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Unit 3

Principles of Finance and Accounting

3.1 Explain the nature �of special journals

At its core, accounting is simply the accurate maintenance of financial accounts. While technology has rendered some aspects of that maintenance obsolete, a solid understanding of the building blocks of accounting will always lead to performing well in this field. If credits and debits are those building blocks, they are constructed on a basic foundation of journals and ledgers.

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Journals and Ledgers

FI:407 Explain the nature of special journals

Journal entries

Original entries
One entry for each transaction
Multiple accounts in each entry

Ledger entries

Based on journal entries
At least two entries for each transaction
One entry for each impacted account

In accounting, a journal is a book that contains the original entry for each business transaction.

Journal entries are recorded in the order of the transaction date, making it easy to research and locate transactions.

Each entry includes a date, the title of the account to be debited, and the amount debited.
This is followed by the title of the account to be credited and the amount credited.

The amount of each transaction is then posted to the appropriate account in a ledger.

Each journal entry will result in at least two ledger entries because each journal entry will impact the balances of at least two accounts.
The first ledger entry is recorded in the account to be debited, and includes a date and the amount debited.
The second ledger entry is recorded in the account to be credited, and includes a date and amount credited.

Due to the different uses of journals and ledgers, the page and column layout may be different for each.
The most important thing to remember about the differences between journals and ledgers is that:

Each journal entry lists the multiple debits and credits to different accounts from a single transaction.
Each ledger entry only contains a single debit or credit that impacts the balance of a specific account.

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General Ledgers

Collection of all accounts
Used to prepare financial statements
May summarize multiple journal entries

FI:407 Explain the nature of special journals

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Special Journals

Similar, high-volume transactions
Number and type differ by company
Common examples:

Sales journal
Cash receipts journal
Purchases journal
Cash payments journal
Payroll journal

FI:407 Explain the nature of special journals

Special journals allow accountants to group together financial transactions into types with similar characteristics. This makes the recording process faster and more efficient.

Most special journals chronicle high-volume transactions.

Due to the sheer number of these transactions, this information is placed into special journals so repeated entries don’t clutter the general ledger.
Often, special journal entries are included in the general ledger in a summarized form.

While the number and type of special journals used by a company depends on the size and characteristics of the company and its transactions, examples of common special journals (along with their typical transactions) are:

Sales journals include product sales billed to customers who have been granted credit.
Cash receipts journals include cash from product sales, collected from customers or other sources.
Purchases journals include purchases of supplies, equipment, assets, or any other expense.
Cash payments journals include cash paid for expenses, supplies, or any other cash payment.
Payroll journals include cash payments to employees for salary and wages.

All transactions that are not journalized in a special journal are journalized in the general journal.

The general journal typically includes only those transactions that are unusual or infrequent.
However, some smaller companies that do not handle a large number of transactions may prefer to only use one general journal and no special journals.

Discussion #1: Ask students to discuss what types of transactions would be so common for an ice cream shop that they required the use of a special journal. What about for a landscaping company?

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Subsidiary Ledgers

Keep clutter out of general ledger
Contain detailed entries for a single account
Totals often summarized in general ledger

FI:407 Explain the nature of special journals

Subsidiary ledgers share a similar purpose to special journals in that they help keep lengthy lists of transactions out of the general ledger.

A subsidiary ledger often contains the detailed entries of a particular general ledger control account which is typically used to summarize areas that contain a large number of transactions, such as accounts receivable or accounts payable.

Instead of listing every single transaction from these accounts in the general ledger, they are instead listed in a subsidiary ledger and then summarized in the general ledger.
Often, at the end of each day, the aggregate amount for that day’s subsidiary ledger is entered as a single-item summary entry in the general ledger.

The difference between special journals and subsidiary ledgers is that subsidiary ledgers provide details relating to a specific account in the general ledger.

Special journals, on the other hand, group a number of transactions of a similar type, such as sales or payroll.
In either case, a number of individual transactions are recorded in detail and summarized for efficiency in the general ledger.

