Chapter 2 The Recording Process of Accounting Information

Chapter 2 The Recording Process of Accounting Information ACCT 100

Objectives of the Chapter I. Definitions of accounts on the financial statements (F/S). II. Learning the accounting process (AP) in preparing financial statements. a. using the accounting equation, b. using the double-entry system. Processing Accounting Information 2

I. Definitions of Accounts on Financial Statements n n n Assets: economic resources that benefit the business in the future, including: Cash: in all forms: (coins, currency, checking accounts, …) Account receivable: an oral promise for future cash receipt as a result of sales. Inventory (or merchandise): goods for sale. Note receivable: a written promissory note that the customer will pay a fixed amount by a certain date. Processing Accounting Information 3

I. Definitions of Accounts on Financial Statements (contd. ) n n Prepaid expenses: expenses paid in advance. Land: recorded at cost of land. Buildings: record at cost, subject to depreciation. Equipment, furniture and fixture: record at cost, subject to depreciation. Processing Accounting Information 4

I. Definitions of Accounts on Financial Statements (contd. ) Liabilities: legal obligations. n n Note Payable: a written promissory note that the business promises to pay. Account payable: an oral promise to pay, arising from credit purchases of inventory and other goods. Accrued liabilities: liabilities that have occurred but have not been paid. For example: salary payable, interest payable, etc. Processing Accounting Information 5

I. Definitions of Accounts on Financial Statements (contd. ) n n Stockholders’ equity: the owners’ claims to the assets of a corporation including: Common stock: represents the owners’ investment. Retained earnings: the cumulative net income earned by the corporation over its lifetime , minus cumulative losses and dividends. Dividends: distribution of earnings to stockholders. Processing Accounting Information 6

I. Definitions of Accounts on Financial Statements (contd. ) n n Revenues: increase or inflow of assets; will eventually increase stockholders’ equity (i. e. , sales revenue) Expenses: decrease or outflow of assets; will eventually decrease stockholders’ equity. Gains: increase in assets from incidental transactions not related to the major operation. Losses: decrease in assets from incidental transactions. Processing Accounting Information 7

II. Accounting Process and Preparation of Financial Statements n How do accountants prepare financial statements? u. Identify, measure and record business transactions for business entities Processing Accounting Information 8

Accounting Process (Cont. ) a. Using the accounting equation. Accounting Equation: Assets = Liabilities + Stockholders’ Equity b. Using the double-entry system (the process includes the recording of Journal entries, posting Journal entries to ledger accounts, work sheet (including adjustments…), prepare financial statements and closing 9 entries) Processing Accounting Information

a. Using the Accounting Equation - Exhibit 2 -1 (from Financial Accounting by Harrison and Horegren) Analysis of Air & Sea Travel, Inc. , Transactions Panel A - Details of transactions (1) Issued stock to the owners who invested $50, 000 cash in the business. (2) Paid $40, 000 cash for land. (3) Bought $500 of office supplies on account. (4) Received $5, 500 cash from customers for service revenue earned. Processing Accounting Information 10

Using the Accounting Equation - Exhibit 2 -1 (contd. ) (5) Performed services for customers on account, $3, 000. (6) Paid cash expenses: rent, $1, 100; employee salary, $1, 200; utilities, $400. (7) Paid $400 on the account payable created in Transaction 3. (8) Owners paid personal funds to remodel home. This is not a transaction of the business. Processing Accounting Information 11

Using the Accounting Equation - Exhibit 2 -1 (contd. ) (9) Received $1, 000 on the account receivable created in Transaction 5. (10) Sold land for cash at its cost of $22, 000. (11) Declared and paid a dividend of $2, 100 to the stockholders. Processing Accounting Information 12

Using the Accounting Equation - Exhibit 2 -1 (contd. ) Statement of Cash Flows Data Income Statement Data PANEL B - Analysis of transactions Balance Sheet Data For Financial statements, see Exhibit 2 -2. Processing Accounting Information 13 13

b. Introduction of the Double. Entry System and Journal Entries A. Double-entry system B. The T- accounts C. Increases and decreases in the accounts D. Examples of journalizing and posting transactions Processing Accounting Information 14

A. Double-Entry System n n Each transaction affects at least two accounts and the balance of the accounting equation must be maintained. Example: Purchases inventory and charges to accounts payable Assets = Liabilities + Equity Inventory Accounts Payable + + Processing Accounting Information 15

A. Double-Entry System (contd. ) Processing Accounting Information 16

B. Introduction of the Taccount Inventory Debit Credit Accounts Payable Debit Processing Accounting Information Credit 17

C. Increases and Decreases in the Accounts A L E Debit Credit Debit Revenue Credit Debit Expense Debit Credit Processing Accounting Information 18

