance and book balance can occur due to checks issued but not yet presented to the bank,
deposits in transit (deposits made but not yet reflected by the bank), bank fees, interest income,
or errors in recording transactions.
a. Outstanding Checks: A check issued that has not been presented to the bank for payment
before the statement is prepared.
b. Deposits in Transit: deposits that have been made and added to depositors’ checkbook, but
which have not yet been listed on the bank statement
c. Dishonored Checks: a check not paid by the bank when properly presented
d. Canceled Checks: is one that has been cleared by cashing or depositing it, rendering the
check null and void for further transactions. A canceled check indicates that the clearing process
has been completed, so cancmaking eled checks can be used as proof of payment.
e. Debit Memorandum: items the bank deducts from the account balance
(1) Service Charges: A bank charge for services such as check printing and processing.
(2) N.S.F. Checks: non-sufficient funds checks
f. Credit Memorandum: a source document that grants credit to a buyer for purchase return or
purchase allowance
(1) Interest: money paid for the use of money
(2) Collections: Collections of promissory notes or charge accounts made by the bank on behalf
of the depositor.
g. Errors: Errors made by the bank or the depositor in recording cash transactions.
4. Steps in Preparing the Bank Reconciliation
Deposits in Transit and Related Errors
Follow these steps:
Step 1
Compare deposits listed on the bank statement with deposits in transit on last month’s bank
reconciliation. All of last month’s deposits in transit should appear on the current month’s bank
statement.
Step 2
Compare the remaining deposits on the bank statement with deposits listed in the accounting
records. Any deposits listed in the accounting records but not on the bank statement are deposits
in transit on the current bank reconciliation.
Step 3
Compare the individual deposit amounts on the bank statement and in the accounting records. If
they differ, the error needs to be corrected.

Outstanding Checks and Related Errors

Follow these steps:
Step 1
Compare canceled checks with the bank statement and the accounting records. If the amounts
differ, the error needs to be corrected.
Step 2
As each canceled check is compared with the accounting records, place a check mark on the
check stub or other accounting record to indicate that the check has cleared.
Step 3
Any checks written that have not been checked off represent outstanding checks on the bank
reconciliation. This includes outstanding checks from last month’s bank reconciliation that have
not yet cleared.
Additional Reconciling Items
Compare any additions and deductions on the bank statement that are not deposits or checks with
the accounting records. Items that the bank adds to the account are called credit memos. Items
that the bank deducts from the account are called debit memos. Remember that a depositor’s
account is a liability to the bank. Thus, a credit memo increases this liability; a debit memo
reduces the liability. Any of these items not appearing in the accounting records represent
additional items on the bank reconciliation.
5. Illustration of a Bank Reconciliation
6. Journal Entries: Only two kinds of items appearing on a bank reconciliation require journal
entries.
i. Errors in the depositor’s books.
ii. Bank additions and deductions that do not already appear in the books.
7. Electronic Banking and Electronic Funds Transfer (EFT): A process using a computer
rather than paper checks to complete transactions with the bank.
E. The Petty Cash Fund: a fund of currency and coin established for the payment of small
amounts of money. For good control over cash, payments generally should be made by check.
Unfortunately, payments of very small amounts by check can be both inconvenient and
inefficient. Therefore, businesses customarily establish a petty cash fund to pay for small items
with cash. “Petty” means small, and both the amount of the fund and the maximum amount of
any bill that can be paid from the fund are small.
1. Establishing a Petty Cash Fund: To establish a petty cash fund, a check is written to the
petty cash custodian for the amount to be set aside in the fund. The amount may be $50, $100,
$200, or any amount considered necessary.
2. Making Payments from a Petty Cash Fund: A receipt called a petty cash voucher should be
prepared for every payment from the fund. The voucher shows the name of the payee, the
purpose of the payment, and the account to be charged for the payment. Each voucher should be
signed by the custodian and by the person receiving the cash. The vouchers should be numbered
consecutively so that all vouchers can be accounted for. At any time, the sum of the current
vouchers and the unused cash should equal the original amount of the fund.
a. Petty Cash Voucher: a form used to reflect payments from the petty cash fund
b. Source Documents: the first record of a business transaction, such as check stubs, receipts,
sales invoices, purchase invoices, cash register tapes, etc.
3. Petty Cash Payments Record: A special multi-column record that supplements the regular
accounting records.
4. Replenishing the Petty Cash Fund: The petty cash fund should be replenished whenever the
fund runs low and at the end of each accounting period, so that the accounts are brought up to
date. The amount columns of the petty cash payments record are totaled to verify that the total of
the Total Amount column equals the total of the Distribution columns.
F. The Change Fund and Cash Short and Over
1. Establishing and Operating the Change Fund: The journal entries for establishing and
maintaining a change fund are very similar to the ones just used for petty cash.
2. Cash Short and Over: a special ledger account which is used to keep track of unexplained
shortages or overages of cash

VIII. Chapter 8
Payroll Accounting: Employee Earnings and
Deductions
A. Employees and Independent Contractors: the distinction between an employee and an
independent contractor is important for payroll purposes. Government laws and regulations
regarding payroll are much more complex for employees than independent contractors.
1. Employee: one who is under the control and direction of an employer with regard to the
performance of employment
2. Employer: a person or company that provides a job, paying wages or a salary to one or more
people. Must deduct certain taxes, maintain payroll records and file numerous reports for all
employees
3. Independent Contractor: any person who agrees to perform a service for a fee and who is
not subject to the control of those for whom the service is performed
B. Employee Earnings and Deductions: 3 steps are required to determine how much to pay an
employee for a pay period
1. Salaries and Wages: Compensation for managerial or administrative services is usually called
SALARY, which is expressed in bi-weekly, monthly, or annual terms. Compensation for skilled
or unskilled labor is referred to as wages, which are expressed in terms of hours, weeks or units
produced.
a. Fair Labor Standards Act (FLSA): requires employers to pay overtime at 1.5 times the
regular rate to any hourly employee who works over 40 hours a week.
(1) Salary: generally considered to be compensation for managerial or administrative services,
expressed in terms of a month or year
(2) Wage: a form of compensation usually for skilled and unskilled labor, expressed in terms of
hours, weeks or pieces completed
b. Minimum Wage Standard: Minimum wage one can pay their employees, California its
$16.00.
2. Computing Total Earnings: Compensation usually is based on the time worked during the
payroll period. Sometimes it is based on sales or units of output during the period. When
compensation is based on time, a record must be kept of the time worked by each employe.
a. Gross Pay Calculation:
Regular hours 40 hours a week + overtime hours (1.5) + double time = total hours worked
b. Overtime Pay Calculation: time and a half (1.5) of hourly rate.

