Ch02 - ACCT 1710 Introduction To Financial Accounting...

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Unformatted text preview: ACCT 1710 Introduction To Financial Accounting Chapter 2 The Recording Process Dr. HU Bingbing HKBU 1 Study Objectives 1. What is an account, and how it is used in recording process. 2. Explain debit and credit rule and double-entry system. 3. What are journal and ledger, how they are used in recording process. 4. Identify the basic steps in the recording process: Analyzing Journalizing (make accounting entries) Posting 5. Prepare a trial balance. 2 THE ACCOUNT An account: a device used by accountants to record increases and decreases in a specific asset, liability, equity, revenue or expense item. Storage unit for transactions Classifying and summarizing transactions of the same nature A separate account Each item Assets : Cash, Accounts Receivable, Supplies, Equipment, etc; Liabilities: Accounts Payable, Notes Payable, Salaries Payable, etc; Equity: Share Capital, Retained Earnings; Services Revenue, Utilities Expenses, etc 3 THE ACCOUNT T account: the simplest form of account. - account title : describe what is recorded - a left (or debit) side To record - a right (or credit) side increase or decrease Title of Account Left or debit side 4 Right or credit side T Account THE ACCOUNT (Cont.) Three-column form of account: standard form, for practical uses. Account title, account number Date, Explanation, and Ref. column Debit, Credit, and Balance column: 3 money columns 5 DEBITS,CREDITS AND BALANCE Debit (Dr.) = Left, Credit (Cr.) = Right. Directional signals An accounting custom Entering an amount on the left side of an account Debiting the account; Entering on the right side Crediting the account. Cash Debiting Balance 6 10,000 8,000 2,000 Crediting DEBITS,CREDITS AND BALANCE Account Balance: the difference between total debit and total credit amounts. Total debit amounts > Total credit amounts Debit Balance Total debit amounts < Total credit amounts Credit Balance Total debit amounts = Total credit amounts Zero Balance Supplies 1,000 Bal. 800 200 Accounts Payable 1,800 3,000 Bal. 1,200 7 DEBITS AND CREDITS RULES AND NORMAL BALANCE Debit and credit indicate: either increase or decrease Depend on the type of account involved Assets, Expenses, and Dividends accounts: AED Debits increase, Credits decrease. Liabilities, Share Capital, Retained earnings, and Revenues account: Debits decrease, Credits increase. LSRR Normal balance of an account: always on the increase side. 8 Asset s Debit / Dr. Credit / Cr. Liabilit ies Debit / Dr. Credit / Cr. Normal Balance Normal Balance Chapter 3-23 Chapter 3-24 Expense Debit / Dr. Credit / Cr. Equit y Debit / Dr. Credit / Cr. Normal Balance Normal Balance Chapter 3-27 Chapter 3-25 Dividends Debit / Dr. Credit / Cr. Revenue Debit / Dr. Credit / Cr. Normal Balance Chapter 3-26 Normal Balance 9 Chapter 3-27 EXPANDED BASIC EQUATION AND DEBIT/CREDIT RULES Basic Equation Assets = Liabilities + Equity Expanded Basic Equation Assets Dr. + Cr. - = Liabilities + Dr. -Cr. + + Share Capital Dr. -Cr. + + + Retained Earnings Dr. Cr. + + + Revenues Dr. Cr. + + The equation must be in balance after every transaction. For every Debit there must be a Credit. 10 - Dividends - Expenses Dr. + + Cr. Dr. + + Cr. - Review Questions 1. Debits: a. increase both assets and liabilities. b. decrease both assets and liabilities. c. increase assets and decrease liabilities. d. decrease assets and increase liabilities. 2.Accounts that normally have debit balances are: a. assets, expenses, and revenues. b. assets, expenses, and retained earnings. c. assets, liabilities, and dividends. d. assets, dividends, and expenses. 