D. Examples of Journalizing and Posting Transactions 1. Transaction: Air & Sea Travel, Inc. , received $50, 000 cash from the business and in turn issued common stock to them. Journal Entry: Cash 50, 000 Common Stock 50, 000 Issued common stock to owners. Ledger Accounts: Cash 50, 000 Common Stock 50, 000 Processing Accounting Information 19

D. Examples of Journalizing and Posting Transactions (contd. ) 2. Transaction: The business paid $40, 000 cash for land as a future office location. Journal Entry: Land Cash Paid cash for land. 40, 000 Ledger Accounts: Cash 50, 000 40, 000 Land 40, 000 Processing Accounting Information 20

D. Examples of Journalizing and Posting Transactions (contd. ) 3. Transaction: The business purchased $500 office supplies on account. Journal Entry: Office Supplies Accounts Payable 500 Ledger Accounts: Office Supplies 500 Accounts Payable 500 Processing Accounting Information 21

D. Examples of Journalizing and Posting Transactions (contd. ) 4. Transaction: The business performed travel service for clients and received cash of $5, 500. Journal Entry: Cash 5, 500 Service Revenue 5, 500 Ledger Accounts: Cash 50, 000 40, 000 5, 500 Service Revenue 5, 500 Processing Accounting Information 22

D. Examples of Journalizing and Posting Transactions (contd. ) 5. Transaction: The business performed service for clients who did not pay immediately. Air & Sea Travel billed the clients for $3, 000 on account. Journal Entry: Accounts Receivable Service Revenue 3, 000 Ledger Accounts: Accounts Receivable 3, 000 Service Revenue 5, 500 3, 000 8, 500 Processing Accounting Information 23

D. Examples of Journalizing and Posting Transactions (contd. ) 6. Transaction: The business paid $2, 700 for the following expenses: office rent, $1, 100; employee salary; $1, 200; and utilities, $400. Journal Entry: Rent Expense Salary Expense Utilities Expense Cash Ledger Accounts: Cash 50, 000 40, 000 5, 500 2, 700 Salary Expense 1, 200 1, 100 1, 200 400 2, 700 Rent Expense 1, 100 Utilities Expense 400 Processing Accounting Information 24

D. Examples of Journalizing and Posting Transactions (contd. ) 7. Transaction: The business paid $400 on the account payable created in Transaction 3. Journal Entry: Accounts Payable Cash 400 Ledger Accounts: Cash 50, 000 40, 000 5, 500 2, 700 400 Accounts Payable 400 500 100 Processing Accounting Information 25

D. Examples of Journalizing and Posting Transactions (contd. ) 8. Transaction: The Lyons remodeled their personal residence. This is not a transaction of the travel agency, so no journal entry is made. Processing Accounting Information 26

D. Examples of Journalizing and Posting Transactions (contd. ) 9. Transaction: The business collected $1, 000 cash on account from the clients in transaction 5. Journal Entry: Cash Accounts Receivable 1, 000 Ledger Accounts: Cash 50, 000 40, 000 5, 500 2, 700 1, 000 400 Accounts Receivable 3, 000 1, 000 2, 000 Processing Accounting Information 27

D. Examples of Journalizing and Posting Transactions (contd. ) 10. Transaction; The business sold land for its cost of $22, 000, receiving cash Journal Entry: Cash Land 22, 000 Ledger Accounts: Cash 50, 000 40, 000 5, 500 2, 700 1, 000 400 22, 000 Land 40, 000 22, 000 18, 000 Processing Accounting Information 28

D. Examples of Journalizing and Posting Transactions (contd. ) 11. Transaction: Air & Sea Travel, Inc. , paid the Lyons cash dividends of $2, 100. Journal Entry: Dividends Cash Ledger Accounts: Cash 50, 000 40, 000 5, 500 2, 700 1, 000 400 22, 000 2, 100 33, 300 2, 100 Dividends 2, 100 Processing Accounting Information 29

D. Examples of Journalizing and Posting Transactions (contd. ) n The followings are examples of Taccounts, trial balance and financial statements of the example in Exhibit 2. 1. Processing Accounting Information 30

Exhibit 2 -2 (from Financial Accounting by Harrison and Horgren) ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY A/P Cash (1) 50, 000 (2)40, 000 (7) 400 (3) 500 Bal. 100 (4) 5, 500 (6) 2, 700 (9) 1, 000 (7) 400 (10)22, 000 (11) 2, 100 Bal. 33, 300 A/R (5) 3, 000 (9) 1, 000 Bal. 2, 000 Office Supplies (3) 500 Bal. 500 Land (2) 40, 000 (10)22, 000 Bal. 18, 000 EXPENSES Comm Stock (1) 50, 000 Rent Exp. Bal. 50, 000 (6) 1, 100 Bal. 1, 100 Dividends (11) 2, 100 Bal. 2, 100 REVENUE Service Rev. (4) 5, 500 (5) 3, 000 Bal. 8, 500 Processing Accounting Information Salary Exp. (6) 1, 200 Bal. 1, 200 Utilities Exp. (6) 400 Bal. 400 31