3. Deductions from Total Earnings: An employee’s total earnings are called gross pay. Various
deductions are made from gross pay to yield take-home or net pay. Deductions from gross pay
fall into three major categories:
i. Federal (and possibly state and city) income tax withholding.: Withholding is the portion of
an employee's wages that is not included in their paycheck but is instead remitted directly to
federal tax authorities and, where applicable, state and local tax authorities.
ii. Employee FICA tax withholding: FICA stands for the Federal Insurance Contributions Act
and requires employers to withhold three separate taxes from an employee's gross earnings: 6.2%
Social Security tax, 1.45% Medicare tax, and 0.9% Medicare surtax.
iii. Voluntary deductions: are amounts which an employee has elected to have subtracted from
gross pay. Examples are group life insurance, healthcare and/or other benefit deductions, Credit
Union deductions, etc.
a. Mandatory Deductions: are subtracted from an employee's gross pay based on established
rates as well as employee requests for voluntary deductions. For payroll purposes, deductions are
divided into two types: Voluntary deductions. Involuntary (mandatory) deductions: taxes,
garnishments, and fines.
(1) Income Tax Withholding: Federal law requires employers to withhold certain amounts from
the total earnings of each employee. These withholdings are applied toward the payment of the
employee’s federal income tax.
(a) Withholding Allowance: A specific dollar amount of an employee’s gross pay that is exempt
from federal income tax withholding
(b) Wage-Bracket Method: a method of determining the amount to withhold from an
employee’s gross pay for a specific time period. Wage bracket tables are provided by the Internal
Revenue Service
(c) Federal Income Tax: is a progressive tax on an employee's income imposed by the federal
government. Federal Income Tax Extended Definition. Federal income tax is a tax on income
and is imposed by the U.S. federal government.
(d) State Income Tax: is a direct tax levied by a state on income earned in or from the state. In
your state of residence, it may mean all your income earned anywhere. Like federal tax, state
income tax is self-assessed, which means taxpayers file required state tax returns.
(2) Employee F.I.C.A. Tax Withholding: The Federal Insurance Contributions Act requires
employers to withhold FICA taxes from employees’ earnings. FICA taxes include amounts for
both Social Security and Medicare programs. Social Security provides pensions and disability
benefits. Medicare provides health insurance.
(a) Social Security: 6.2%, provides benefits for pensions and disability
(b) Medicare: 1.45%, provides benefits for health insurance
b. Voluntary Deductions: depend on specific agreements between the employee and employer.
U.S. savings bond purchases; health insurance premiums; credit union deposits; pension plan
payments; charitable contributions
(1) Court-Ordered Deductions
(a) Garnishment: a court-ordered method of debt collection in which a portion of a person's
salary is paid to a creditor.
(b) Settlement: An account settlement generally refers to the payment of an outstanding balance
that brings the account balance to zero. It can also refer to the completion of an offset process
between two or more parties in an agreement, whether a positive balance remains in any of the
accounts.
(c) Child Support: is the amount of money that a court tells a parent to pay every month. This
money is to help pay for the children's living expenses. Usually, child support is paid to the
person primarily caring for the children.
(d) Alimony: refers to a periodic predetermined sum awarded to a spouse or former spouse
following a separation or divorce.
(2) Insurance Premiums: is the amount of money an individual or business must pay for an
insurance policy. Insurance premiums are paid for policies that cover healthcare, auto, home, and
life insurance.
(3) Savings Plans: An insurance premium is the amount of money an individual or business
must pay for an insurance policy. Insurance premiums are paid for policies that cover healthcare,
auto, home, and life insurance.
(4) Charitable Donations: An account settlement generally refers to the payment of an
outstanding balance that brings the account balance to zero. It can also refer to the completion of
an offset process between two or more parties in an agreement, whether a positive balance
remains in any of the accounts.

(5) Dues: Regular fees or charges often paid to an organization at regular intervals.
4. Computing Net Pay: To compute an employee’s net pay for the period, subtract all tax
withholdings and voluntary deductions from the gross pay
C. Payroll Records: Payroll records should provide the following information for each
employee:
* Name, address, occupation, Social Security number, marital status, and number of withholding
allowances.
* Gross amount of earnings, date of payment, and period covered by each payroll.
* Gross amount of earnings accumulated for the year.
* Amounts of taxes and other items withheld.
1. Payroll Register: A form used to assemble the data required at the end of each payroll period.
2. Paying Employees: Employees should be paid by check or by direct deposit. Data needed to
prepare a paycheck for each employee is contained in the payroll register. In a computer-based
system, the paychecks and payroll register normally are prepared at the same time. The employer
furnishes an earnings statement to each employee along with each paycheck.
3. Payroll Check: the employee should detach the stub and keep it for his records.
4. Employee Earnings Record: A separate record of each employee’s earnings.
D. Accounting for Employee Earnings and Deductions
1. Journalizing Payroll Transactions:
2. Wages and Salaries Expense: This account is debited for the gross pay of all employees for
each pay period. Sometimes separate expense accounts are kept for the employees of different
departments. Thus, separate accounts may be kept for Office Salaries Expense, Sales Salaries
Expense, and Factory Wages Expense.
3. Employee Federal Income Tax Payable: This account is credited for the total federal income
tax withheld from employees’ earnings. The account is debited for amounts paid to the IRS.
When all of the income taxes withheld have been paid, the account will have a zero balance. A
state or city income tax payable account is used in a similar manner.
4. Social Security and Medicare Taxes Payable: Income, Social Security, and Medicare taxes
are withheld from earnings when employees are paid. Thus, when wages and salaries are accrued
at year end, these tax liabilities are not accrued.
These accounts are credited for (1) the Social Security and Medicare taxes withheld from
employees’ earnings and (2) the Social Security and Medicare taxes imposed on the employer.
The accounts are debited for amounts paid to the IRS. When all of the Social Security and
Medicare taxes have been paid, the accounts will have zero balances.

5. Other Deductions: Health Insurance Premiums Payable are credited for health insurance
contributions deducted from an employee’s pay. The account is debited for the subsequent
payment of these amounts to the health insurer. United Way Contributions Payable is handled in
a similar manner.
E. Payroll Record-Keeping Methods
1. Manual System: Payroll system in which all records are prepared by hand.
2. Electronic System: a computer system based on a software package that performs all payroll
record keeping and prepares payroll checks
3. Payroll Processing Center: a business that sells payroll record-keeping services. The
employer provides the center with all basic employee data and each period’s report of hours
worked. The processing center maintains all payroll records and prepares each period’s payroll
checks. Payroll processing center fees tend to be much less than the cost to an employer of
handling payroll internally.