11 Exercise Time! Exercise Time! (a) For each account, indicate how an increase in the account is recorded (DR/CR) (b) For each account, indicate the normal balance (DR/CR) Account Increase NB 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Cash (Example) Accounts Receivable Rent Expense Service Revenue Accounts Payable Share Capital Dividends Unearned Revenue Insurance Expense Notes Payable Retained Earnings 12 DOUBLE-ENTRY SYSTEM A system that records in appropriate accounts the dual effect of each transaction. Each transaction must affect at least two accounts (at least one debit and one credit). For each transaction, total debits must always equal total credits. The accounting equation will always stay in balance. Assets 13 Liabilities Equity MAKING ENTRY Under double-entry system, the effect of each transaction is recorded through making entry. A complete entry consists of: 1. the date of the transaction; 2. the accounts and amounts to be debited and credited Always put debit account and debit amount first, then credit account and credit amount Total debits must equal total credits 3. a brief explanation of the transaction. Sept. 1 Cash 15,000 Share Capital 15,000 Issued shares of stock for cash. 14 Example: Company purchased equipment $5,000 for cash. Accounts affected Equipment A+ Dr. Cash A+Cr. Entry: Equipment 5,000 Cash 5,000 Specific Accounts Type Increase/Decrease Dr./Cr. 15 Exercise Selected transaction of T. Carter Inc., an interior decorating firm, in its first month of business, are as follows. Do: for each transaction indicate the following Jan.2 Invested $20,000 cash in business in exchange for common stock. 3 Paid $500 cash for advertising. 9 Purchased equipment for $7,000 cash. 11 Billed customers $2,300 for service performed. 16 Purchased supplies on account for $700. 20 Received $1,100 from customer billed on Jan.11. 23 Paid creditor $400 cash on balance owed. 28 Paid a $1,200 cash dividend. The specific accounts affected; The basic type of accounts affected (A,L, E, etc.); Whether the specific account is increased or deceased; Whether the specific account should be debited or credited. 16 17 STEPS IN THE RECORDING PROCESS Three basic steps: 1. Analyze each transaction: based upon business documents (eg. a sales slip, a check, a bill, or a cash register tape). 2. Making Entry to record the transaction in a journal Journalizing 3. Transfer the journal entries to the appropriate accounts in the ledger Posting. 18 Step1. Analyzing Transactions 1.Determine what accounts are affected 2.Determine whether each account is increased or decreased, and by how much. 3.Apply debit and credit rules to translate the increases and decreases into debits and credits: Account Type+ incr./decr. 19 Step2. JOURNALIZING Apply the double-entry rules to make entries. Entries are first recorded in journal journalizing. One entries for one transaction : in chronological order. 20 THE JOURNAL Journal: a book of original entries, where transactions are initially recorded in chronological order. General journal contains 5 columns: 1. Date; 2. Account Titles and Explanations; 3. Ref.; 4. Debit and Credit. 21 TECHNIQUE OF JOURNALIZING SIX STEPS September 1, stockholders invested $15,000 cash in the corporation in exchange for shares of stock. 1.The date of the transaction is entered in the date 1.The date of the transaction is entered in the date column. column. 22 ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING 2. The debit account title is entered first at the 2. The debit account title is entered first at the extreme left margin of the Account Titles and extreme left margin of the Account Titles and Explanation column. The amount of the debits is Explanation column. The amount of the debits is recorded in the Debit column. recorded in the Debit column. 23 ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING 3. The credit account title is indented and entered 3. The credit account title is indented and entered on the next line in the Account Titles and on the next line in the Account Titles and Explanation column. The amount of the credits is Explanation column. The amount of the credits is recorded in the Credit column. recorded in the Credit column. !!! Equality of debits and credits. 24 ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING 4. A brief explanation of the transaction is given. 4. A brief explanation of the transaction is given. 