In some cases this section offers practice on a particular issue; in other cases, the material is presented in demonstration format. Those section that permit practice are are marked (ex for exercise); those that are demonstrations are marked (demo).
One can go through these sequentially or use the buttons to select specific exercises and demonstrations. Additionally, the exercises and demonstrations are given indentifying numbers such as 5XD-1 for exercise and demonstration 1. Thus, assignments can be made by identifying numbers
5XD-1.Scrambling
and unscrambling the elements of the
cycle (ex)
Below in the left column is a list of the elements of the accounting cycle but scrambled. In the middle is room for reordering.
Also below is a button for requesting the listing in its proper order. In doing the exercise, assume that everything in the cycle occurs in blocks and that one block most be completely finished before another started. For example all the budget or actual entries are made before the next step is undertaken. Just print out this page and try the scrample as pencil and paper exercise.
scrambled unscrambling entries are posted ? budget is authorized ? financial statements ? actual entries journalized ? budget placed into books ? adjusting entries made ? closing entries ?See Proper Order for the answer to this accounting cycle exercise.
Return to exercise and demonstration menu.
A complete accounting equation might look like this:
A = L + FB
50,000 20,000 30,000
5XD-2. Name each component:
A __________________
L __________________
FB __________________
5XD-3. Give the correct value for each question mark (?).
A = L + FB
10,000 ? 3,000
A = L + FB
? 10,000 13,000
A = L + FB
30,000 10,000 ?
5XD-4. Give an example of each element.
A __________________
L __________________
FB __________________
5XD-5. Which fund described below via the accounting equation is
in better financialcondition? Explain your
answer.
1) A = L + FB
100,000 90,000 10,000
2) A = L + FB
100,000 101,000 (1,000)
For answers to this exercise on accounting equations see the section onequation answersReturn to exercises and demonstration menu.
A typical entry, presented in manual style, is:
date {account} dr cr
1/2/x0 cash 100,000
revenue 100,000
Make the entries for the following {transactions}, assuming the
general fund.
5XD-6. On 1/15/x0, the {fund} collect fees $50,000.
5XD-7. On 2/1/x0 the fund paid wages of $40,000.
5XD-8. On 2/28/x0 the fund closed the actual accounts.
See journal entry answers for assistance with this exercise.Return to exercises and demonstration menu.
Assume that a unit has cash of $10,000 and that the sources of this cash come from a short term loan or liability of $5,000 and equity from profits of $5,000. For simplicity, the exercise assumes no interest due or charged. The accounting equation to represent this business situation is:
Assets Liabilities Equity
A = L + E
10,000 5,000 5,000
During some period, the unit has three transactions. It buys products to sell, paying 1,000 It sells the products for 1,500 It pays wages of 300These transactions and the impact they have on the financial situation of the unit can be conveyed simply by using the accounting equation or using debits and credits. Both approaches will yield the same results since the debits and credits are derived from the accounting equation. Below is the accounting equation approach.
Beginning A = L + E
10,000 5,000 5,000
pays for products (1,000)
new inventory 1,000
sells product 1,500 1,500
inventory decrease (1,000) (1,000)
pays wages (300) (300)
Ending A = L + E
10,200 5,000 5,200
In the first transaction, cash is reduced by $1,000 and
the inventory of products is increased by $1,000 when the
firm pays $1,000 for the goods.In the second transaction cash is increased by $1,500 and expense (or cost of goods sold) are also included in this second transaction by the $1,000 decrease in assets and $1,000 decrease in equity. Expenses decrease equity. Recall that equity handles both revenues and expenses and in this case the cost of the inventory is now an expense because it was sold.
In the third transaction, cash is decreased by $300 as the unit pays out the money and equity decreases by $300 since an expense (a wage expense in this case) decreases equity. Now, examine the effects of the transactions and what happens in using the accounting equation to track these transactions.
