Accounting Fundamentals: Journal Entries and Statements

UGBA 107 Notes: Fernando Lopez

Financial Accounting: Journal Entry Rules (T-Accounts)

Understanding the fundamental rules of debit and credit is essential for accurate journal entries. These rules dictate how different account types increase or decrease:

• Assets: Debit increases, Credit decreases
• Liabilities: Debit decreases, Credit increases
• Equity: Debit decreases, Credit increases
• Revenue: Debit decreases, Credit increases
• Expenses: Debit increases, Credit decreases

Essential Journal Entries for Common Transactions

Below are standard journal entries for typical business activities:

• Receiving cash for services to be provided later:
  • Debit: Cash
  • Credit: Unearned Revenue (Liability until service is performed)
• Providing services on account (not yet paid):
  • Debit: Accounts Receivable
  • Credit: Service Revenue
• Collecting cash for services provided earlier:
  • Debit: Cash
  • Credit: Accounts Receivable
• Purchasing supplies on credit:
  • Debit: Supplies
  • Credit: Accounts Payable
• Paying off Accounts Payable:
  • Debit: Accounts Payable
  • Credit: Cash

Accruals, Deferrals, and Depreciation Basics

• Accrued Expenses (e.g., wages earned but unpaid):
  • Debit: Expense
  • Credit: Liability (e.g., Wages Payable)
• Deferred (Prepaid) Expenses (e.g., insurance paid in advance):
  • Debit: Prepaid Expense
  • Credit: Cash
• Depreciation:
  • Debit: Depreciation Expense
  • Credit: Accumulated Depreciation (Contra-asset)

Understanding Contra-Accounts in Accounting

Contra-accounts are used to reduce the balance of another related account.

• Contra-Asset:
  • Accumulated Depreciation decreases asset values (linked to assets such as equipment).
• Contra-Revenue:
  • Reduces total revenue (e.g., Sales Discounts).

The Three Primary Financial Statements

• Balance Sheet:

  The fundamental accounting equation: Assets = Liabilities + Stockholders' Equity

  • Contains assets (e.g., cash, receivables), liabilities (e.g., payables, unearned revenue), and equity.
• Income Statement:

  The profitability calculation: Revenues - Expenses = Net Income

  • Reflects operational success or failure over a specific period.

Adjusting Entries: Recognition Principles and Examples

Adjusting entries are necessary at the end of an accounting period to ensure revenues and expenses are recorded in the correct period, adhering to GAAP principles.

• Revenue Recognition Principle: Revenue is recorded when earned, regardless of when cash is received.
• Expense Recognition Principle (Matching): Expenses are recorded when incurred, regardless of when payment is made.
• Adjusting for Accrued Expenses:
  • Debit: Expense
  • Credit: Liability (e.g., Interest Payable)
• Adjusting for Prepaid Expenses:
  • Debit: Expense
  • Credit: Prepaid Asset (e.g., Prepaid Insurance)
• Adjusting for Depreciation:
  • Debit: Depreciation Expense
  • Credit: Accumulated Depreciation

Statement of Cash Flows (SCF) Activities

The SCF categorizes cash movements into three main activities:

• Operating Activities: Cash flows from regular business operations (includes paying interest).
• Investing Activities: Buying or selling long-term assets (e.g., property, plant, and equipment).
• Financing Activities: Transactions involving borrowing or repaying debt, issuing stock, or paying dividends.

Differentiating Accrued and Deferred Items

• Accrued vs. Deferred Revenue:
  • Accrued Revenue: Revenue earned but cash not yet received.
  • Deferred (Unearned) Revenue: Cash received but revenue not yet earned.
• Accrued vs. Deferred Expenses:
  • Accrued Expenses: Expense incurred but cash not yet paid.
  • Deferred (Prepaid) Expenses: Cash paid in advance but expense not yet incurred.

Depreciation and Asset Disposal Calculation Example

Calculating gain or loss upon the sale of a depreciable asset:

• Original cost of equipment: $100,000
• Accumulated depreciation: $60,000
• Net book value: $100,000 - $60,000 = $40,000
• Selling price: $50,000
• Gain on Sale: $50,000 (Selling Price) - $40,000 (Net Book Value) = $10,000