25 ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING 5. A space is left between journal entries. The 5. A space is left between journal entries. The blank space separates individual journal entries blank space separates individual journal entries and makes the entire journal easier to read. and makes the entire journal easier to read. 26 ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING 6. The Ref. column is left blank at the time journal 6. The Ref. column is left blank at the time journal entry is made and is used later when the journal entry is made and is used later when the journal entries are transferred to the ledger accounts. entries are transferred to the ledger accounts. 27 SIMPLE AND COMPOUND JOURNAL ENTRIES SIMPLE AND COMPOUND JOURNAL ENTRIES Simple Entry Two accounts, one debit and one credit. Compound Entry Three or more accounts. (Note all debit accounts are listed before any credit accounts.) Example On June 15, H. Burns, purchased equipment for $15,000 by paying cash of $10,000 and the balance on account (to be paid within 30 days). Dat e J une 15 Account Tit le Eq uipm e nt Ca s h Ac c o unt s pa y a b le (Pur c ha s e d e q uipm e nt ) General Journal Ref . Debit ,0 0 0 15 Credit ,0 0 0 10 5 ,0 0 0 28 !!!In a compound entry, the total debit !!!In a compound entry, the total debit must equal total credit amounts!!! must equal total credit amounts!!! COMPOUND JOURNAL ENTRY This is the wrong format; all debits must be This is the wrong format; all debits must be listed before the credits are listed. listed before the credits are listed. 29 Step 3. Posting Posting: transferring journal entries to the ledger accounts. 4 steps involved: 1. Journal Ledger (debit account): date, journal page, and amount 2. Enter debit account number in journal reference column 3. Journal Ledger (credit account): date, journal page, and amount 4. Enter credit account number in journal reference column Posting should be completed chronologically. Entry-by-entry 30 THE LEDGER THE LEDGER Ledger: the entire group of accounts maintained by a company. A collection of accounts: Assets, Liabilities, Equity, etc; A bound record book (each account is kept on a separate page). Ledger accounts are arranged in the order in which they are presented in the financial statements. Individual Assets Equipment Land Supplies Cash 31 Individual Liabilities Interest Payable Salaries Payable Accounts Payable Individual Equity Salaries Expense Service Revenue Share Capital Retained Earnings Notes Payable CHART OF ACCOUNTS Most companies have a chart of accounts that lists the accounts and the Most companies have a chart of accounts that lists the accounts and the account numbers which identify their location in the ledger. Accounts are account numbers which identify their location in the ledger. Accounts are numbered starting with the B/S accounts followed by the I/S accounts. numbered starting with the B/S accounts followed by the I/S accounts. 32 POSTING A JOURNAL ENTRY Step1: In the ledger, enter in the appropriate columns of the account (s) debited the date, journal page, and debit amount shown in the journal. GENERAL JOURNAL Date 2008 Sept. 1 Account Titles and Explanation Cash Share Capital ( issued shares of stock for cash) Ref. Debit 15,000 15,000 Credit J1 GENERAL LEDGER CASH Date 2008 Sept. 1 Explanation Ref. J1 Debit 15,000 Credit NO. 101 Balance 15,000 NO. 311 Share Capital COMMON STOCK Date Explanation Ref. Debit Credit Balance 33 POSTING A JOURNAL ENTRY Step2: In the reference column of the journal, write the Step2: In the reference column of the journal, write the account number to which the debit amount was account number to which the debit amount was posted. posted. J1 GENERAL JOURNAL Date 2008 Sept. 1 Account Titles and Explanation Cash Share Capital (issued shares of stock for cash) Ref. Debit Credit 101 15,000 15,000 GENERAL LEDGER CASH Date 2008 Sept 1 Sept. 1 Explanation Ref. J1 Debit 15,000 Credit NO. 101 Balance 15,000 NO. 311 Date 2001 Sept. 1 Explanation COMMONCapital Share STOCK Ref. Debit Credit Balance 34 POSTING A JOURNAL ENTRY Step3: In the ledger, enter in the appropriate columns of the account(s) Step3: In the ledger, enter in the appropriate columns of the account(s) credited the date, ,journal page, ,and credit amount shown in the journal. credited the date journal page and credit amount shown in the journal. GENERAL JOURNAL Date 2008 Sept. 1 Account Titles and Explanation Cash Share Capital (issued