1 Chapter 2 The Basic Model External events: involve an exchange between the company and a separate economic entity

Internal events: events that do not involve an exchange transaction but do affect the companys financial position The accounting equation Assets =Liabilities + Owners Equity Paid-in capital: invested capital consisting primarily of amounts invested by shareholders when they purchase shares of stock from the corporation Retained Earnings: amounts earned by the corporation on behalf of its shareholders and not (yet) distributed to them as dividends General Ledger: a collection of storage areas, called accounts, used to keep track of increases and decreases in financial position elements In a debits and credits system: debits mean left side, credits right side Permanent accounts: represents assets, liabilities, and shareholders equity at a point in time Temporary accounts: represent changes in the retained earnings component of shareholders equity for a corporation caused by revenue, expense, gain/loss transactions The balances in these accounts are usually zeroed out or closed The accounting processing cycle Steps of the accounting processing cycle: 1. Obtain information about external transactions from source documents 2. Analyze the transaction 3. Record the transaction in a journal 4. Post from the journal to the general ledger accounts 5. Prepare an unadjusted trial balance 6. Record adjusting entries and post to the general ledger accounts 7. Prepare and adjusted trial balance 8. Prepare financial statements 9. Close the temporary accounts to retained earnings 10. Prepare a post-closing trial balance Adjusting entries: internal transactions recorded at the end of any period when financial statements are prepared They are necessary for: 1. Prepayments: occur when the cash flow precedes either expense or revenue recognition Prepaid expenses: the costs of assets acquired in one period and expensed in a future period Example: Supplies$$$ Supplies expense.$$$ When the item is expensed Rent expense$$$ Prepaid rent.$$$ 2. Unearned revenues: created when a company receives cash from a customer in one period for goods or services that are to be provided in a future period Example: Unearned rent revenue Rent revenue Alternative approach to record payments: recording the external transaction directly into an expense or revenue account Example: July 1st Rent expense Cash July 31st Prepaid rent Rent expense Accruals: occur when the cash flow comes after either expense or revenue recognition

2 Chapter 2 Example: a company often uses the services of another entity in one period and pays them in a subsequent period Accrued liabilities: concerned with expense incurred by not yet paid Example: Salaries expense Salaries payable Accrued receivables: involve the recognition of revenue earned before cash is received Example: Interest receivable Interest revenue 3. Estimates Bad debt expense Allowance for uncollectable accounts Adjusted trial balance: adjusted balances have been posted to the accounts Financial statements Income statement: summarizes the profit-generating activities of the company that occurred during a particular period of time A change statement in that it reports changes in retained earnings that occurred during the period as a result of revenues, expenses, gains, losses Balance sheet: to present the financial position of a company on a particular date Provides an organized list of assets, liabilities, and shareholders equity at a point in time Statement of cash flows: a change statement disclosing the events that caused cash to change during the period. Classifies into three categories: 1. Operating activities 2. Investing activities 3. Financing activities Statement of stockholders equity: a change statement, discloses the sources of the changes in the various permanent shareholders equity accounts that occurred during the period The closing process Serves a dual purpose: 1. Temporary accounts (revenues, expenses, gains, and losses) are reduced to zero balances 2. Temporary account balances are closed to retained earnings to reflect the changes that have occurred in the account during the period Income summary: account that is a bookkeeping convenience used in the closing process that provides a check that all temporary accounts have been properly closed Example: Sales revenue Rent revenue Income summary Post closing trial balance: purpose it to verify that the closing entries were prepared and posted correctly and that the accounts are now ready for next years transactions