IX. Chapter 9
Payroll Accounting: Employer Taxes and
Reports
A. Employer Payroll Taxes: Most employers must pay FICA, FUTA (Federal Unemployment
Tax Act), and SUTA (state unemployment tax) taxes.
1. Employer FICA Taxes: taxes levied on employers at the same rates and on the same earnings
bases as the employee FICA taxes
2. Self-Employment Tax: The self-employment tax rate is double the employee and employer
Social Security and Medicare rates because the self-employed person is considered both the
employer and employee.
3. Employer FUTA Tax: is levied only on employers. It is not deducted from employees’
earnings. The purpose of this tax is to raise funds to administer the combined federal/state
unemployment compensation program.
4. SUTA Tax: is also levied only on employers in most states. The purpose of this tax is to raise
funds to pay unemployment benefits. Tax rates and unemployment benefits vary among the
states.
B. Accounting for Employer Payroll Taxes: Now that we have computed the employer payroll
taxes, we need to journalize them. It is common to debit all employer payroll taxes to a single
account—Payroll Taxes Expense. However, we usually credit separate liability accounts for
Social Security, Medicare, FUTA, and SUTA taxes payable.

1. Journalizing Employer Payroll Taxes:

2. Payroll Taxes Expense: The Social Security, Medicare, FUTA, and SUTA taxes imposed on
the employer are expenses of doing business. Each of the employer taxes is debited to Payroll
Taxes Expense.
3. Social Security and Medicare Taxes Payable: These are the same liability accounts used to
record the Social Security and Medicare taxes withheld from employees’ earnings. The accounts
are credited to the Social Security and Medicare taxes imposed on the employer. They are
debited when the taxes are paid to the IRS. When all of the Social Security and Medicare taxes
have been paid, the accounts will have zero balances.
4. FUTA Tax Payable: A separate liability account entitled FUTA Tax Payable is kept for the
employer’s FUTA tax. This account is credited for the tax imposed on employers under the
Federal Unemployment Tax Act. The account is debited when this tax is paid. When all of the
FUTA taxes have been paid, the account will have a zero balance.
5. SUTA Tax Payable: A separate liability account entitled SUTA Tax Payable is kept for the
state unemployment tax. This account is credited for the tax imposed on employers under the
state unemployment compensation laws. The account is debited when this tax is paid. When all
of the state unemployment taxes have been paid, the account will have a zero balance.
6. Total Payroll Cost of an Employee: The employer must, of course, pay the gross wages of an
employee. In addition, the employer must pay payroll taxes on employee earnings up to certain
dollar limits.
C. Reporting and Payment Responsibilities: Employer payroll reporting, and payment
responsibilities fall into six areas:
1. Federal income tax withholding and Social Security and Medicare taxes
2. FUTA taxes: is an unemployment tax that is charged to employers. The FUTA acronym
is short for the Federal Unemployment Tax Act. The amounts paid in by employers go
into a federal fund that pays the cost of administering the unemployment insurance and
job service programs in all states.
3. SUTA taxes: The State Unemployment Tax Act (SUTA) tax is a type of payroll tax that
states require employers to pay. SUTA was established to provide unemployment benefits
to displaced workers. States use funds to pay out unemployment insurance benefits to
unemployed workers.
4. Employee Wage and Tax Statement (Form W-2): Form W-2, also known as the Wage
and Tax Statement, is the document an employer is required to send to each employee
and the Internal Revenue Service (IRS) at the end of the year. A W-2 reports employees'
annual wages and the amount of taxes withheld from their paychecks.
5. Summary of employee wages and taxes (Form W-3): is a tax form used by employers
to report combined employee income to the Internal Revenue Service (IRS) and the
Social Security Administration. Employers who send out more than one Form W-2 to
employees must complete and send this form to summarize their total salary payment and
withholding amounts.
6. Employment eligibility verification (Form I-9): Employment eligibility verification
(Form I-9)
Most federal tax deposits are made using the EFTPS. In addition, two forms are needed in
reporting and paying employer payroll taxes:
1. Form 941, Employer’s Quarterly Federal Tax Return
2. Form 940, Employer’s Annual Federal Unemployment Tax Return: is a form
employers must file annually with the IRS. Form 940 Extended Definition. All businesses
with that paid wages of at least $1,500 during the year or had an employee work anytime
during 20 or more weeks must file Form 940.
By January 31 of each year, employers must provide each employee with a Wage and Tax
Statement, Form W-2.
By January 31 of each year, employers must file Form W-3 and Copy A of Forms W-2 with the
Social Security Administration.
1. Federal Income Tax Withholding and Social Security and Medicare Taxes: Three
important aspects of employer reporting and payment responsibilities for federal income tax
withholding and Social Security and Medicare taxes are as follows:
i. Determining when payments are due.
ii. Use of electronic funds transfer to make federal tax deposits.
iii. Use of Form 941, Employer’s Quarterly Federal Tax Return
2. FUTA Taxes: Federal Unemployment Tax Act; a tax levied on employers to raise funds to
administer the federal/state unemployment program; Federal unemployment taxes must be
calculated on a quarterly basis. If the accumulated liability exceeds $500, the total must be
deposited by the end of the month following the close of the quarter. If the liability is $500 or
less, no deposit is necessary. The amount is simply added to the amount to be deposited for the
next quarter. FUTA taxes are deposited using an electronic funds transfer, usually EFTPS.
3. SUTA Taxes: State Unemployment Tax Act; a tax levied on employers to raise funds to pay
unemployment benefits; Deposit rules and forms for state unemployment taxes vary among the
states. Deposits usually are required on a quarterly basis.
4. Employee Wage and Tax Statement: By January 31 of each year, employers must furnish
each employee with a Wage and Tax Statement, Form W-2. This form shows the total amount of
wages paid to the employee and the amounts of taxes withheld during the preceding taxable year.
The employee earnings record contains the information needed to complete this form.
5. Summary of Employee Wages and Taxes: Employers send Form W-3, Transmittal of Wage
and Tax Statements, with Copy A of Forms W-2 to the Social Security Administration. Form W-3
must be filled by January 31 following the end of each taxable year. This form summarizes the
employee earnings and tax information presented on Forms W-2 for the year. Information needed
to complete Form W-3 is contained in the employee earnings records.
6. Employment Eligibility Verification: Every employee hired after November 6, 1986, must
complete Form I-9, Employment Eligibility Verification. The purpose of this form is to document
that each employee is authorized to work in the United States. The employee completes Section
1 of the form and provides the employer with evidence of the employee’s identity and
authorization to work. The employer completes Section 2 of the form indicating what evidence
the employer examined.
7. Summary of Taxes, Reports, and Payments:
Undeposited FIT (federal income tax) and Social Security and Medicare taxes of $2,500 at the
end of each quarter and less than $50,000 during the lookback period.
Undeposited FUTA taxes of more than $500 at the end of each quarter
SUTA taxes deposited quarterly.
The combination of payroll taxes, reports, deposit rules, and due dates can make payroll
accounting rather complex. In fact, this is a major reason why small businesses often hire an
accountant or an outside company to handle payroll.
D. Workers’ Compensation Insurance: insurance carried out by employers for employees who
suffer a work-related illness or injury.