shares of stock for cash) Ref. Debit Credit 101 15,000 15,000 J1 GENERAL LEDGER CASH Date 2008 Sept. 1 Explanation Ref. J1 Debit 15,000 Credit NO. 101 Balance 15,000 NO. 311 Date 2008 Sept. 1 Explanation Share Capital Ref. J1 Debit Credit 15,000 Balance 15,000 35 POSTING A JOURNAL ENTRY Step4: In the reference column of the journal, write the Step4: In the reference column of the journal, write the account number to which the credit amount was account number to which the credit amount was posted. posted. GENERAL JOURNAL Date 2008 Sept. 1 Account Titles and Explanation Cash Share Capital (issued shares of stock for cash) Ref. Debit Credit 101 15,000 311 J1 15,000 GENERAL LEDGER CASH Date 2008 Sept. 1 Explanation Ref. J1 Debit 15,000 Credit NO. 101 Balance 15,000 NO. 311 Share Capital Date 2008 Sept. 1 Explanation Ref. J1 Debit Credit 15,000 Balance 15,000 36 ILLUSTRATION 2-20 INVESTMENT OF CASH BY STOCKHOLDERS Transaction October 1, stockholders invest $10,000 cash in an advertising venture to be known as the Pioneer Advertising Agency Inc. Basic Analysis The asset Cash is increased $10,000, and Share Capital is increased $10,000. Debit -Credit Analysis 37 Debits increase assets: debit Cash $10,000. Credits increase equity: credit Share capital $10,000. ILLUSTRATION 2-20 INVESTMENT OF CASH BY STOCKHOLDERS 10, 000 10,000 Share Capital Posting 10,000 10,000 38 ILLUSTRATION 2-21 PURCHASE OF OFFICE EQUIPMENT Transaction October 1, office equipment costing $5,000 is purchased by signing a 3-month, 12%, $5,000 note payable. Basic Analysis The asset Office Equipment is increased $5,000, and the liability Notes Payable is increased $5,000. Debit -Credit Analysis 39 Debits increase assets: debit Office Equipment $5,000. Credits increase liabilities: credit Notes Payable $5,000. ILLUSTRATION 2-21 PURCHASE OF OFFICE EQUIPMENT 5,00 0 5,000 Posting 5,000 5,000 40 ILLUSTRATION 2-22 RECEIPT OF CASH FOR FUTURE SERVICE October 2, a $1,200 cash advance is received from R. Knox, a client, for advertising services that are expected to be completed by December 31. Transaction Basic Analysis The asset Cash is increased $1,200; the liability Unearned Revenue is increased $1,200 because the service has not been rendered yet. Note that although many liabilities have the word "payable" in their title, unearned revenues are considered a liability even though the word payable is not used. 41 Debit -Credit Analysis Debits increase assets: debit Cash $1,200. Credits increase liabilities: credit Unearned Revenues $1,200. ILLUSTRATION 2-22 RECEIPT OF CASH FOR FUTURE SERVICE Journal Entry 1,200 1,200 Posting 1,200 Unearned Rev 209 Oct. 2 1,200 42 ILLUSTRATION 2-23 PAYMENT OF MONTHLY RENT Transaction October 3, office rent for October is paid in cash, $900. Basic Analysis The expense Rent is increased $900 because the payment pertains only to the current month; the asset Cash is decreased $900. Debit-Credit Analysis 43 Debits increase expenses: debit Rent Expense $900. Credits decrease assets: credit Cash $900. ILLUSTRATION 2-23 PAYMENT OF MONTHLY RENT 900 900 Posting 900 Rent Expense Oct. 3 900 729 44 ILLUSTRATION 2-24 PAYMENT FOR INSURANCE Transaction October 4, $600 is paid for a one-year insurance policy that will expire next year on September 30. Basic Analysis The asset Prepaid Insurance is increased $600 because the payment extends to more than the current month; the asset Cash is decreased $600. Note that payments of expenses that will benefit more than one accounting period are identified as prepaid expenses or prepayments. When a payment is made, an asset account is debited in order to show the service or benefit that will be received in the future. 