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Journalizing Business Transactions

Paper or digital
Entries ordered by date
General or special journals

FI:381 Journalize business transactions

3.2 Journalize business transactions

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Selecting the Correct Journal

Sales journal
Cash receipts journal
Purchases journal
Cash payments journal
Payroll journal
General journal

FI:381 Journalize business transactions

After analyzing the transaction and determining the necessary information for the journal entry, the appropriate journal for the entry is selected.

Some commonly used special journals, and the source documents that are often associated with them, are:

Sales journals include product sales billed to customers who have been granted credit.

Source documents for sales journals are almost always invoices.

Cash receipts journals include cash from product sales, collected from customers or other sources.

Source documents for cash receipts journals are often cash memos or receipts.

Purchases journals include purchases of supplies, equipment, assets, or any other expense that is purchased on credit only.

Source documents for purchases journals include invoices and purchase orders.

Cash payments journals include cash paid for expenses, supplies, or any other cash payment.

Source documents for cash payments journals are often cash memos or receipts.

Payroll journals include cash payments to employees for salary and wages.

Source documents for payroll journals are commonly employee time cards, paychecks, and paystubs.

Because all entries that are not appropriate for one of the special journals are entered into the general journal, these transactions tend to be those that are uncommon for the company.

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Making a Journal Entry

Date of transaction
Account to be debited
Amount to be debited
Account to be credited
Amount to be credited
Reference to source document
Brief description of transaction

FI:381 Journalize business transactions

Before making any journal entry, an accountant must first identify the accounts involved in the transaction.

Then, to record the journal entry, the following information is entered into the appropriate fields:

Date of transaction
Ledger accounts involved (use the chart of accounts for the appropriate account titles)
Amount of transaction (use debit and credit rules to determine if the accounts are debited or credited)
Reference to source document, if available
Brief narrative to describe the transaction

Traditionally, debited accounts are listed before credited accounts, but both are listed under the same entry in a journal.

Discussion #1: Ask students to discuss the importance of following the same routine every time they complete a journal entry. If it doesn’t matter if debits or credits are listed first, why is it standard to follow the same routine with each entry?

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Sample General Journal Entry

For more information and examples: https://www.principlesofaccounting.com/chapter-2/the-journal/

FI:381 Journalize business transactions

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3.3 Post journal entries to general ledger accounts

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The General Ledger

Collection of a company’s accounts
Used to prepare financial statements
Contains chart of accounts

FI:382 Post journal entries to general ledger accounts

3.3 Post journal entries to general ledger accounts

A general ledger is a collection of the accounts used to organize and store the information from a company’s business transactions.

The information posted in the general ledger is used to prepare a company’s financial statements.
Each general ledger entry comes from information first journalized in either the general journal or a special journal.
The general ledger will have a separate page or section for each account listed in the chart of accounts.

The exact name of the account that appears in the chart of accounts should be reflected in each journal entry and also listed at the top of the account in the general ledger.
It is important that these names remain consistent in all documents so the information can be easily tracked.

Discussion #1: Ask students why they think it is important to mark a journal entry after it has been posted to a ledger. Why is it the last step in the posting process?

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Posting to the General Ledger

Locate the correct account.
Enter the date.
Reference journal and page.
Enter debit/credit.
Update the balance.
Mark the journal entry posted.

FI:382 Post journal entries to general ledger accounts

Posting is the act of moving debit and credit account balances from individual journals into their corresponding ledger accounts.

It is important to note that information from each journal entry will need to be recorded into at least two accounts in the general ledger.
Posting to the general ledger usually follows these six steps:

Locate the correct account in the general ledger.
Enter the date that corresponds with the journal entry.
In the “Description” column, make reference to the specific journal and page number the information comes from. In the following example, the information comes from the general journal.
Enter the debited and/or credited amount into the appropriate column.
Refer to the rules of debits and credits to determine how the balance will be impacted by the entry and update the account balance accordingly.
Mark the posting reference column in the journal entry to signify that the posting of this entry into the general ledger accounts has been completed.

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Sample General Journal Entry

Journal Entry:

FI:382 Post journal entries to general ledger accounts

Ledger Account Entries:

For a video demonstration of posting journal entries in general ledger accounts, click here: https://www.youtube.com/watch?v=w2FmuagHkF4.