Exhibit 2 -3 (from Financial Accounting by Harrison and Horngren) AIR & SEA TRAVEL, INC. Trail Balance 4/30/19 x 1 Account Title Cash Accounts receivable Office supplies Land Accounts payable Common Stock Dividends Service revenue Rent expense Salary expense Utilities expense Total Balance Debit Credit $33, 300 2, 000 500 18, 000 $ 100 50, 000 2, 100 8, 500 1, 100 1, 200 400 $58, 600 Processing Accounting Information 32

Exhibit 2 -4 (from Financial Accounting by Harrison and Horngren) AIR & SEA TRAVEL, INC. Income Statement Month Ended April 30, 19 x 1 Revenue: Service revenue ($5, 500+$3, 000). . . Expenses: Salary expense …………… Rent expense ……………. . Utilities expense …………. . Total expenses …………… Net income ………………. . $ 8, 500 $1, 200 1, 100 400 AIR & SEA TRAVEL, INC. Statement of Retained Earnings Month Ended April 30, 19 x 1 Retained earnings, April 1, 19 x 1 ……. . . Add: Net income for the month. . ……… Less: Dividends ……………. Retained earnings, April 30, 19 x 1……… Processing Accounting Information 2, 700 $5, 800 $ 0 5, 800 2, 100 $3, 700 33

Exhibit 2 -3 (contd. ) Statement of Retained Earnings Month Ended April 30, 19 x 1 Retained earnings, April 1, 19 x 1 ……. . . Add: Net income for the month. . ……… Less: Dividends ……………. Retained earnings, April 30, 19 x 1……… $ 0 5, 800 2, 100 $3, 700 AIR & SEA TRAVEL, INC. Balance Sheet April 30, 19 x 1 Assets Liabilities Cash …………. . . $33, 300 Accounts payable …. . . $ 100 A/R ……………. . 2, 000 Office supplies. . 500 Stockholders’ Equity Land …………. . . 18, 000 Common stock ………. 50, 000 Retained earnings …. . . 3, 700 Total stockholders’ equity ……………. . 53, 700 Total liabilities and Total assets ……. $53, 800 stockholders’ equity. . . $53, 800 Processing Accounting Information 34

Exhibit 2 -3 (contd. ) Balance Sheet, April 30, 19 x 1 Assets Cash …………. $33, 300 A/R …………. . . 2, 000 Office supplies ………. . . 500 Land …………. 18, 000 Total assets …………. … $53, 800 Liabilities Accounts payable ……………. . . $ 100 Stockholders’ Equity Common stock ………………. . 50, 000 Retained earnings ……………. . 3, 700 Total stockholders’ equity …. . 53, 700 Total liabilities and stockholders’ equity…………. . $53, 800 Statement of Cash Flows, Month Ended April 30, 19 x 1 Cash flows from operating activities: Receipts: Collections fm customers ($5, 500+1, 000) ……. . $ 6, 500 Payments: To suppliers and employees ($2700+400) ……. (3, 100) Net cash inflow fm operating activities ……. . . 3, 400 Cash flows from investing activities: Acquisition of land …………………. . $(40, 000) Sale of land ……………………. . 22, 000 Net cash outflow from investing activities…. . . (18, 000) Cash flows from financing activities: Issuance (sale) of stock to owners ………………. . $50, 000 Dividends ………………………. (2, 100) Net cash inflow from financing activities……. 47, 900 Net increase in cash …………………. . $33, 300 Cash balance, April 1, 19 x 1 ……………. 0 Cash balance, April 30, 19 x 1 ……………. . . $33, 300 Processing Accounting Information 35

An Example of the Journal and A Ledger Account (cash): Processing Accounting Information 36

An Example of the Journal and A Ledger Account (cash): (contd. ) The Ledger: all individual accounts (assets, liability, and stockholder’s equity accounts) combined make up the ledger. Processing Accounting Information 37

The Flows of Accounting Data Transaction Source Analysis. Transaction. Amounts Occurs Documents Takes Entered in. Posted to Prepared Place Journal Ledger Processing Accounting Information 38

The Normal Balance of an Account Assets Liabilities Stockholder’s Equity (overall) Common Stock Retained Earnings Dividends Revenues Expenses Debit Credit Debit Credit Debit Processing Accounting Information 39

The Chart of Accounts Processing Accounting Information 40