CHAPTER 3 The Mechanics of Accounting Learning Objective

CHAPTER 3 The Mechanics of Accounting

Learning Objective 1 Understand the process of transforming transaction data into useful accounting information.

What Are the Different Exchange Transactions? Borrow and invest money. Buy and sell goods or services. Purchase land, buildings, and equipment. Exchange Transactions Pay wages to employees. Pay taxes to the government. Distribute earnings to owners.

Business Documents n Examples: Sales invoice, purchase order, check stub. n Business documents are used uto confirm that an arm’s-length transaction has occurred. uto establish the amounts to be recorded. uto facilitate the analysis of business events. These documents must be analyzed. n

What is the Sequence of the Accounting Cycle? Step 1 2 3 4 Analyze transactions. Record the effects of the transactions. Summarize the effects of transactions. 1. Posting journal entries. 2. Preparing a trial balance. Prepare reports. 1. Adjusting entries. 2. Preparing financial statements. 3. Closing the books.

Learning Objective 2 Analyze transactions and determine how those transactions affect the accounting equation (step one of the accounting cycle).

Step 1: Analyze Transactions Transaction analysis framework À What accounts are involved? Á Did each account Transaction analysis: increase or decrease? u breaks down complex By how much? transactions into manageable pieces. u provides a self-checking mechanism.

What Is the Accounting Equation? Assets = Liabilities + Owners’ Equity Resources = Creditors’ claims against resources + Owners’ claims against resources

Describe Effect of the Following Transactions on a Company. A Borrow money Invest in company Pay off a note Purchase equipment Borrow funds to settle a debt = L + OE

What Is the Rule of Double-Entry Accounting? The debits must always equal the credits. Debits = Credits

Using Accounts provide an efficient method to categorize transactions. n A T-account is a simplified depiction of an account. n Name of Account Debit Credit

Using a T-Account The cash account has a beginning balance of $35. A check for $12 is written to pay for supplies. Using a T-account, what is the ending balance of the cash account? Cash 35 23 12

Debits and Credits Remember: Debits are simply entries on the left. Credits are simply entries on the right.

Debits and Credits Assets = Liabilities + Owners’ Equity DR CR (+) (-) (+) Asset accounts: Debit is an increase. Credit is a decrease. Liabilities and owners’ equity accounts: Debit is a decrease. Credit is an increase.

Expanding the Equation Revenues Increases in a company’s resources from the sale of goods or the performance of services. Expenses Decreases in a company’s resources incurred in the normal course of business to generate revenues. Dividends Distributions to owners, which reduce Owners’ Equity.

Expanded Accounting Equation Assets DR + CR – Liabilities = DR – CR + Capital Stock DR – Expenses DR + CR – + Owners’ Equity DR – Retained Earnings CR + DR – Dividends DR + CR – CR + Revenues DR – CR +

Learning Objective 3 Record the effects of transactions using journal entries (step two of the accounting cycle).

Step 2: Record Transactions Record the results of the transactions in a journal. n Journalizing provides a chronological record of all business activities. n What is another name for the journal? Journal -book of original entry

Step 2: Record Transactions n n Record the results of the transactions in a journal. Journalizing provides a chronological record of all business activities. General Journal Entry Format: Date Debit Entry. . . . xx Credit Entry. . . Explanation. xx

Journal Entries What is the three-step process? 1 Identify which accounts are involved. 2 For each account, determine if it is increased or decreased. 3 For each account, determine by how much it will change.

Example 1: Journal Entry Supplies purchased for $25 are purchased “on account. ” Prepare the correct journal entry. What do we mean by purchased “on account”? Jan. 1 Supplies. . . . 25 Accounts Payable. . . . 25 Purchased supplies on account. We purchase on credit and use accounts payable.

Example 2: Journal Entry A check for $100 is received in payment for services rendered. Make the correct journal entry. Feb. 1 Cash. . . . . 100 Revenue. . . . Received cash for services. 100

Example 3: Journal Entry Merchandise is sold to a customer on account for $75. The cost of the product was $60. Make the journal entries. Mar. 1 Accounts Receivable. . . . 75 Sales Revenue. . . 75 Sold merchandise on account. Mar. 1 Cost of Goods Sold. . 60 Inventory. . . . 60 To record cost and reduce inventory.

Journal 1 Date Transaction Jan. 1 Supplies Accounts Payable Page 1 Ref. Debits Credits 25 25 Purchased supplies on account. Feb. 1 Cash Revenue 101 100 Received cash for services. Mar. 1 Accounts Receivable Sales Revenue 75 75 Sold merchandise on account. Entered when posted to ledger.

Learning Objective 4 Summarize the resulting journal entries through posting and prepare a trial balance (step three of the accounting cycle).

Step 3: Posting Journal Entries and Preparing a Trial Balance Posting Define the Following Terms transferring amounts from the journal to the ledger. Ledger a book of accounts where journal transactions are posted and thereby summarized. Posting reference a cross-reference number between the general journal and the accounts in the general ledger. Chart of accounts a systematic listing of all accounts used by a company.

General Ledger ACCOUNT: Cash Date Explanation Account No. 101 Ref. Debits Credits Jan. 1 Balance 100 2 Issued 100 shares of capital stock at $10 per share GJ 1 3 Purchased equipment GJ 1 4 Sold inventory GJ 1 5 Monthly payment on loan GJ 1 6 Revenue GJ 1 1, 000 1, 100 300 60 860 230 2, 500 800 630 3, 130

Chart of Accounts ASSETS (100 -199): Current Assets (100 -150): 101 Cash 105 Accounts Receivable 107 Inventory Long-Term Assets (151 -199): 151 Land 152 Buildings OWNERS’ EQUITY (300 -399): 301 Capital Stock 330 Retained Earnings SALES (400 -499): 400 Sales Revenue EXPENSES (500 -599): 500 Cost of Goods Sold 501 Sales Salaries and Commissions LIABILITIES (200 -299): 523 Rent Expense Current Liabilities (200 -219): 528 Advertising Expense 201 Notes Payable 573 Utilities Expense 202 Accounts Payable 579 Accounting and Legal Long-Term Liabilities (220 -239): Fees 222 Mortgage Payable

Determining Account Balances Name of Account An account’s balance is usually on the side that increases the account. It is referred to as the “Normal Balance. ” Debit Credit Accounts with typical debit typical credit balances are? Expenses Assets Dividends Owners’ Equity Revenues or Income Liabilities Do you see the mnemonic memory device, DEAD COIL?

Define The Trial Balance What is the Trial Balance used for? From the data in the trial balance, the balance sheet and income statement can be prepared. A listing of all account balances; provides a means to assure that debits equal credits.

Sample Trial Balance The Example Company Trial Balance December 31, 2003 Debits Cash $ 21 Accounts Receivable The trial 15 Inventory 12 shows balance Land 200 that debits Accounts Payable Capital Stock equal credits. Retained Earnings Sales Revenue Cost of Goods Sold 850 Advertising Expense 10 Miscellaneous Expenses 15 Total $ 1, 123 Credits $ 30 150 24 919 ______ $ 1, 123

Learning Objective 5 Describe how technology has affected the first three steps of the accounting cycle.

Advantages of Computers 9 Large amounts of information can be quickly processed without mathematical errors. 9 More documents can be produced than humanly possible in the same amount of time. 9 Common tasks can be automated for increased efficiency.

Disadvantages of Computers – Computer hardware and software require human judgment and input. – GIGO (garbage in, garbage out). – Once an error is identified, fixing the problem may require many adjustments.

End Chapter 3