MIDTERM CHECKPOINT

X. Chapter 10
Accounting for Sales and Cash Receipts
A. Merchandise Sales Transactions: the seller sells a product and transfers the legal ownership
(title) of the goods to the buyer. A business document called an invoice (a sales invoice for the
seller and a purchase invoice for the buyer) becomes the basis for recording the sale.
1. Retailer: a person or business that sells goods to the public in relatively small quantities for
use or consumption rather than for resale.
2. Wholesaler: a person or company that sells goods in large quantities at low prices, typically to
retailers.
3. Manufacturer: A manufacturer is a person or company that produces finished goods from raw
materials by using various tools, equipment, and processes, and then sells the goods to
consumers, wholesalers, distributors, retailers, or to other manufacturers for the production of
more complex goods
4. Credit Memorandum: a document issued when credit is given for merchandise returned or
for an allowance
a. Sales Returns: merchandise returned by a customer for a refund.
b. Sales Allowances: reductions in the price of merchandise granted by the seller because of
defects or other problems with the merchandise.
5. Cash Discount: discounts to encourage prompt payment by the customers who buy
merchandise on account
6. Bank Credit Card Expenses: with respect to any Property, authorized expenses relating to
the day-to-day operation of such Property which expenses are charged by any local on-site
administrator or staff of such Property on any charge card provided to such local on-site
administrator or staff by the Manager of such
a. Vendor Credit Card Expenses: A credit card vendor is a lending institution or a third-party
payment processor that handles credit card processing.
b. Consumer Credit Card Expenses: Credit card means any card, plate, coupon book, or other
credit device existing for the purpose of obtaining money, property, labor, or services on credit.
Consumer account means an account established primarily for personal, family, or household
use.
B. Merchandise Sales Accounts: Merchandising refers to the marketing and sales of products.
Merchandising is most often synonymous with retail sales, where businesses sell products to
consumers. Merchandising, more narrowly, may refer to the marketing, promotion, and
advertising of products intended for retail sale.
1. Sales Account: A sales account contains the record of all sales transactions. This includes both
cash sales and credit sales. The account total is then paired with the sales returns and allowances
account to derive the net sales figure that is listed at the top of the income statement. The sales
account concept can also refer to a current customer. Once sales are made to a customer, it is
known as a sales account.
2. Sales Tax Payable Account: is a liability account in the balance sheet that keeps track of the
sales tax collected from the customers on behalf of the governing tax authority.
3. Sales Returns and Allowances Account: are refunds or credits given to customers for
returned products or products that they are allowed to keep without full payment. Sales returns
and allowances are deducted from sales revenue when net sales are calculated.
4. Sales Discounts Account: are taken as contra revenue accounts. It is a reduction of gross sales
which correspondingly causes a decrease in the net sales figure.
C. Journalizing and Posting Sales and Cash Receipts Transactions: The sales journal is used
to record receivables, such as credit sales for goods and/or services. Cash transactions are
recorded in a receipts journal used to record transactions paid in cash. The sales journal is a sub-
journal used to record detailed sales transactions from the general ledger.
1. Sales Journal: is a manual accounting system used to store the summary of invoices issued to
customers. The sales journal is used to record receivables, such as credit sales for goods and/or
services. Cash transactions are recorded in a receipts journal used to record transactions paid in
cash.
2. Posting Sales to the General Ledger: involves recording detailed accounting transactions in
the general ledger. It involves aggregating financial transactions from where they are stored in
specialized ledgers and transferring the information into the general ledger.
3. Posting Sales to the Accounts Receivable Ledger: The accounts receivable ledger is a
subledger in which is recorded all credit sales made by a business. It is useful for segregating
into one location a record of all amounts invoiced to customers, as well as all credit memos and
(more rarely) debit memos issued to them, and all payments made against invoices by them.
a. Subsidiary Ledger: a separate ledger made up of individual accounts that contain the details
for a controlling account.
b. Controlling Account: a summary account maintained in the general ledger with a subsidiary
ledger (for example, the accounts receivable ledger)
4. Sales Returns and Allowances: are refunds or credits given to customers for returned
products or products that they are allowed to keep without full payment. Sales returns and
allowances are deducted from sales revenue when net sales are calculated.
5. Cash Receipts Journal: is used to record all cash receipts of the business. All cash received
by a business should be reported in the accounting records. In a cash receipts journal, a debit is
posted to cash in the amount of money received. An additional posting must be made to
balancing the transaction.
6. Journalizing Cash Receipts: used to record all cash receipts of the business. All cash
received by a business should be reported in the accounting records. In a cash receipts journal, a
debit is posted to cash in the amount of money received. An additional posting must be made to
balancing the transaction.
7. Posting Cash Receipts to the General Ledger and Accounts Receivable Ledger: A cash
receipts journal is a record of financial transactions that includes bank deposits and withdrawals
as well as all cash payments and receipts. The general ledger account is then updated with the
cash receipts journal entries. A cash receipts journal is also known as a specialized accounting
journal.
D. Schedule of Accounts Receivable: an alphabetical or numerical listing of customer accounts
and balances, usually prepared at the end of the month.
XI. Chapter 11
Accounting for Purchases and Cash
Payments
A. Merchandise Purchases Transactions: Within accounting, merchandise is considered a
current asset because it's usually expected to be liquidated (sold, turned into cash) within a year.
When purchased, merchandise should be debited to the inventory account and credited to cash or
accounts payable, depending on how the merchandise was paid for.
1. Purchase Requisition: an internal form sent to the purchasing department to request the
purchase of merchandise or other property
2. Purchase Order: a written order to buy goods from a specific vendor (supplier)
3. Receiving Report and Purchase Invoice: A report is a document that indicates the quantity
of goods received. This report is often matched in the accounts payable department with the
purchase order and the vendor's invoice prior to paying.
A purchase invoice is a document that specifies the products or services purchased by a
customer and the corresponding cost. The invoice is sent to the buyer after the purchase has been
made and is matched to the corresponding purchase order before payment is issued.
4. Cash and Trade Discounts: Essentially, trade discounts are discounts given to customers by
manufacturers or wholesalers in order to improve sales volume, whereas cash discounts are given
to customers by sellers in order to increase cash flow. If a customer pays for items with cash, he
or she can take advantage of both trade and cash discounts.
a. Cash Discount: refer to an incentive that a seller offers to a buyer in return for paying a bill
before the scheduled due date. In a cash discount, the seller will usually reduce the amount that
the buyer owes by either a small percentage or a set dollar amount.
b. Trade Discount: a reduction from the list or catalog price offered to different classes of
customers.
B. Merchandise Purchases Accounts
1. Purchases Account: an account in the purchase ledger where money spent on goods and
services in a particular period is recorded on the debit side: New inventory purchases are
recorded in the purchases account.
2. Purchases Returns and Allowances Account: is an account that is paired with and offsets the
purchases account in a periodic inventory system. The account contains deductions from
purchases for items returned to suppliers, as well as deductions allowed by suppliers for goods
that are not returned.
3. Purchases Discounts Account: Companies that take advantage of sales discounts usually
record them in an account named purchases discounts, which is another contra‐expense account
that is subtracted from purchases on the income statement.
4. Freight-In Account: Freight in describes the cost incurred by a business for shipping raw
materials or goods into their storage facility or production. It is a direct expense incurred as part
of the business' daily operation and recorded as a debit in the inventory records.
5. Computation of Gross Profit: Gross profit—also known as sales profit or gross income—is
measured by subtracting the cost of goods sold (COGS) from the revenue made from sales. It's
an easy formula that should help you measure the value your goods and services bring to your
business.
a. Net Sales: Net sales is the sum of a company's gross sales minus its returns, allowances, and
discounts. Net sales calculations are not always transparent externally. They can often be
factored into the reporting of top line revenues reported on the income statement.
b. Cost of Goods Sold: (COGS) is the cost of acquiring or manufacturing the products that a
company sells during a period, so the only costs included in the measure are those that are