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Trial Balances

Worksheet that lists account balances at the end of an accounting period
Helps check the accuracy of journal and ledger entries
Total credits should equal total debits.
Unadjusted vs. adjusted

FI:383 Prepare a trial balance

3.4 Prepare a trial balance

A trial balance is a worksheet that lists the different accounts found in a business’s general ledger along with their current balances at the end of an accounting period.

The trial balance is done to check the accuracy of journal and ledger entries.

It is not a formal financial statement.
Instead, the trial balance is an opportunity to double-check the bookkeeping you’ve done to make sure the total debits posted equal the total credits posted.

In a trial balance, each line item only contains the final balance for each account at the end of the accounting period, and every account that has a final balance that is not zero.

Accounts are also typically listed in the order they appear in the chart of accounts.

An unadjusted trial balance is prepared based on entries into the general ledger and helps identify if any errors have occurred in the ledger or journal entries.

If the listed debits do not equal the listed credits, there are entry errors that will need to be adjusted.

An adjusted trial balance lists the original information from the unadjusted trial balance along with any adjustments that were made.

In an adjusted trial balance, the credit and debit amounts have been combined into one column, a new column shows the total amount of adjustments made to an account, and a third column contains the adjusted balance for that account.

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Limits of Trial Balances

Even if debits and credits are balanced, there could still be errors in the books.
Entries could be missing entirely.
Entries could be in incorrect accounts.

FI:383 Prepare a trial balance

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Sample Trial Balance

FI:383 Prepare a trial balance

For more examples and information: �https://www.accountingtools.com/articles/2017/5/16/the-trial-balance-example-format

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Revenues and Expenses

Revenues: money earned

Sales revenue account
Product revenue account
Services revenue account

FI:384 Journalize and post adjusting entries

Expenses: money spent

Operating expenses

Utilities expenses account
Rent expenses account
Salary expenses account
Cost of goods sold account

Nonoperating expenses

Interest expense

3.5 Journalize and post adjusting entries

Before exploring adjusting entries, there are a few important terms to define.

A revenue is an amount (often of money) earned when a company provides its product to a customer.

Revenues are recorded into revenue accounts, which are accounts that chart the amount of incoming money from a particular activity (usually a kind of sale) during a single accounting period.
Some common revenue accounts are sales revenue accounts, product revenue accounts, and services revenue accounts.

An expense is a cost that a company incurs in the process of generating revenues.

This means that any money spent that allows a company to accomplish sales is considered an expense.
Expenses are recorded into expense accounts, which are accounts that chart the amount of outgoing money related to a particular activity during a single accounting period.

There are two main types of expenses.

An operating expense is a cost that relates directly to the company’s selling activities.

Common operating expenses include the cost of goods sold, utilities expenses (such as electricity or water), rent expenses, salary expenses, and advertising expenses.
These directly allow the company to accomplish business activities and therefore to achieve sales.

A nonoperating expense relates to costs that are incidental to a company doing business.

If a company borrows money and ends up paying interest on that debt, that interest is recorded as a nonoperating expense.

At the end of each accounting period, the balance of a company’s revenue accounts and expense accounts are reported in a company’s income statement.

Because revenue accounts and expense accounts only chart incoming and outgoing money during a single accounting period, these are examples of temporary accounts (sometimes called income statement accounts).
Conversely, permanent accounts (such as asset accounts, liability accounts, and equity accounts) compile ongoing balances that extend across multiple accounting periods and these balances are reported on the company’s balance sheet.

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Adjusting Entries

Adjusting entries

End of accounting period
Amend ending balances in ledger accounts
Help accountants meet standards like GAAP

Matching principle

One of four GAAP principles
All expenses matched and recorded with revenues

In accounting period incurred, not paid
Part of accrual accounting method

FI:384 Journalize and post adjusting entries

Adjusting entries are journal entries recorded at the end of an accounting period to amend the ending balances in general ledger accounts for that period.

Typically, these adjustments aid accountants in aligning their reported data with accounting frameworks like the Generally Accepted Accounting Practices (GAAP).
Adjusting entries are an important part of moving from trial balances to the financial statements step of the accounting cycle.