First, note that the equality is maintained. The unit started with assets being equal to liabilities and equity and ends that way, namely, assets amount to $10,200 and when liabilities and equity are added they too equal $10,200 Second, all the transactions are handled by the equation. Each transaction involves assets, liabilities, and equity and the equation is made up of these elements. Third, the unit has grown and apparently prospered; its assets and equity are larger. Assets are now $10,200 compared to $10,000 and equity is $5,200 compared to $5,000 In other words the unit made or earned $200 since it had revenues of $1,500 and expenses of $1,300 However, the unit still has that liability of $5000 which it has not addressed. All the financial statements could be derived, although that would require extracting a good deal of detail from the data in the equation. For example, equity would have to be broken into revenue and expense to generate the income statement. The same detail break down would be needed for assets and liabilities to produce a balance sheet.
The tracking for these transactions could be done by using debits and credits, but that can be more involved than the use of the accounting equation since each individual journal entry needs to be transferred into a summary account then into the financial statements. A simple debits and credits demonstration is given below without producing the financial statements.
The beginning accounts include:
cash 10,000
current liabilities or payables 5,000
owners equity 5,000
The following are the journal entries for the several
transactions.
inventory 1,000
cash 1,000
The unit buys products to resell.
cash 1,500
revenue 1,500
The unit sells the product.The asset cash is increased (a debit) as the unit takes in money on the sales. Revenue is increased by the sales which is handled by a credit.
cost of goods sold 1,000
inventory 1,000When the inventory is sold it is an expense (a debit) and of course the physical asset is gone so it is decreased and thus credited. Sale of inventory in a perpetual inventory system is called cost of goods sold.
wages expense 300
cash 300Expenses is debited since expenses are part of equity and equity is debited when decreased. Cash, as an asset, is credited since in this case it is credited when decreased.
These debits and credits can be used to see the impact on the unit. The most detailed way would be to go through the accounting cycle. For simplicity the values are summarized without the details of the cycle.
Cash is increased by $200 and that is the only asset that changes from beginning to end. The increase in inventory is cancelled since it was sold. So assets increase by $200. Nothing happens to liabilities. The liability is still $5,000 Equity increases by $200 since revenues exceeded expenses by that amount. The unit is slightly better off since it had a profit but it still has that large liability.
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In this instance the legislature adopts a budget of revenues and appropriations with each having several categories. This particular illustration comes from the general fund budget entry in lesson 3 of this chapter..
The one complete budget entry would yield the following.
dr cr
estimated revenue - property tax 250,000
estimated revenue - intergovernmental revenue 50,000
estimated revenue - fees 50,000
estimated revenue - licenses 25,000
estimated revenue - fines 25,000
appropriations - general administrat 100,000
appropriations - safety 75,000
appropriations - education 100,000
appropriations - housing 3,000
appropriations - sanitation 50,000
appropriations - recreation 25,000
transfer out - library 45,000
transfers out -debt service 625
transfer out - pension 1,000
fund balance 375
With the subsidiary approach only the total for the broad
categories (ie, estimated revenues, appropriations, and transfer
out)
would be given, with the details saved for the subsidiary
ledgers.
dr cr
estimated revenue 400,000
appropriations 353,000
transfer out 46,625
fund balance 375
The estimated revenues, appropriations, etc. are called
control accounts. With these so
called control accounts in
place the details are presented in the subsidiary ledgers. The
main accounts are often called control accounts because the
subsidiary accounts must add up to what is in the main or
control account. Put another way the control accounts control
what is
in the subsidiary accounts.In this case, three subsidiary accounts would be needed.
Subsidiary Ledger for estimated revenue: estimated revenue - property tax 250,000 estimated revenue - intergovernmental revenue 50,000 estimated revenue - fees 50,000 estimated revenue - licenses 25,000 estimated revenue - fines 25,000 Notice that the total in this estimated revenue is equal to the total in the estimated revenue control account that is, control total $400,000 and subsidiary total $400,000
Subsidiary ledger for appropriations: appropriations - general administrat 100,000 appropriations - safety 75,000 appropriations - education 100,000 appropriations - housing 3,000 appropriations - sanitation 50,000 appropriations - recreation 25,000 Subsidiary ledger for transfers out: transfer out - library 45,000 transfers out -debt service 625 transfer out - pension 1,000The subsidiary accounts are nothing more than the details that were placed in the one complete budget entry. The subsidiary method divides the labor but the subsidiary approach increases the coordination required. Whomever is responsible for the estimated revenue account would have to make sure that any legislative changes in estimated revenue during the year are recorded in both the subsidiary ledger, summed, then transferred or updated to the controlling ledger.
