The Accounting Cycle Capturing Economic Events Chapter 3

The Accounting Cycle Capturing Economic Events Chapter 3 Power. Point Authors: Susan Coomer Galbreath, Ph. D. , CPA Charles W. Caldwell, D. B. A. , CMA Jon A. Booker, Ph. D. , CPA, CIA Cynthia J. Rooney, Ph. D. , CPA Mc. Graw-Hill/Irwin Copyright © 2012 The Mc. Graw-Hill Companies, Inc. 3 -1

The Role of Accounting Records Establishes accountability for assets and transactions. Keeps track of routine business activities. Obtains detailed information about a particular transaction. Evaluates efficiency and performance within company. Maintains evidence of a company’s business activities. 3 -2

The Ledger Cash Accounts Payable Capital Stock Accounts are individual records showing increases and decreases. The entire group of accounts is kept together in an accounting record called a ledger. 3 -3

The Use of Accounts Increases are recorded on one side of the T account, and decreases are recorded on the other side. Title of Account Left or Debit Side Right or Credit Side 3 -4

Debit and Credit Entries Receipts are on the debit side. Payments are on the credit side. The balance is the difference between the debit and credit entries in the account. 3 -5

Debit and Credit Entries Debits and credits affect accounts as follows: A = L + OE ASSETS LIABILITIES EQUITIES Debit Credit for Increase Debit Credit for Decrease Increase 3 -6

Double Entry Accounting The Equality of Debits and Credits A = L + OE = Debit balances Credit balances In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits. 3 -7

Let’s record selected transactions for JJ’s Lawn Care Service in the accounts. 3 -8

May 1: Jill Jones and her family invested $8, 000 in JJ’s Lawn Care Service and received 800 shares of stock. Cash increases $8, 000 with a debit. Capital Stock increases $8, 000 with a credit. 3 -9

May 2: JJ’s purchased a riding lawn mower for $2, 500 cash. Cash decreases $2, 500 with a credit. Tools & Equipment increases $2, 500 with a debit. 3 -10

May 8: JJ’s purchased a $15, 000 truck. JJ’s paid $2, 000 in cash and issued a note payable for the remaining $13, 000. Truck increases $15, 000 with a debit. 3 -11

May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. Tools & Equipment decreases $150 with a credit. 3 -12

The Journal In an actual accounting system, transactions are initially recorded in the journal. 3 -13

Posting Journal Entries to the Ledger Accounts Posting simply means updating the ledger accounts for the effects of the transactions recorded in the journal. 3 -14

Posting Journal Entries to the Ledger Accounts 3 -15

Posting Journal Entries to the Ledger Accounts 3 -16

Posting Journal Entries to the Ledger Accounts Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service. 3 -17

Ledger Accounts After Posting This ledger format is referred to as a running balance. 3 -18

Ledger Accounts After Posting T accounts are simplified versions of the ledger account that only show the debit and credit columns. 3 -19

What is Net Income? Net income is not an asset it’s an increase in owners’ equity from profits of the business. A = L + OE Increase Decrease As income is earned, either an asset is increased or a liability is decreased. Increase Net income always results in the increase of Owners’ Equity 3 -20

Retained Earnings A = L + OE Capital Stock Retained Earnings The balance in the Retained Earnings account represents the total net income of the corporation over the entire lifetime of the business, less all amounts which have been distributed to the stockholders as dividends. 3 -21

The Income Statement: A Preview The income statement summarizes the profitability of a business for a specified period of time. 3 -22

Accounting Periods Time Period Principle To provide users of financial statements with timely information, net income is measured for relatively short accounting periods of equal length. 3 -23

Revenue and Expenses The price for goods sold and services rendered during a given accounting period. Increases owners’ equity. The costs of goods and services used up in the process of earning revenue. Decreases owner’s equity. 3 -24

The Matching Principle: When To Record Revenue Matching Principle Revenue should be recognized at the time goods are sold and services are rendered. 3 -25

The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up. 3 -26

The Accrual Basis of Accounting Current Accounting Period Jan. 1, 2011 Future Accounting Period Dec. 1, 2011 Cash is received or paid here Jan. 1, 2012 But. . . Dec. 1, 2012 The income statement reports revenue or expense here OR The income statement reports revenue or expenses here But. . . Cash is received or paid here 3 -27

Debit and Credit Rules for Revenue and Expenses decrease owners’ equity. EQUITIES Debit Credit for Decrease Increase Revenues increase owners’ equity. EXPENSES REVENUES Debit Credit for Increase Debit Credit for Decrease Increase 3 -28

Dividends Payments to owners decrease owners’ equity. EQUITIES Debit Credit for Decrease Increase DIVIDENDS Debit Credit for Increase Decrease Owners’ investments increase owners’ equity. CAPITAL STOCK Debit Credit for Decrease Increase 3 -29

Let’s analyze the revenue and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction. 3 -30

May 29: JJ’s provided lawn care services for a client and received $750 in cash. Cash increases $750 with a debit. 3 -31

May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Cash decreases $50 with a credit. 3 -32

May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Cash decreases $200 with a credit. 3 -33

Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May. 3 -34

All balances are taken from the ledger accounts on May 31 after considering all of JJ’s transactions for the month. 3 -35

The Accounting Cycle in Perspective Accountants spend much of their time focusing on the more analytical aspects of their discipline. 3 -36

End of Chapter 3 3 -37