Even after preparing an adjusted trial balance, accountants almost always need adjusting entries to comply with aspects of accounting standards like the matching principle.

The matching principle is one of the four underlying principles of the GAAP.

It states that all expenses must be matched and recorded with their respective revenues in the period in which the expenses were incurred—not when they are paid.

This means that revenues are recorded in the same accounting period along with any expenses that relate to them.

This core principle of the accrual accounting method creates the need for adjusting entries because entries are made when the transactions occur and not when they are paid/completed.

If, for example, a company takes out a loan during the October accounting period, but the interest on that loan is not set to be paid until June 30th at the end of the fiscal year, parts of the interest that won’t be paid until June are actually accumulated during October, November, December, and so on.

The amount of interest that accumulates during a given accounting period needs to be reported on the financial statements for that accounting period, even though it will not be paid until a future one.
The reason for this is because this accrued interest is an expense that has contributed to the company’s ability to generate revenues during each of these accounting periods.
Thus, according to the matching principle, that expense needs to be matched and recorded with the revenue generated during the period.
To do this, an adjusting entry is made.

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Types of Adjusting Entries

Accruals

Accrued revenues: money earned but not received
Accrued expenses: costs incurred but not paid

Deferrals

Deferred revenues: money collected but not earned
Deferred expenses: costs paid in advance

FI:384 Journalize and post adjusting entries

A number of situations require the use of adjusting entries. Most will relate to either accruals or deferrals.

Adjusting entries relating to accruals involve unrecorded revenues and/or expenses that gradually accumulate throughout an accounting period.

Accrued revenues, for example, are often represented by money earned during one accounting period that will not be collected until a future one.
Accrued expenses, like the interest expense from the previous example, are paid at a time after they are earned.

Adjusting entries relating to deferrals involve recorded revenues and/or expenses that have been paid but not yet earned.

Deferred (or unearned) revenue refers to money that is collected in one accounting period, but the good or service is not provided until a future period.
Deferred (or prepaid) expenses are paid in advance of when the good or service is obtained.

Typically, when an accrual or deferral is entered into a journal, an asset or liability account is impacted.

Making an adjusting entry for deferred revenue, for example, will increase the balance of a liability account.

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Sample Adjusting Entry

For more information on adjusting entries, click here: https://www.accountingcoach.com/adjusting-entries/explanation.

FI:384 Journalize and post adjusting entries

In this example of an adjusting entry for a deferral, the company has charged a client $2,500 for the sale of a product, but has not yet delivered that product.

This revenue is unearned by the end of the April accounting period.
The adjusting entry is made at the end of the accounting period to demonstrate that this revenue is unearned, and thus appears as a liability for this accounting period: (See chart).

Discussion #1: Ask students to discuss why the “product revenues” account is a revenue account, but the “deferred revenues” account is a liability account. What is the difference between these types of accounts? Why would there need to be a liability account for revenues?

�For more information on adjusting entries, click here: https://www.accountingcoach.com/adjusting-entries/explanation.

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Closing Entries

Occur at the end of each accounting period
Transfer balances from temporary to permanent accounts

Temporary accounts (revenue, expense)
Permanent accounts (asset, liability, equity)

Three steps:

Transfer revenue account balances to income summary account
Transfer expense account balances to income summary account
Transfer income summary account balance to retained earnings account

FI:385 Journalize and post closing entries

3.6 Journalize and post closing entries

Temporary accounts (such as revenue and expense accounts) contain balances that only pertain to a specific accounting period.

That means that the balances for all temporary accounts must be reset to zero at the end of each period.

To set them to zero, the temporary account balances must be transferred to permanent accounts (such as asset accounts, liability accounts, and equity accounts) through closing entries.

Discussion #1: Ask students to discuss why it is important to have some accounts that only show transactions for a single accounting period and other accounts that carry balances for multiple accounting periods. What is different about the information in a temporary account and the information in a permanent account?

Closing entries are journal entries recorded at the end of an accounting period in which balances from temporary accounts are transferred to a retained earnings account by way of an income summary account.