directly tied to the production of the products, including the cost of labor, materials, and
manufacturing overhead.
(1) Beginning Inventory: Beginning inventory is the total monetary value of items that are in
stock and ready to use or sell at the start of an accounting period. Also called opening inventory,
beginning inventory matches the previous accounting period's ending inventory.
(2) Net Purchases: refer to the total cost of all purchases made by a business over a specified
period, after deducting any purchase returns, allowances, and discounts. Purchase returns are
goods that are sent back to the supplier because they were damaged or incorrect.
(3) Cost of Goods Available for Sale: the cost of the raw materials and labor used to
manufacture goods that a company has that are finished and ready and available to be sold. When
the cost of goods purchased is added to beginning inventory, the result is the cost of goods
available for sale.
(4) Ending Inventory: known as closing inventory, is the value of goods that a company has
available for sale at the end of a given accounting period
c. Gross Margin: The portion of a company's revenue left over after direct costs are subtracted.
Gross margin is one of the most important indicators of a company's financial performance. It's
the portion of business revenue left over after you subtract direct costs, such as labor and raw
materials.
C. Journalizing and Posting Purchases and Cash Payments Transactions
1. Purchases Journal: A purchase journal is a special form of accounting log used by a company
to track and record orders and purchases. Once an order has been received, a company (assisted
by an invoice document) will post the transaction to the purchase log.
2. Posting Purchases to the General Ledger: Purchases Ledger is a Ledger that records all
transactions related to purchases that your business entity makes. In other words, Purchase
Ledger records all the transactions taking place between you and your suppliers.
3. Posting Purchases to the Accounts Payable Ledger: When a company purchases goods on
credit which needs to be paid back in a short period of time, it is known as Accounts Payable. It
is treated as a liability and comes under the head 'current liabilities'. Accounts Payable is a short-
term debt payment which needs to be paid to avoid default.
The Purchase Ledger: is your record of your purchases and expenses, whether or not you have
paid them and how much you still owe. On a Balance Sheet, the total unpaid bills will usually be
called Trade Creditors or Accounts Payable. The Purchase Ledger has an Account for every
Supplier.
4. Purchases, Returns and Allowances: is a contra account to purchases since it reduces
purchases by the number of returns and allowances. In purchase returns, a customer purchases a
defective product and returns it to the seller for a full or partial refund.
5. Cash Payments Journal: also called a cash disbursement journal, is a cash record of all
transactions paid with cash by a firm. The cash payments journal tracks all credit transactions to
cash, meaning all cash payments made by the firm that decreases the balance in the cash account.
6. Posting Cash Payments to the General Ledger and Accounts Payable Ledger: Cash
posting involves moving transaction data from various sub-ledgers or journals to the company's
general ledger. It's done when a business collects many transaction records, like expenses, sales,
accounts receivable (AR), and accounts payable (AP).
D. Schedule of Accounts Payable: an alphabetical or numerical listing of supplier accounts and
balances, usually prepared at the end of the month.
XII. Chapter 12
Special Journals
A. Special Journals: a journal designed for recording only certain kinds of transactions.
B. Sales Journal: a special journal used to record only sales of merchandise on account.
1. Types of Transactions:
* Sales in cash and credit to customers.
* Receipt of cash from a customer by sending an invoice.
* Purchase of fixed assets and movable assets.
* Borrowing funds from a creditor.
* Paying off borrowed funds from a creditor.
* Payment of cash to a supplier from a sent invoice
2. Posting from the Sales Journal: Posting in accounting refers to moving a transaction entry
from a journal to a general ledger, which contains all of a company's financial accounts. A
journal's entries are chronological while a ledger compiles its transactions by accounts, such as
assets or liabilities.
A sales journal is a specialized accounting journal, and it is also a prime entry book used in an
accounting system to keep track of the sales of items that customers(debtors) have purchased on
account by charging a receivable on the debit side of an accounts receivable account and
crediting revenue on the credit side.
C. Cash Receipts Journal: a special journal used to record only cash receipts transactions.
1. Types of Transactions
* Sales in cash and credit to customers.
* Receipt of cash from a customer by sending an invoice.
* Purchase of fixed assets and movable assets.
* Borrowing funds from a creditor.
* Paying off borrowed funds from a creditor.
* Payment of cash to a supplier from a sent invoice
2. Posting from the Cash Receipts Journal: A cash receipts journal is used to record all cash
receipts of the business. All cash received by a business should be reported in the accounting
records. In a cash receipts journal, a debit is posted to cash in the amount of money received. An
additional posting must be made to balancing the transaction.
D. Purchases Journal: is a special form of accounting log used by a company to track and
record orders and purchases. Once an order has been received, a company (assisted by an invoice
document) will post the transaction to the purchase log.
1. Types of Transactions
* Sales in cash and credit to customers.
* Receipt of cash from a customer by sending an invoice.
* Purchase of fixed assets and movable assets.
* Borrowing funds from a creditor.
* Paying off borrowed funds from a creditor.
* Payment of cash to a supplier from a sent invoice
2. Posting from the Purchases Journal: The amounts from the purchases journal are posted as
credits to individual suppliers' accounts in the accounts payable subsidiary ledger. This posting
occurs immediately after an entry has been made in the purchases journal.
E. Cash Payments Journal: a special journal used to record only cash payments transactions.
1. Types of Transactions
* Sales in cash and credit to customers.
* Receipt of cash from a customer by sending an invoice.
* Purchase of fixed assets and movable assets.
* Borrowing funds from a creditor.
* Paying off borrowed funds from a creditor.
* Payment of cash to a supplier from a sent invoice
2. Posting from the Cash Payments Journal: In summary, cash posting is the process of
recording received payments in the company's accounting system and linking them to the correct
customer accounts and invoices.
XIII. Chapter 13
Accounting for Merchandise Inventory
A. The Impact of Merchandise Inventory on Financial Statements: Merchandise inventory is
reported as a current asset on a retailer's balance sheet. A current asset is one that will provide an
economic benefit during a given accounting period, typically a year. Merchandise inventory
qualifies because it is expected to be sold during a fiscal or calendar year.
B. Types of Inventory Systems: Periodic and Perpetual: The periodic inventory system uses
an occasional physical count to measure the level of inventory and the cost of goods sold. The
perpetual system keeps track of inventory balances continuously, with updates made
automatically whenever a product is received or sold.
C. Assigning Cost to Inventory and Cost of Goods Sold: Cost of Goods Sold = Beginning
Inventory + Purchases – Ending Inventory. Based on the above, we see how an inventory error
(where either beginning or ending inventory is. over or under-stated), can affect both the income
statement and balance sheet by distorting.
1. Taking a Physical Inventory: a physical count of the goods on hand
2. The Periodic Inventory System: under this system, the ending inventory and cost of goods
sold are determined at the end of the accounting period, when a physical inventory
a. Specific Identification Method: a method of allocating merchandise cost in which each unit
of inventory is specifically identified.
b. First-In, First-Out Method (FIFO): a method of allocating merchandise cost which assumes
that the first goods purchased were the first goods sold and therefore, that the latest goods
purchased remain.
c. Weighted Average Method: a method of allocating merchandise cost based on the average
cost of identical units. The average cost of identical units is determined by dividing the total cost
of units available for sale by the total number of units available for sale.
d. Last-In, First-Out Method (LIFO): a method of allocating merchandise cost which assumes
that the sales in the period were made from the most recently purchased goods. Therefore, the
earliest goods purchased remain in inventory.
3. The Perpetual Inventory System: under this system, the merchandise inventory and cost of
goods sold accounts are updated when merchandise is bought and sold
4. Lower-of-Cost-or-Market Method of Inventory Valuation: an inventory valuation method
under which inventory is valued
D. Estimating Ending Inventory and Cost of Goods Sold: Ending inventory is calculated by
adding the period's net purchases to the beginning inventory, then subtracting cost of goods sold
(COGS). Although all methods for calculating ending inventory use this formula, they calculate
COGS in different ways and may yield different values for ending inventory.
1. Gross Profit Method of Estimating Inventory: a method of estimating inventory in which a
business’s normal gross profit percentage is used to estimate the cost of goods sold and ending
inventory
2. Retail Method of Estimating Inventory: a variation of gross profit method that is used by
many retail businesses, such as department and clothing stores, estimate the cost of goods sold
and ending inventory