Subsidiary ledgers are a generic concept and not limited to budget entries. For examples, subsidiary ledgers can be used for taxes receivable. The main or control account might have the amount for total property tax receivable but the subsidiary ledger would have all the accounts for individual properties. Thus, while subsidiary ledgers are demonstrated here for budgetary accounts they can be used in many circumstances.
Return to the menu list of items for exercises and demonstrations.
The model for the salary entry is:
dr cr
salary expenditure gross
deductions amounts
cash net
The deductions are liabilities since the government employer is
just collecting the money to pay others, such as taxes to the
Internal Revenue Service (IRS).
A simple example, without any details would be,
dr cr
salary expenditure 10,000
deductions 3,000
cash 7,000
In this case the deductions, or liabilities, amount to
$3,000Assume in the above example the deductions of $3,000 are as follows.
dr cr
salary expenditure 10,000
income tax withheld 1,500
fica 750
health insurance 750
cash 7,000
The specific liabilities are for income tax, social security (called fica, or
federal insurance contribution act), and health insurance. The employer must follow
rules on how much to deduct and when to pay the amounts to the appropriate
entities. More and more of this type tax information is on the Internet. For
example there is a Payroll tax
site on the Web with background information and forms.In this illustration, the gross salary is $10,000 but only $7,000 goes to the employees. The $3,000 goes to the other entities that demand or contract for these amounts. Income tax withheld might go to the IRS; FICA to the Social Security Administration; and health insurance to a particular provider (Blue Cross or Aneta, eg).
The above entry is just a sample; the actual rules are far more complex. Imagine the calculations that can go into estimating withholding income tax for a given employee.
In addition to the salary paid to the employees and the deductions taken, the employer must also pay a variety of employer taxes. That general entry might be:
dr cr
employer tax expenditure $$$
taxes payable $$$
Below is an illustration with two specific taxes an employer
might have to pay.
dr cr
employer tax expenditure 875
fica payable 750
unemployment payable 125
Here the employer pays a total tax of $875 with
$750 going to social security and $125
going for an unemployment pool.Return to menu of topic listings for the exercise and demonstration section.
The following entries show the accrual process, with the expensing of an asset.
dr cr
supplies 10,000
cash 10,000
The supplies are an asset. The debit means the asset was
increased by $10,000. The credit to cash means that the asset
cash was decreased by the same amount to buy the asset.
supplies expense 5,000
supplies 5,000
Supplies are used in the course of business in order to earn
revenue. As the supplies are used they are expensed. This
entry shows a debit for supplies expense. The debit decreases
equity. Supplies are credited to show the asset is decreased.
cash 6,000
revenue 6,000
The use of the supplies brings in
revenue.At the end of the cycle or process the firm show that revenues ($6,000) exceeded expenses ($5,000) and that some assets are left over for next period. In this case $5,000 in supplies have not been used and carried over as assets for the next period.
In governmental fund accounting, the objective is to see whether the inflows of money was sufficient to cover the outflow. No effort is made to match revenues with expenses (ie, use of assets). The approach is sometimes referred to flow of financial resources since the emphasis is on cash and other types of financial or expendable resources. The following illustrates the balancing of inflows with outflows.
dr cr
cash 6,000
revenue 6,000
The fund collects $6,000 in revenues.
The asset cash increases so it is debited. Revenue increases
fund balance (similar to equity) so it is
credited.
supplies expenditures 6,000
cash 6,000
The fund spends the $6,000 and immediately recognizes
an expenditure even though the supplies have not been used and
are still, in essence, an asset since they have future
economic benefit. The expenditure decreased fund balance
(similar to the equity account) and is debited. Cash is
deceased and is credited.
In this case there is a perfect balance between the inflows
and the outflows without any effort to determine if the use of
the supplies helped to earn enough revenue to cover the
expenses. Six thousand came in as cash revenue and went out as
cash expenditure.
Governmental funds take this inflow-outflow approach
since these funds are concerned with what can be expended for
acquisition of resources. Since supplies cannot be expended to
buy more assets they are immediately classified as an outflow,
in this case an expenditure. Governmental funds can, however,
recognize, that they have supplies on hand by offsetting the
supplies
not used with a reserver for
supplies in the fund balance
section of the balance sheet.