The final balance of this income summary account represents the company’s net income or net loss for that accounting period.

Once all temporary account balances have been moved to the income summary account, the net income or net loss is transferred over to the retained earnings account.
In summary, the process of journalizing closing entries follows this three-step process:

Transfer revenue account balances to the income summary account through a debit to the revenue accounts and a credit to the income summary account.
Transfer expense account balances to the income summary account through a debit to the income summary account and a credit to the expense accounts.
If the total revenues are greater than the total expenses (resulting in net income), close the income summary through a debit to the income summary account and a credit to the retained earnings account. If the total expenses are greater than the total revenues (a net loss), debit the retained earnings account and credit the income summary account.

NOTE: The difference between adjusting and closing entries is that adjusting entries are entered before the financial statements are prepared and ensure that these financial statements adhere to accounting standards.

Closing entries are done on the last day of an accounting period and after financial statements are completed.
They are used to close out temporary accounts so these balances are set to zero for the beginning of a new accounting period.

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Sample Closing Entries

For more information on how to journalize and post closing entries, click here: https://www.youtube.com/watch?v=nNTFxSMgZrk.

FI:385 Journalize and post closing entries

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Post-Closing Trial Balances

For more information on post-closing trial balances, click here: https://www.myaccountingcourse.com/accounting-cycle/post-closing-trial-balance.

FI:386 Prepare a post-closing trial balance

3.7 Prepare a post-closing trial balance

A post-closing trial balance is a trial balance that demonstrates that all accounts are in balance at the end of an accounting period, and after these accounts have been closed.

Any account that shows a balance of zero at the end of the accounting period does not appear on the post-closing trial balance.

For example, because all of the temporary account balances have already been transferred to permanent accounts and currently have a zero balance, a post-closing trial balance does not list any temporary accounts.

Just like the previous trial balances, all of the debits and credits recorded in the post-closing trial balance should result in a net of zero.

For more information on post-closing trial balances, click here: https://www.myaccountingcourse.com/accounting-cycle/post-closing-trial-balance.

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Reversing Entries

Entered on the first day of a new accounting cycle
Undo adjusting entries from previous accounting cycle

FI:386 Prepare a post-closing trial balance

After the post-closing trial balance has been completed, accountants can begin preparing any reversing entries for the beginning of the next accounting period.

Reversing entries are journal entries that undo the adjusting entries from the end of the previous accounting period.

Adjusting entries that were entered for accruals or deferrals in the previous accounting period need to be reversed so that the same transaction does not get counted twice when the transaction is completed (paid or earned) and recorded.
When viewed at the end of the new accounting period, the effects of the adjusting entry and the reversing entry are nullified.

Reversing entries are recorded on the first day of a new accounting cycle and appear as a simple reversal of the debit and credit made in the adjusting entry.

Discussion #1: Ask students to discuss why accountants make adjusting entries only to reverse them a day or two later.

�

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Sample Reversing Entries

Adjusting entry to be reversed:

FI:386 Prepare a post-closing trial balance

Reversing entry:

For more information on reversing entries, click here: https://www.accountingtools.com/articles/what-is-a-reversing-entry.html.

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3.8

Identify and correct accounting errors

Accounting errors are accidents; they are unintentional and can occur for a variety of reasons. However, they are not due to fraud. Fraud refers to a willful or intentional act to deceive through the misrepresentation or falsification of records.

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Accounting Errors

Unavoidable
Not fraud
Trial balances show some types of errors

FI:675 Identify and correct accounting errors

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Common Accounting Errors

Errors of omission
Errors of commission
Errors of principle

FI:675 Identify and correct accounting errors

There are many types of accounting errors. Some of the most common ones will fall into these categories:

Errors of omission

An error of omission occurs when a transaction that was supposed to be entered into a journal or ledger was entirely left out.

The best way to avoid this type of error is to establish a routine procedure for recording transactions and follow it every time.

It is important that accountants record transactions in a timely fashion to lessen the chances that source documents become misplaced.

Errors of commission

An error of commission is one that falls into a broad classification of errors mostly relating to incorrect entries or miscalculations.