45 Debit -Credit Analysis Debits increase assets: debit Prepaid Insurance $600. Credits decrease assets: credit Cash $600. ILLUSTRATION 2-24 PAYMENT FOR INSURANCE 600 600 Posting Cash Oct. 1 10,000 Oct. 3 2 1,200 4 101 900 600 600 46 ILLUSTRATION 2-25 PURCHASE OF SUPPLIES ON CREDIT October 5, an estimated 3-month supply of advertising materials is purchased on account from Aero Supply for $2,500. Transaction Basic Analysis The asset Advertising Supplies is increased $2,500; the liability Accounts Payable is increased $2,500. Debit -Credit Analysis 47 Debits increase assets: debit Advertising Supplies $2,500. Credits increase liabilities: credit Accounts Payable $2,500. ILLUSTRATION 2-25 PURCHASE OF SUPPLIES ON CREDIT 2,500 2,500 Posting 2,500 2,500 48 ILLUSTRATION 2-26 HIRING OF EMPLOYEES Transaction October 9, hire four employees to begin work on October 15. Each employee is to receive a weekly salary of $500 for a 5-day work week, payable every 2 weeks -- first payment made on October 26. A business transaction has not occurred. There is only an agreement between the employer and the employees to enter into a business transaction beginning on October 15. Basic Analysis Debit -Credit Analysis 49 A debit-credit analysis is not needed because there is no accounting entry. ILLUSTRATION 2-27 DECLARATION AND PAYMENT OF DIVIDEND October 20, the board of directors declares and pays a $500 cash dividend to stockholders. Transaction Basic Analysis The dividends account is increased $500; the asset Cash is decreased $500. Debit -Credit Analysis 50 Debits increase dividends: debit Dividends $500. Credits decrease assets: credit Cash $500. ILLUSTRATION 2-27 DECLARATION AND PAYMENT OF DIVIDEND 500 500 Posting 500 51 Dividends Oct. 20 332 500 ILLUSTRATION 2-28 PAYMENT OF SALARIES Transaction October 26, employee salaries of $4,000 are owed and paid in cash. (See October 9 transaction.) Basic Analysis The expense account Salaries Expense is increased $4,000; the asset Cash is decreased $4,000. Debit -Credit Analysis 52 Debits increase expenses: debit Salaries Expense $4,000. Credits decrease assets: credit Cash $4,000. ILLUSTRATION 2-28 PAYMENT OF SALARIES 4,000 4,000 Posting 4,000 4,000 53 ILLUSTRATION 2-29 RECEIPT OF CASH FOR SERVICES Provided Transaction October 31, received $10,000 in cash from Copa Company for advertising services rendered in October. Basic Analysis The asset Cash is increased $10,000; the revenue acct. Service Revenue is increased $10,000. Debit -Credit Analysis 54 Debits increase assets: debit Cash $10,000. Credits increase revenues: credit Service Revenue $10,000. ILLUSTRATION 2-29 RECEIPT OF CASH FOR SERVICES Provided 10,000 10,000 Service Revenue Posting 10.000 400Oct. 31 10,000 55 Katherine Turner recorded the following transactions during the month of March. Post these entries to the Cash account. 56 THE TRIAL BALANCE THE TRIAL BALANCE A trial balance is a list of accounts and their balances at a given time. The purpose: to prove "total debits recorded=total credits recorded". For every amount debited, an equal amount must be credited. Helps uncover errors in journalizing and posting. Useful for preparing financial statements. Three steps : 1. List each account title and their balances: Debit balances in the left column, credit balances in the right column In the order in which they appear in the ledger 2. Add the debit and credit columns. 3. Prove the equality of the totals. 57 A TRIAL BALANCE Q: Before preparing TB, how do you determine the balance of each account? PIONEER ADVERTISING AGENCY Trial Balance October 31, 2011 Cash Advertising Supplies Prepaid Insurance Office Equipment Notes Payable Accounts Payable Unearned Revenue Share Capital Dividends Service Revenue Salaries Expense Rent Expense 58 The total The total debits must debits must equal the equal the total credits. total credits. Debit $ 15,200 2,500 600 5,000 Credit $ 5,000 2,500 1,200 10,000 500 10,000 4,000 900 $ 28,700 $ 28,700 LIMITATIONS OF A TRIAL LIMITATIONS OF A TRIAL BALANCE BALANCE 59 Does not prove that all transactions have been recorded properly. the trial balance may balance even though numerous errors exist. 1. a transaction is not journalized, 2. a correct journal entry is not posted, 3. a journal entry is posted twice, 4. incorrect accounts are used in journalizing or posting, 5. offsetting errors are made in recording the amount of the transaction. Summary Transactions Double Entry System Step 1:Analyzing Step2: Journalizing (making entry) Step3: Posting Cash ...... Accounts payable ...... Service Revenue Dividends ...... Ledger Accounts Trial Balance 60 Presentation Problems Group 3: P2-3B Group 4: P2-4B 61 ...
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