XIV. Chapter 14
Adjustments and the Work Sheet for a
Merchandising Business
A. Adjustment for Merchandise Inventory: Periodic Inventory System; Periodic Inventory
System- At period end, enter a four-line adjustment: Credit the inventory account for the value of
beginning inventory. Credit the balance in the inventory purchases account. Debit inventory for
its ending value.
B. Adjustment for Unearned Revenue: Once the performance of an obligation has been
satisfied relating to unearned revenues then an adjustment needs to be recorded. The adjustment
records a decrease in liabilities by debiting unearned revenue and an increase to revenues by
crediting sales or service revenue.
1. Expanded Chart of Accounts
2. Listed as a Liability on Balance Sheet
C. Preparing a Work Sheet for a Merchandising Business
1. Adjustments for Northern Micro
2. Preparing a Work Sheet for Northern Micro
D. Adjusting Entries: Adjusting entries refers to a set of journal entries recorded at the end of
the accounting period to have an updated and accurate balance of all the accounts. Adjusting
entries are mere application of the accrual basis of accounting.
E. Adjusting Entries Under the Perpetual Inventory System: The perpetual inventory method
has ONE additional adjusting entry at the end of the period. This entry compares the physical
count of inventory to the inventory balance on the unadjusted trial balance and adjusts for any
difference. The difference is recorded into cost of goods sold and inventory.

XV. Chapter 15
Financial Statements and Year-End Accounting for a
Merchandising Business
A. The Income Statement: The income statement shows a company's expense, income, gains,
and losses, which can be put into a mathematical equation to arrive at the net profit or loss for
that time period. This information helps you make timely decisions to make sure that your
business is on a good financial footing.
1. Single-Step Income Statement: this statement lists all revenue items and their total first,
followed by all expense items and their total
2. Multiple-Step Income Statement: this statement shows a step-by-step calculation of net
sales, cost of goods sold, gross profit, operating expenses, income from operations, other
revenues and expenses, and net income.
a. Income from Operations: gross profit minus operating expenses on a multiple-step income
statement.
b. Other Income: Other income is income that does not come from a company's main business,
such as interest. Examples of other income include income from interest, rent, and gains
resulting from the sale of fixed assets. Companies present other income in a separate section
before income from operations.
c. Other Expenses: Other expenses are expenses that do not relate to a company's main
business. As well as operating costs, the company needs to consider other expenses including
interest expenses and losses from the disposing of fixed assets. Examples of other expenses
include interest expense and losses from disposing of fixed assets.
B. The Statement of Owner’s Equity: A statement of owner's equity is a one-page report
showing the difference between total assets and total liabilities, resulting in the overall value of
owner's equity. Tracked over a specific timeframe or accounting period.
C. Balance Sheet: a statement of the assets, liabilities, and capital of a business or other
organization at a particular point in time, detailing the balance of income and expenditure over
the preceding period.
1. Current Assets: cash and all other assets expected to be converted into cash or consumed
within one year or the normal operating cycle of the business, whichever is longer
2. Property, Plant, and Equipment: assets that are expected to be used for more than one year
in the operation of a business
a. Plant Assets: Plant assets, also known as fixed assets, are any asset directly involved in
revenue generation with a useful life greater than one year. Named during the industrial
revolution, plant assets are no longer limited to factory or manufacturing equipment but also
include any asset used in revenue production.
b. Long-Term Assets: Long-term assets are investments in a company that will benefit the
company for many years. Long-term assets can include fixed assets such as a company's
property, plant, and equipment, but can also include intangible assets, which can't be physically
touched such as long-term investments or a company's trademark.
3. Current Liabilities: those obligations that are due within one year or the normal operating
cycle of business, whichever is longer, and will require the use of current assets.
4. Long-Term Liabilities: those obligations that will extend beyond one year or the normal
operating cycle, whichever is longer
5. Owner’s Equity: is the owner's investment in an asset after they deduct any liabilities. It's the
difference between the number of assets and the value of liabilities that allows the owner to
know what they own after paying off debts. Owner's equity is also called net worth or net assets.
D. Financial Statement Analysis: is the process of analyzing a company's financial statements
for decision-making purposes. External stakeholders use it to understand the overall health of an
organization and to evaluate financial performance and business value.
1. Balance Sheet Analysis: refers to the company's assets, liabilities, and owner's capital
analysis. It is performed by various stakeholders to obtain an accurate financial business position
at a specific period.
a. Current Ratio: The current ratio is a liquidity ratio that measures a company's ability to pay
short-term obligations or those due within one year. It tells investors and analysts how a
company can maximize the current assets on its balance sheet to satisfy its current debt and other
payables.
b. Quick Ratio: quick assets divided by current liabilities.
2. Interstatement Analysis: compares the relationship between certain amounts in the income
statement and balance sheet.
a. Return on Owner’s Equity: net income divided by average owners’ equity.
b. Accounts Receivable Turnover: the number of times the accounts receivable turned over, or
were collected, during the accounting period. When 365 is divided by the turnover, this measure
can be expressed in terms of the average number of days required to collect receivables.
c. Inventory Turnover: the number of times the merchandise inventory turned over, or was sold,
during the accounting period. When 365 is divided by the turnover this measure can be expressed
in terms of the average number of days required to sell inventory
E. Closing Entries: is a journal entry made at the end of accounting periods that involves
shifting data from temporary accounts on the income statement to permanent accounts on the
balance sheet.
1. Post-Closing Trial Balance: is the final trial balance prepared before the new accounting
period begins. It is a complete list of the balance sheet accounts that have a non-zero balance at
the end of your reporting period.
2. Reversing Entries: are accounting journal entries you make in a certain period to reverse, or
cancel out, some entries of a previous accounting period. You can make them at the beginning of
an accounting period, and they usually adjust some entries for accrued expenses and revenues
from the end of the previous period.

