4/9/2012. Recording Transactions. Learning Objectives (LO) LO 1 Double-Entry System. LO 1 Double-Entry System. LO 1 Double-Entry System

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1 4/9/212 Recording Transactions CHAPTER 3 Learning Objectives (LO) After studying this chapter, you should be able to 1. Use double-entry accounting 2. Describe the five steps in the recording process 3. Analyze and journalize transactions and post journal entries to the ledgers 4. Prepare and use a trial balance 5. Close revenue and expense accounts and update retained earnings 6. Correct erroneous journal entries and describe how errors affect accounts 7. Explain how computers have transformed the processing of accounting data 2of 37 Basic accounting equation + specific accounts (Act.) ASSETS = LIABILITIES + OWNERS EQUITY Cash Accounts Payable Paid in Capital Accounts Receivable Notes Payable Retained Earnings Prepaid items Revenue Equipment Expenses Building Gains (later) Land Losses (later) NET INCOME Distributions to owners Dividends At least two entries required to maintain equality Analyze transactions, events, circumstances looking for three things Which accounts are affected? What amounts are involved? In which direction did the accounts change? Up = +; Down = Debits and credits Analogy check register for cash (the account) Date Reference Description Deposit Withdrawal Balance Beginning balance 1, 6/2/2X2 6/22/2X2 Paycheck Groceries , of 37 4of 37 T-account = visualization of every account EVERY ACCOUNT Left side Right side DEBIT CREDIT Increase (+) or decrease ( )? Increase (+) or Decrease ( )? Assets = Liabilities + Owners Equity D C D C Paid in Capital Retained Earnings D C Revenue (Expense) (Dividend) D C D C D C T-account = visualization of every account EVERY ACCOUNT Left side Right side DEBIT CREDIT Increase (+) or decrease ( )? Increase (+) or Decrease ( )? Assets = Liabilities + Owners Equity D C D + C Paid in Capital Retained Earnings D C + + Revenue (Expense) (Dividend) D C D C D C of 37 6of 37 1

2 4/9/212 Usage as a verb Debit Credit Assets Increase Decrease Liabilities Decrease Increase Owners Equity Decrease Increase Paid-in in Capital Decrease Increase Retained Earnings Decrease Increase Revenues Decrease Debits increase these accounts Increase (Expenses) Decrease but they also reduce owners Increase (Dividends) Decrease equity Increase At least two entries are required to keep the accounting equation in balance Transactions Documentation LO 2 Recording Process Journal Ledger Trial Balance Financial Statements Transaction Documentation - original records underlying transactions, events, circumstances are analyzed to determine the amounts, accounts, and direction (up/down) each caused Journal chronological listing of events (diary) Ledger grouping like events into one record, e.g. cash in minus cash out = cash balance Trial Balance ledger acts. collectively balance 7of 37 8of 37 LO 2 Recording Process Analyze each transaction to find Accounts Chart of accounts used in the business Amounts given/obvious or have to back into Beg.(1) + Purchase (5) less Used (?) = End (4) Direction - Debit Assets Liabilities/owners equity - Credit Assets Liabilities/owners equity LO 3 Posting to Ledger Accounts Posting = copying amounts from the journal to the ledger At least two postings per transaction For complex events, could involve many accounts (called compound journal entries) Cross-referencing - using numbering, dating, and/or some other identification in the ledger to trace it back to the appropriate journal entry or vice versa 9of 37 1 of 37 LO 3 Posting to Ledger Accounts Ledger formats may differ Sale of merchandise on credit (Part 1) Transaction: Customer charged purchase $18,; paid later in full Analysis: Accounts Receivable and ultimately Cash increase Stockholders equity increases because Revenue was earned at the time of sale Journal Entry: Accounts Receivable 18, Revenue 18, Cash 18, Accounts Receivable 18, Cash Accounts Receivable Revenue 18, 18, 18, 18, 11 of of 37 2

3 4/9/212 Sale of merchandise on credit (Part 2) Transaction: Cost of merchandise sold, $1, Analysis: Merchandise Inventory decreases Stockholders equity decreases because an expense account (a negative stockholders account) increases Journal Entry: 1, Merchandise Inventory 1, Sale of merchandise on credit (Part 3) Transaction: Customer pays for charged purchase $18, Analysis: Accounts Receivable decreases and Cash increases Journal Entry: Cash 18, Accounts Receivable 18, Merchandise Inventory 1, 1, Cash 18, Accounts Receivable Revenue 18, 18, 18, 13 of of 37 Cash is received before it is earned Transaction: Customer paid $5, in advance, service later performed Analysis: Cash increases Unearned Revenue (liability) increases then decreases Stockholders equity increases when Revenue is earned Journal Entry: E t Cash 5, Unearned Revenue 5, Unearned Revenue 5, Revenue 5, Cash Unearned Revenue Revenue 5, 5, 5, 5, 15 of 37 Purchased an asset before consuming 1/3 of it Transaction: Cost of assets acquired = $6,; consumed = $2, Analysis: Prepaid Rent increases then decreases when consumed Cash decreases Stockholders equity decreases because an expense account Rent Expense (a negative stockholders account) increases Journal Entry: Prepaid Rent 6, Cash 6, Rent Expense 2, Prepaid Rent 2, Cash Prepaid Rent Rent Expense 6, 6, 2, 2, 16 of 37 Purchase an asset and depreciate it (Part 1) Matching suggests expenses include only those costs that contribute to the production of revenue To deduct total cost of multi-year asset in first year is poor matching Alternative approach deduct some each year Cost ($1,) less its salvage value ($) = amount allocated Estimated useful life (1 years) each year ($1) Purchase an asset and depreciate it (Part 2) Transaction: Buy equipment $1,; 1 year life; zero salvage value Analysis: Cash decrease, Equipment increases then decreases Stockholders equity decreases because an expense account (a negative stockholders account) increases Journal Entry: Equipment 1, Cash 1, * 1, Equipment 1, * {1, ) / 1 year life = 1, / year} Cash Equipment Depreciation Exp. 1, 1, 1, 1, 17 of of 37 3