Assume that half of the $6,000 purchased for supplies only
half were used. The statement of revenues, expenditures and
changes in fund balance would show the expenditure of $6,000
but in the balance sheet, a reserve for supplies of $3,000 lets
the legislature (and other interested
parties) know that supplies still existed and that the amount
in the reserve did not have to be spent again.
In short business waits until an asset is used before they
expense it while governmental fund often create an expenditure
as soon as the asset cost is paid. Business matches revenues
against the effort or expenses that was incurred to create the
revenue, with aim of measuring profit; government compares
inflows against outflows to determine if the two balance.
Of course, as with most topics there are options and
alternatives.
Governmental funds can take an expenditure as soon as supplies
are
purchased or use a system similar to the business approach of
waiting until the supplies are used to record an expenditure.
One of these is called the purchase method; the other, the
consumption
method.
Return to menu of topic listings for the exercise and demonstration
sections.
Adjusting entries and matching for business accounting
(demo)
Whenever the word matching is used, the
focus is on business or
business type accrual accounting. With matching, adjusting
entries are
used to make sure that all costs and revenues of the period are
matched, particularly those that were not recorded for some
reason
or where recorded, but need to be updated.
The following offers an example of the matching and adjusting
process for business accounting. A journal entries are made to
show the operations of a firm. Then the adjusting entries are
recorded to make sure all costs are matched against all revenue.
Assume the firm begins the period with $2,000 in cash and the
source of this cash is equity (consider the equity came from
revenue exceeding costs)
cash 7,000
unearned revenue
7,000
The firm collects $7,000, promising to deliver
$7,000 worth of work and products. Notice that the firm has
not yet done the work and thus has not earned the revenue. As a
result, the firm actually has a liability -- unearned revenue.
machine 5,000
cash 5,000
A machine, and asset, is purchased for $5000.
supplies 4,000
cash 4,000
Supplies are purchased buy on credit.
These entries show the movement of money, the acquisition of
of assets, and in one case, the incurrence of a liability.
They do not show the earning process. In this case it will
take the adjusting entries to show the matching, that is, to
give a picture of the earning process.
unearned revenue 7,000
revenue 7,000
The firm does the work and now can claim that it
earned the revenue.
depreciation expense
1,000
accumulated
depreciation 1,000
The machine was used for the period (one year) to help earn
the revenue. The assumption here is that the machine has a useful
life of five periods ($1000 per period) with no salvage value.
Thus, $1000 is allocated to this year and the expenses incurred
to
earn the revenue of the year.
supplies expense 4,000
supplies 4,000
All the supplies were used in the earning process.
Overall the firm was successful on an accrual basis since more
revenue was earned ($7,000) than expenses incurred (5000).
However, notice that more cash ($9,000) went out than revenues
earned ($7,000) for this period. Of course one must presume
that the firm had cash from previous periods. Prior to the
beginning of the period the accounting equation might have
been:
A = L + E
2,000 2,000
with the asset being in the form of cash.
Then the firm earned $7,000 in cash and
spent $9,000 for a machine and supplies.
But of the $9,000 spent only $5,000
was used to earn the revenue, leaving a profit of
$2,000. As a result it is necessary to look at the income
statement
and balance sheet as well as other statements to get a good
picture of performance. The new accounting equation can help with
these judgments on performance and is represented below:
A = L + E
4,000 4,000
All the cash was spent but the firm now has $4,000 in un
allocated or undepreciated equipment. Presumably this equipment
will help earn revenues in the future. The firm has $4,000 in
equity -- $2,000 from prior efforts and $2,000 from this period.
The adjusting entries played a key role in helping to match all
costs with all the revenue the cost served to produce.
Return to the menus of topic listings for exercises and demonstration
section.
Use of encumbrance for compliance -- (demo)
The encumbrance process is designed to prevent overspending
in a given budget appropriation category, often within a
governmental funds.
For instance, the total allowed for health might
be $150,000. Assume that health salaries take up
$100,000 of the amount. At this point it appears that
$50,000 is left. But what if a large purchase order
for $25,000 were made and not communicated to others
in the organization. Someone might think that the balance is
$50,000 when in fact a large part of that $50,000
will in all likelihood be spent. If another purchase
order is made for $30,000 then the unit might end up
overspending. As a result the encumbrance process was
developed to deduct the amount for purchase orders
from authorized amounts to keep track of how much is uncommitted.