Specialized Accounting Procedures for Merchandising Businesses

XVI. Chapter 16
Accounting for Accounts Receivable
A. Uncollectible Accounts Receivable: are receivables, loans, or other debts that have virtually
no chance of being paid. An account may become uncollectible for many reasons, including the
debtor's bankruptcy, an inability to find the debtor, fraud on the part of the debtor, or lack of
proper documentation to prove that debt exists.
1. Bad Debts Expense: Bad debt expense is used to reflect receivables that a company will be
unable to collect. Bad debt can be reported on financial statements using the direct write-off
method or the allowance method. The amount of bad debt expense can be estimated using the
accounts receivable aging method or the percentage sales method.

3. Allowance for Doubtful Accounts: An allowance for doubtful accounts, also known as
bad debt reserve, is money set aside by a company to cover receivables that might not be
paid by their customers over a given time period. It's the total amount receivables the
company never expects to collect.
B. Allowance Method: is an estimate of the amount the company expects will be uncollectible
made by debiting bad debt expense and crediting allowance for uncollectible accounts. If a
specific account becomes uncollectible, it will debit allowance for doubtful accounts and credit
accounts receivable.
1. Net Receivables: are the total money owed to a company by its customers minus the money
owed that will likely never be paid. Net receivables are often expressed as a percentage, and a
higher percentage indicates a business has a greater ability to collect from its customers.
2. Contra Account: is a negative account that is netted from the balance of another account on
the balance sheet. The two most common contra accounts are the allowance for doubtful
accounts/bad debt reserve, which is subtracted from accounts receivable, and accumulated
depreciation, which is subtracted from fixed assets.
C. Estimating and Writing Off Un-collectibles: A write-off is an elimination of an
uncollectible account receivable recorded on the general ledger. An accounts receivable balance
represents an amount due to Cornell University. If the individual is unable to fulfill the
obligation, the outstanding balance must be written off after collection attempts have occurred.
1. Percentage of Sales Method: is a financial forecasting model in which all of a business's
accounts — financial line items like costs of goods sold, inventory, and cash — are calculated as
a percentage of sales. Those percentages are then applied to future sales estimates to project each
line item's future value.
2. Percentage of Receivables Method: estimates uncollectible accounts by determining the
desired size of the Allowance for Uncollectible Accounts. Rankin would multiply the ending
balance in Accounts Receivable by a rate (or rates) based on its uncollectible accounts
experience.
3. Comparison of Methods: measures the closeness of agreement between the measured values
of two methods. Note: The term method is used as a generic term and can include different
measurement procedures, measurement systems, laboratories, or any other variable that you want
to if there are differences between measurements.
4. Write-Off of Uncollectible Accounts: Writing it off means adjusting your books to represent
the real amounts of your current accounts. To write off bad debt, you need to remove it from the
amount in your accounts receivable. Your business balance sheet will be affected by bad debt.
5. Recovery of Accounts Previously Written Off–Allowance Method: occasionally, an
account that was written off is collected
D. Direct Write-Off Method: the bad debt expense is not recognized until it has been
determined that an account is uncollectible.
1. Advantage and Disadvantages of Direct Method: the direct write-off method has one
advantage. It is very simple to apply. However, there are three disadvantages of using this
method. First, efforts to collect the account often extend over many months. Thus, the revenue
from the sale might be recognized in one period and the bad debt expense recognize in another.
This violates the matching principle. Second, the amount of bad debt expense recognized in a
given period can be manipulated by management. This occurs because there is no general rule
for deciding when an account becomes uncollectible. Thus, management can use its subjective
judgment in deciding when to recognize bad debt expense. Third, the amount of accounts
receivable reported on the balance sheet does not represent the net realizable value of the
receivables, the amount of cash actually expected to be collected. Thus, the assets are overstated
by the amount of uncollectible accounts included in accounts receivable. For these reasons, the
direct write-off method is generally not acceptable for financial reporting purposes. It is
acceptable only if the amount of uncollectible accounts cannot be reasonably estimated and if the
estimated amount is very small. This method is required, however , for income tax purposes.
2. Recovery of Accounts Previously Written-Off Direct Write-Off Method: occasionally, an
account that was written off is collected. The proper entries for the recovery depend on the
period in which the cash is collected.