For example, a transaction is entered into the wrong account, but it is the correct type of account (such as an expense account).
In this case, because the total debits and credits will still balance correctly, this type of error will not show up in a trial balance.

An example of an error of commission that would appear in a trial balance is the recording of the wrong value into an account. Errors of principle

Discussion #1: Ask students to come up with more examples of errors that would or would not appear in a trial balance.�

Errors of principle

An error of principle occurs when an aspect of an accounting standard is not followed correctly.

One possible example is the incorrect recording of a business expense as a personal expense.

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Correcting Accounting Errors

Depends on type and when they are noticed
Correcting entries
https://www.double-entry-bookkeeping.com/bookkeeping-basics/accounting-errors/

FI:675 Identify and correct accounting errors

The method for correcting an accounting error is determined by the type of error that was committed and when the error was noticed.

Correcting errors in a previous accounting period can be complicated, for example.
Most accounting errors made in journals that are recognized in the same period in which they occurred can be fixed with correcting entries.

If, for example, the error occurred by entering a transaction into the wrong expense account, a correcting entry that simply debits the correct account and credits the incorrectly debited account for the amount of the transaction would fix the problem.
If an incorrect amount was entered into an account, a correcting entry that either debited or credited the difference between the incorrect amount and the correct amount could fix the error.

For more information on accounting errors and correcting entries, click here: https://www.double-entry-bookkeeping.com/bookkeeping-basics/accounting-errors/.

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3.9Use accounting applications �and systems

Modern computerized accounting systems can perform many tasks throughout the accounting cycle with the simple click of a button. Although it is still important to know how to perform these tasks manually, the increased efficiency that the computerized systems bring to accounting is often well worth the cost of investing in one.

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Computerized Accounting Options

Spreadsheet programs
Complete accounting software

NF:225 Use accounting applications and systems

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Spreadsheet Programs

Free accounting templates:

Video tutorial:

https://www.youtube.com/watch?v=doPjZsGMhQc

NF:225 Use accounting applications and systems

While spreadsheet programs are capable of performing calculations based on entered formulas, they are not necessarily constructed to perform as accounting systems.

Because of this, many accountants who use these programs rely on templates for creating their journals, ledgers, trial balances, balance sheets, etc.

There are a number of templates online that are available for use. Some are free to download and use (although they often contain ads for the companies that create them).
Here are a few options for free accounting spreadsheet templates:

Here is a video tutorial for using Microsoft Excel for small-business accounting:

https://www.youtube.com/watch?v=doPjZsGMhQc

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Complete Accounting Software

Intuit’s QuickBooks

Tutorials: https://quickbooks.intuit.com/tutorials/all-quickbooks-tutorials/
Video tutorials: https://www.youtube.com/playlist?list=PL5zKSeS09l33BOOa0hSekdMoEFi__NB_n

Selecting the right program: https://www.patriotsoftware.com/accounting/training/blog/how-use-accounting-software/

NF:225 Use accounting applications and systems

If a company chooses a more complete accounting software system, it can use these programs to provide much more than accounting equations.

Systems like Intuit’s QuickBooks program are built for accounting and can perform tasks like automatically creating reversing entries and closing entries or one-click trial balances.

Discussion #1: Ask students to discuss why it is important to learn how to perform these tasks even if a computer-based system can do them for you.

They also help minimize the potential for errors, and make the errors that do occur easier to locate, correct, and manage.

There are many options for learning how to use these systems.

For a listing of Intuit’s QuickBooks tutorials, click here: https://quickbooks.intuit.com/tutorials/all-quickbooks-tutorials/.
For video tutorials that cover some of the basics of using QuickBooks, click here: https://www.youtube.com/playlist?list=PL5zKSeS09l33BOOa0hSekdMoEFi__NB_n.

QuickBooks is not the only accounting software available.

For some advice from a competing company on how to select and use the right accounting software, click here: https://www.patriotsoftware.com/accounting/training/blog/how-use-accounting-software/.

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Copyright

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Acknowledgments

Content sourced from intellectual property owned by �MBA Research and Curriculum Center®

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