Introduction to Financial Accounting Horngren Sundem Elliott Philbrick
Introduction to Financial Accounting Horngren | Sundem | Elliott | Philbrick Recording Transactions 11 e Chapter 3
Learning Objective 1 Use Double-Entry Accounting Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall.
LO-1 The Double-Entry Accounting System Method followed for recording transactions, whereby every transaction affects at least two accounts q Accountants analyze each transaction to determine: q § Which accounts it affects § Whether to increase or decrease the balances § How much each balance will change Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -3
The Double-Entry Accounting System q LO-1 Transactions are recorded in: § General Journal: Chronological record of an organization’s transactions and how each transaction affects the balances in particular accounts § General Ledger: Collection of all ledger accounts that supports an organization’s financial statements § Ledger account: Listing of all the increases and decreases in a particular account Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -4
LO-1 General Ledger: T-Account Device used to portray individual ledger accounts in the general ledger q Each T-account takes the form of the capital letter T and represents an individual ledger account q Transactions affecting a particular ledger account are accumulated here q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -5
LO-1 General Ledger: T-Account Assets increase on the left side of the Taccount and decrease on the right side q Liabilities and owners’ equity accounts increase on the right side of the T-account and decrease on the left side q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -6
LO-1 General Ledger: T-Account q Balance: Net result of all activity that has been recorded in an account as of a particular point in time § In a T-account, it is the difference between the total left-side and right-side amounts § The balance in a ledger account at the end of the period is computed as: q Beginning balance + Amount of increases – Amount of decreases Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -7
LO-1 General Ledger In the double-entry system, every transaction affects at least two accounts q After each transaction, the balance sheet equation must always remain in balance q Assets = Liabilities + Stockholders’ Equity q The process of creating a new T-account in preparation for recording a transaction is called opening the account Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -8
LO-1 Recording Transactions in TAccounts 1. Initial investment by owners, $400, 000 cash § Analysis q q The asset Cash increases The stockholders’ equity Paid-in Capital increases Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -9
Recording Transactions in TAccounts 2. LO-1 Loan from bank, $100, 000 § Analysis q q The asset Cash increases The liability Note Payable increases Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -10
Recording Transactions in TAccounts 3. LO-1 Acquired store equipment for cash, $15, 000 § Analysis q q The asset Cash decreases The asset Store Equipment increases Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -11
LO-1 Debits and Credits q Accountants use the terms § Debit (abbreviated Dr. ): An entry or balance on the left side of any account § Credit (abbreviated Cr. ): An entry or balance on the right side of any account q Some accountants use the word “charge” instead of debit Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -12
Learning Objective 2 Describe the Five Steps in the Recording Process Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall.
LO-2 The Recording Process q Sequence of five steps in recording and reporting transactions Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -14
LO-2 Five Steps in Recording Process q Step 1 - Transaction documentation § Source documents: Original records supporting any transaction q q q Generated as a result of transactions Filed to verify details and accuracy of subsequent records Step 2 - General journal or book of original entry § Contains analysis of the transaction, based on the source documents Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -15
LO-2 Five Steps in Recording Process q Step 3 - Ledger § Enter transactions into ledger accounts q Step 4 - Trial balance § List of accounts in general ledger together with their balances § Aids in verifying clerical accuracy and in preparing financial statements Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -16
LO-2 Five Steps in Recording Process q Step 5 - Preparing financial statements § Occurs at least once a quarter, every three months, for publicly traded companies in the United States § Occurs at least annually for companies reporting under IFRS Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -17
LO-2 Chart of Accounts A numbered or coded list of all account titles q Typically arranged in order in which accounts appear in the financial statements q Varies across companies as a function of the size, nature, and complexity of the firm q May be used instead of account names q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -18
Learning Objective 3 Analyze and Journalize Transactions and Post Journal Entries to the Ledgers Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall.