Chapter 17
XVII. Accounting for Notes and Interest
A. The Promissory Note: (usually called a note) is a written promise to pay a specific sum at a
definite future date. Notes are often used when credits are extended for 60 days or more, when
large amounts of money are involved.
1. Principal: sum of money lent or invested, on which interest is paid.
2. Rate: assigned standard or value to something according to a particular scale
3. Time
4. Interest: money paid regularly at a particular rate for the use of money lent, or for delaying
the repayment of a debt
5. Maker: the person or the business agreeing to pay the amount of a note plus interest on the
due date
6. Payee: the specific person or business to whom a note plus interest is payable
B. Calculating Interest and Determining Due Date: to calculate interest on notes, three major
factors are used.
* Principal of the note: the amount the maker promises to pay when the note comes due
* Rate of interest: the rate at which interest is charged on the note
*Term of the note is the months or days from the issue date to the maturity date.
1. Calculating Interest; the principal, interest rate, and time of the note are used in the following
formula to calculate interest:
INTEREST = PRINCIPAL x RATE x TIME
a. Formula for Determining Simple Interest
b. Interest = Principal X Rate X Time
2. Determining the Due Date: the period of time between the issue date and the maturity date of
a note may be stated in either months or days. If the term of the note is stated in the months, the
due date is determined by counting the number of months from, the due date was determined by
counting the number of months from the date the note was issued.
a. Maturity Date: the date when a note will come due.
(1) Banker’s Method
(2) Exact Method
b. Maturity Value: the principal of the note plus interest equals the maturity value. P+I=MV
C. Accounting for Notes Receivable Transactions
1. Note Received from a Customer in Exchange for Assets Sold: when a business makes a
large sale, it may accept a note for the amount of the sale.
2. Note Received from a Customer to Extend Time for Payment: when a customer s account
is due, the customer may issue a note for all or part of the amount
3. Note Collected at Maturity: when a note receivable matures, it may be collected by one of
the following: the payee, the bank named in the note, a bank where it was left for collection
4. Note Renewed at Maturity: if the maker of the note is unable to pay the amount due at
maturity, the payee may allow the maker to renew all or part of the note.
5. Note Discounted Before Maturity: if a business needs cash before the due date of a note, it
can endorse the note and transfer it to a bank
6. Note Dishonored: if the maker of a note does not pay or renew it at maturity, the note is said
to be dishonored
7. Collection of Dishonored Note: the payee records collection of the account receivable,
interest often is charged for the period from the due date of the original note to the final
collection date.
8. Notes Receivable Register: a detailed auxiliary record of notes receivable
9. Accrued Interest Receivable: interest revenue that has been earned but not yet received
D. Accounting for Notes Payable Transactions
1. Note Issued to a Supplier in Exchange for Assets Purchased: when a business makes a
large purchase, it may give a note for the amount of the purchase
2. Note Issued to a Supplier to Extend Time for Payment: when a firm’s account with a
supplier is due, the supplier may be willing to accept a note for all or part
3. Note Issued as Security for Cash Loan: businesses sometimes have brief periods during
which receipts from customers are not adequate to finance operations
4. Note Paid at Maturity: the proper entry to make when a note is paid at maturity depends on
whether the note is interest bearing or non-interest bearing
5. Note Renewed at Maturity: the payee of a note may allow the maker to renew all or part of
the note at maturity
6. Notes Payable Register: when a business issues many notes, it may keep a notes payable
register
7. Accrued Interest Payable: as with notes receivable, it is also necessary to record accrued
interest on notes payable at the end of the period. For notes payable issued in one period and due
in the following period, accrued interest payable must be recorded.
XVIII. Chapter 18
Accounting for Long-Term Assets
A. Acquisition Cost of Property, Plant, and Equipment: the cost of a long-term-asset includes
all amounts spent to acquire the asset and prepare it for its intended use.
1. Land: all cost incurred to purchase land and prepare it for its intended use are debited to the
land account
2. Land Improvements: cost related to land that are not permanent in nature are normally
debited to the land improvements account
3. Buildings: the cost of buildings that are purchased includes the purchase price, realtor and
legal fees, and related taxes on the purchases
4. Equipment: the cost of equipment includes the purchase price, transportation charges,
insurance while in transit, instalation36
5. Treatment of Interest When Acquiring or Constructing Assets: the proper treatment of
interest depends on whether the asset is being purchased or constructed. Often business must
borrow money to buy major long-term assets. The method used to finance the acquisition of an
asset should not affect the cost. Interest incurred while an asset is being constructed should be
included as part of the cost of the asset. Since the asset is not operational during the construction
period, it is not generating revenues against which the interest could be matched.
B. Depreciation: the portion of a plant’s assets’ cost that is recognized as expense.
C. Depreciation Methods:
1. Straight-Line Method: A depreciation method in which the depreciable cost of an asset is
allocated equally over the years of the asset’s useful life
2. Declining-Balance Method: an accelerated depreciation system of recording larger
depreciation expenses during the earlier years of an asset's useful life while recording smaller
depreciation during its later years.
3. Sum-of-the-Years’-Digits Method: an accelerated method for determining an asset's
expected depreciation over time. Depreciation is an accounting technique that involves pairing
the cost of using a tangible asset with the advantage gained over its useful life.
4. Units-of-Production Method: assigns an equal amount of depreciation to each unit of product
manufactured or service rendered by an asset. Since this method of depreciation is based on
physical output, firms apply it in situations where usage rather than obsolescence leads to the
demise of the asset.
5. Depreciation for Federal Income Tax Purposes: the recovery of the cost of the property
over a number of years. You deduct a part of the cost every year until you fully recover its cost
D. Repairs, Maintenance, Additions, Improvements, and Replacements to Plant and
Equipment: Repairs and maintenance are expenses for normal maintenance and upkeep of
capital assets that are necessary to keep the assets in their usual condition. These expenses are
recurring in nature and do not extend the useful life of the asset. For tax filing purposes, repairs
and maintenance fall into the operational expense (OpEx) bucket, while improvements are
classified as capital expenditures (CapEx).
E. Disposal of Plant Assets: the sale, scrapping, demolition, or other loss of plant assets.
1. Discarding or Retiring Plant Assets: When retiring a plant asset from service, a company
removes the asset's cost and accumulated depreciation from its plant asset accounts. The
discarding of a plant asset is disposing of an asset in exchange for no cash but on the other hand
selling of a plant is disposing of an asset in exchange for cash.
2. Selling Plant Assets: often the disposal of a company's equipment (or other asset) that had
been used in the company's business operations.
3. Exchange or Trade-In of Plant Assets: When plant assets are exchanged and loss is
recognized, the new assets are recorded at market value. Debit the loss and new asset and credit
the old asset. When plant assets are exchanged and profit is recognized, the new asset is recorded
at cash paid for new assets plus the net book value of the old asset. A trade of one asset for
another in which the book value of the old asset is removed from the records while the new asset
is recorded at the fair value surrendered (if known); the difference creates a gain or loss to be
reported.
4. Property, Plant, and Equipment Records: Property, Plant, and Equipment (PP&E) is a non-
current, tangible capital asset shown on the balance sheet of a business and is used to generate
revenues and profits.
5. Fully Depreciated Plant Assets: A fully depreciated asset is a property, plant or piece of
equipment (PP&E) which, for accounting purposes, is worth only its salvage value. Whenever an
asset is capitalized, its cost is depreciated over several years according to a depreciation
schedule.
F. Natural Resources: Natural resources represent inventories of raw materials that can be
consumed (exhausted) through extraction or removal from their natural setting (e.g. removing oil
from the ground). When property is purchased, a journal entry assigns the purchase price to the
two assets purchased—the natural resource and the land.
G. Intangible Assets: long-term assets that have no physical substance ( patents, copyrights,
trademarks, franchises and goodwill)
1. Patents: a grant by the federal government to an inventor giving the exclusive right to
produce, use and sell an invention
2. Copyrights: A grant by federal government of the exclusive right to the reproduction and sale
of a literary, artistic or musical composition
3. Trademarks: a symbol or jingle identified with a particular product or company