Following is an illustration of the above facts using no
encumbrance and using an encumbrance with the above
information, that is, $150,000 has been authorized, $100,000
will go toward salaries and two offices have made orders for
$25,000 and $30,000.
No encumbrance - health appropriation
Total authorized 150,000
salary 100,000
available 50,000
outstanding orders
orders 55,000
over(under) (5,000)
Encumbrance - health available
Total authorized 150,000 150,000
salary 100,000 50,000
order 1 25,000 25,000
At this point the unit wanting to make an order for
$30,000 knows that such an order would lead to overspending.
In this fashion the encumbrance process subtracts orders
as soon as they are made rather than waiting until
the goods or services are delivered and the bill presented.
Encumbrance is an integral part of compliance accounting,
wherein governmental units cannot legally overspend legislature
authorization.
In actuality legislatures have moved away from detailed line item type budgets where the encumbrance process was
considered a
necessity to prevent illegal acts of overspending or spending for
items not authorized.
Legislatures give more flexibility to administrators by
allowing administrators to move money, within limits, among
categories within a fund. Such flexibility does not mean that
encumbrances are no longer necessary. Encumbrances are needed in
a compliance environment. But
now the limits on spending for a given functional area or
object are often set by administrators as spending guides
instead of legal mandates. For example, if spending and
commitments are pushing the ceiling on a functional area,
administrators often have the authority to shift money from
one function to another.
Return to menu for topic listings in the exercise and demonstration
section.
Posting and keeping track of journal entry results --
(demo)
The debits and credits of journal
entries are crucial
to keeping track of the relevant financial transactions
and events. However, the journal entries are in chronological
order, and, as a result, provide no summary information on the
status of each account such as cash, vouchers payable, or
revenues from a particular sources. Here is where the
posting process adds summary information for
each account
within a fund. In the posting process a search is made
of all the journal entries, picking data account by account,
and summarizing how much was added to and subtracted from
a particular account, such as cash.
Consider this simple example to show how posting provides
summary data on interest revenue and cash. The individual
journal entries are given then posted for these two accounts.
journal entries
cash 250,000
revenues 250,000
Cash is increased by collection of revenues.
short term investments 100,000
cash 100,000
Some of the cash is taken out of the cash account and
invested in a short term investment that pays
6.00% interest on an annualized basis or 0.50%(ie,
.06/12)
every month. The fund intends to keep the investment
for 6 months. The fund accruals the interest each
month.
Interest is actually paid every three months.
For simplicity, no compounding is done,
ie, the interest is
calculated on the principal and only the principal.
interest receivable 500
interest revenue 500
Accrued interest for one month, ie, ($100,000 * (.06/12)) = $500
interest receivable 500
interest revenue 500
The same as above for the next month.
cash 1,500
interest revenue 500
interest receivable 1,000
Interest is paid at the end of three months. The interest
receivable is reduced. Interest revenue is recognized for the
third month.
Notice, there is no summary information on any
of the accounts. How much is in cash and in interest revenue?
Posting from the journal entries to the accounts will
provide that summary information. Cash is presented first.
Cash balance
dr cr
250,000 250,000
100,000 150,000
1,500 151,500
The summary cash account is something a manager can scan and
read; there is a balance of $151,500 in it at the end of three
months.
The journal entries are critical for keeping day to day track
but the posting is
essential for managerial interests. It is necessary to be able
to pull up an account at any time to see the status.
The interest revenue account is
next.
Interest revenue balance
dr cr
500 500
500 1,000
500 1,500
Again, examining the interest revenue account is easier
than trying to figure out summary data from the journal entries.
Reading the accounts is not without its technical complexity.
In the above illustration, dr (debits) and cr (credits)
are still shown and can engender confusion. But these technical
aspects can be filtered out with only the balances presented.
Return to the menu of topic listings in the exercise and demonstration
section.
Proper order for the accounting cycle as requested in the scramble
exercise is given below:
accounting equations answers Answers to accounting equation exercise will go here.
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Journal entry answers will go here.
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