LO-3 Journalizing Transactions This is Step 2 of the recording process q Journalizing: The process of entering transactions into the general journal q Journal entry q § An analysis of effects of a single transaction on various accounts, usually accompanied by an explanation q Identifies accounts to be debited and credited Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -20
LO-3 Recording Journal Entries q Conventions for recording journal entries in the general journal § Date and identification number comprise the first two columns § Accounts and Explanation in the third column q q Names of accounts affected Debit account titles on the left margin Credit account titles indented Narrative explanation of the transaction Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -21
LO-3 Recording Journal Entries § Fourth column is posting reference (Post Ref. ) q Contains identifying number from chart of accounts, which is used for cross-referencing to ledger accounts § Debit and credit columns are the fifth and sixth columns q q q Show the amounts debited (left-entry) or credited (right-entry) to each account Currency symbols not used Negative numbers do not appear Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -22
LO-3 Posting Transactions to the General Ledger This is Step 3 of the recording process q Posting: The transferring of amounts from general journal to the appropriate accounts in the general ledger q Cross-referencing q § Helps identify each general ledger posting to appropriate journal entry § Allows users to find all the components of the transaction in the general ledger Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -23
Posting Transactions to the General Ledger q LO-3 The following example shows § How the $15, 000 credit to Cash from the purchase of store equipment in transaction 3 is posted from the general journal to the general ledger § Columns for dates, explanations, journal references, and amounts in the ledger Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -24
Posting Transactions to the General Ledger Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. LO-3 3 -25
LO-3 Posting Transactions to the General Ledger q Another format for the general ledger § Shows a running balance of the account holdings in the far right column § Provides status report for account at a glance Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -26
LO-3 Simple and Compound Entry Simple entry: A journal entry for a transaction that affects only two accounts q Compound entry: A journal entry for a transaction that affects more than two accounts q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -27
Revenue and Expense Transactions LO-3 Assets = Liabilities + Stockholder’s Equity Assets = Liabilities + ( Paid-in Capital + Retained Earnings) The T-accounts can be grouped in the following way: = + Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. + 3 -28
Revenue and Expense Transactions LO-3 Revenue and expense information is accumulated separately to simplify the preparation of the income statement q However, revenue and expense accounts are part of retained earnings on the balance sheet q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -29
LO-3 Revenue and Expense Transactions q Revenue account accumulates items that increase retained earnings § Credit to revenue is effectively a credit to retained earnings q Expense account accumulates items that decrease retained earnings = § Debit to expense is effectively a debit to retained earnings § Debit entry increases expense, but decreases retained earnings Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -30
LO-3 Recording Revenue and Expense Transactions 10 a. Sales on credit, $160, 000 § Analysis q q The asset Accounts Receivable increases Stockholders’ equity, specifically Retained Earnings, increases because a revenue account, Sales Revenue, increases § Journal Entry Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -31
LO-3 Recording Revenue and Expense Transactions Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -32
LO-3 Recording Revenue and Expense Transactions 10 b. Cost of merchandise inventory sold, $100, 000 § Analysis q q The asset Merchandise Inventory decreases Stockholders’ equity, specifically Retained Earnings, decreases because an expense account, Cost of Goods Sold, increases § Journal Entry Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -33
LO-3 Recording Revenue and Expense Transactions Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -34
Prepaid Expenses and Depreciation Transactions LO-3 12. Paid rent for 3 months in advance, $6, 000 § Analysis q q The asset Cash decreases The asset Prepaid Rent increases § Journal Entry Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -37
Prepaid Expenses and Depreciation Transactions Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. LO-3 3 -38
Prepaid Expenses and Depreciation Transactions LO-3 13. Recognized expiration of rental services, $2, 000 § Analysis q q The asset Prepaid Rent decreases Stockholders’ Equity, specifically Retained Earnings decreases because an expense account, Rent Expense , increases § Journal Entry Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -37
Prepaid Expenses and Depreciation Transactions Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. LO-3 3 -38
LO-3 Prepaid Expenses and Depreciation Transactions 14. Recognized depreciation, $100 § Analysis q q The asset-reduction account Accumulated Depreciation, Store Equipment increases Stockholders’ Equity, specifically Retained Earnings, decreases because an expense account, Depreciation Expense, increases § Journal Entry Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -41
Prepaid Expenses and Depreciation Transactions Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. LO-3 3 -42
LO-3 Accumulated Depreciation: Cumulative sum of all depreciation recognized since the date of acquisition of an asset q Also called Allowance for Depreciation q Contra account q § A separate but related account that offsets or is a deduction from a companion account Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -41
LO-3 Accumulated Depreciation § Balance is on opposite side as that of the related companion account § Contra asset: A contra account whose companion account is an asset q q Contra asset has a credit balance Balance in contra asset is deducted from the related asset account, which has a debit balance Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -42
LO-3 Book Value: Balance of an account shown on the books, minus the value of any associated contra accounts q Called net book value, carrying amount, carrying value q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -43
Learning Objective 4 Prepare and Use a Trial Balance Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall.
LO-4 Preparing the Trial Balance q Purpose § Help check accuracy of postings § Establish a summary of balances in all accounts q Total debits should equal total credits Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -45
LO-4 Preparing the Trial Balance List assets, liabilities, and stockholders’ equity followed by the income statement accounts, revenues and expenses q All accounts except retained earnings show their balances as of the date the trial balance is prepared q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -46
LO-4 Preparing the Trial Balance *If a Retained Earnings balance existed at the start of the accounting period, it would appear here. Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -47
Learning Objective 5 Close Revenue and Expense Accounts and Update Retained Earnings Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall.
Closing the Books and Deriving Financial Statements from the Trial Balance q LO-5 Close the books: To transfer the balances in all revenue and expense accounts to retained earnings § Resets the revenue and expense accounts to zero so that they are ready to record the next period’s transactions Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -49
Closing the Books and Deriving Financial Statements from the Trial Balance q LO-5 Closing entries: Journal entries that transfer balances in the “temporary” stockholders’ equity accounts (revenue and expense accounts) to the “permanent” stockholders’ equity account, Retained Earnings Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -50
Closing the Books and Deriving Financial Statements from the Trial Balance q LO-5 Two approaches to closing entries § Two step process q q Transfer revenue and expense accounts to an Income Summary account Transfer Income Summary account to Retained Earnings account § One step process q Transfer the revenue and expense accounts directly into Retained Earnings account, bypassing the Income Summary account Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -51
LO-5 Closing the Accounts There are three closing entries: C 1: Close all revenue accounts C 2: Close all expense accounts C 3: Close the Income Summary account Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 3 -54
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