The Accounting Cycle Capturing Economic Events Chapter 3

The Accounting Cycle: Capturing Economic Events Chapter 3 Mc. Graw-Hill/Irwin Copyright © 2010 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 Share Capital 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 + E 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 + E = 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

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

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

8 May: 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 Will Truck increase $15, 000 with a debit. or decrease? Will Cash and Notes Payable increase or decrease? 3 -11

11 May: JJ’s purchased some repair parts for $300 on account. Tools Will & Tools Equipment & Equipment increases $300 increase with or decrease? a debit. Will Accounts Payable increase or decrease? 3 -12

18 May: 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 Will & Tools Equipment & decreases Equipment$150 increase with a or decrease? credit. Will Accounts Receivable increase or decrease? 3 -13

The Journal In an actual accounting system, transactions are initially recorded in the journal. 3 -14

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 -15

Posting Journal Entries to the Ledger Accounts 3 -16

Posting Journal Entries to the Ledger Accounts 3 -17

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 -18

Ledger Accounts After Posting This ledger format is referred to as a running balance. 3 -19

Ledger Accounts After Posting T accounts are simplified versions of the ledger account that only show the debit and credit columns. 3 -20

What is Profit? Profit is not an asset it’s an increase in equity from profits of the business. A = L + E Increase Decrease As income is earned, either an asset is increased or a liability is decreased. Increase Profit always results in the increase of Equity 3 -21

Retained Earnings A = L + E Share Capital Retained Earnings The balance in the Retained Earnings account represents the profit of the corporation over the entire lifetime of the business, less all amounts which have been distributed to the shareholders as dividends. 3 -22

The Income Statement: A Preview The income statement summarizes the profitability of a business for a specified period of time. 3 -23

Accounting Periods Time Period Principle To provide users of financial statements with timely information, profit is measured for relatively short accounting periods of equal length. 3 -24

Revenue and Expenses The price for goods sold and services rendered during a given accounting period. Increases equity. The costs of goods and services used up in the process of earning revenue. Decreases equity. 3 -25

The Matching Principle: When To Record Revenue Matching Principle Revenue should be recognized at the time goods are sold and services are rendered. 3 -26

The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up. 3 -27

The Accrual Basis of Accounting Current Accounting Period 1 Jan. 2009 Future Accounting Period 1 Dec. 2009 Cash is received or paid here 1 Jan. 2010 But. . . 1 Dec. 2010 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 -28

Debit and Credit Rules for Revenue and Expenses decrease equity. EQUITIES Debit Credit for Decrease Increase Revenues increase equity. EXPENSES REVENUES Debit Credit for Increase Debit Credit for Decrease Increase 3 -29

Dividends Payments to owners decrease equity. EQUITIES Debit Credit for Decrease Increase DIVIDENDS Debit Credit for Increase Decrease Owners’ investments increase equity. SHARE CAPITAL Debit Credit for Decrease Increase 3 -30

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 -31

29 May: JJ’s provided lawn care services for a client and received $750 in cash. Cash Will Cash increases increase $750 or with decrease? a debit. Will Sales Revenue increase or decrease? 3 -32

31 May: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Will Cash increase Cash decreases $50 or decrease? with a credit. Will Gasoline Expense increase or decrease? 3 -33

31 May: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Will Cash decreases increase $200 or decrease? with a credit. Will Dividends increase or decrease? 3 -34

Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May. 3 -35

All balances are taken from the ledger accounts on 31 May after considering all of JJ’s transactions for the month. 3 -36

The Accounting Cycle in Perspective Accountants spend much of their time focusing on the more analytical aspects of their discipline. 3 -37

End of Chapter 3 3 -38