4 4/9/212 Purchase an asset and depreciate it (Part 3) Transaction: Buy equipment $1,; 1 year life; zero salvage value Analysis: If reduce Equipment account directly, lose track of initial Cost. Better to split amounts into two accounts 1) original cost, and 2) amount of cost allocated Accumulated Depreciation (contra asset account) Journal Entry: * 1, Accumulated Depreciation 1, * {1, ) / 1 year life = 1, / year} Equipment Accumulated Depreciation 1, 1, 1, Purchase an asset and depreciate it (Part 4) Equipment 1, Less Accumulated Depreciation (1,) Book Value (appears in the statements) 9, 19 of 37 2 of 37 LO 4 Trial Balance LO 4 Trial Balance (TB) Trial Balance list of all general ledger accounts and their balances Taken anytime but three times are important Unadjusted TB - before making adjustments (Ch. 3) Adjusted TB - after making adjustments (Ch. 4) Could use TBs to prepare p the financial statements Post-closing TB after closing entries (Ch. 3) Accounts debit balances equal credit balances? Yes proceed but errors can still exist see Learning Objective 6 No go back and find/fix the error 21 of of 37 Closing the accounts - background Adjustments (Ch. 4) must be made before closing Balance sheet accounts are permanent So long as a balance exists, they will be used from year to year, i.e. have a running balance so they are not closed Income statement accounts {Revenue, Expenses, (Gains, Losses later)} and Dividends are temporary accounts Beginning of year - all have a zero balance End of year if activity occurred, have balances Closing the accounts the concept is to take all temporary accounts and Transfer all income statement account balances to a collecting account called Income Summary Transfer the Income Summary balance and Dividends balance to Retained Earnings which is a permanent stockholders equity account Balance remaining in temporary accounts should equal zero and thus be ready for the next accounting period s transactions 23 of of 37 4

5 4/9/212 Bal. 1, Bal. 2, Three Expense and one Revenue accounts need closing to get the ending balance to zero. WHAT NEEDS TO BE DONE? Rent Expense Income Summary Sales Revenue Bal. 16, Bal. 1, Three Expense and one Revenue accounts need closing to get the ending balance to zero) WHAT NEEDS TO BE DONE? Credit the Expense accounts; Debit Income Summary act Debit the Revenue account; Credit Income Summary account Determine the balance in the Income Summary account Close the Income Summary balance to Retained Earnings Rent Expense Income Summary Sales Revenue Bal. 2, Bal. 16, Bal. 1 Bal Bal. 1 Bal. 25 of of 37 Journal entries always precede entries to the ledger accounts Journal Entry: C1 Revenue 16, Income Summary 16, C2 Income Summary 12,1 Cost of goods sold 1, Rent expense 2, Depreciation expense 1 Bal. 1, C2 1, Rent Expense Income Summary Sales Revenue Bal. 2, C2 2, C2 12,1 C1 16, C1 16, Bal. 16, Bal. 1 C2 1 Bal 27 of of 37 Journal entries always precede entries to the ledger accounts Bal. 1, C2 1, Journal Entry: C3 Income Summary 57,9 Retained Earnings 57,9 Rent Expense Bal. 2, C2 2, Bal. 1 C2 1 Income Summary Sales Revenue C2 12,1 C1 16, C1 16, Bal. 16, C3 57,9 Bal. C3 57,9 New bal. 57,9 29 of 37 3 of 37 5

6 4/9/212 Close Dividends directly to Retained Earnings (Dividends are not part of income) C4 Retained Earnings 5 Dividends 5 Retained Earnings Dividends C2 12,1 C1 16, Bal. 5 C4 5 C3 57,9 C4 5 Bal. 57,85 After closing, four financial statements are prepared - As frequently as management desires - SEC quarterly and annual reports Errors are multi-dimensional No entry is made when one should have been made If erroneous entry is made, could be Correct amounts to incorrect accounts Incorrect amounts to correct accounts Transaction omitted GAAP is misapplied Types of accounts involved Permanent always open so correct anytime Temporary If accounts not closed, simple correction If accounts are closed, use Retained Earnings or just wait (self correcting after 2 years) 31 of of 37 Approach to correcting errors an example What was recorded? Rent Expense 1 Cash 1 What should have been recorded? Prepaid Rent 1 Cash 1 Correcting entry depends on where we are in time? Made and discovered in same fiscal year Made in one fiscal year, discovered next fiscal year Made and discovered in same fiscal year, the temporary account Rent Expense is still open (not been closed to Retained Earnings) Prepaid Rent 1 Rent Expense 1 Made last year, discovered this year (Rent Expense was closed to Retained Earnings - Do nothing after 2nd year, will be correct, or Prepaid Rent 1 Retained Earnings 1 - Then later, debit Rent Expense and credit Prepaid Rent 33 of of 37 Ledger ( T ) accounts an analytical tool Information available (black); unavailable (purple) Accounts Receivable Cash 4, Sales? 28, 28, 6, Sales Revenue Sales Revenue? - Assuming all sales were on credit, what was Sales Revenue? - 4, + Sales Revenue 28, = 6, - Sales Revenue =282, LO 7 Computers effect on Accounting Data Processing hardware and software used to record, analyze, store, and report on activities In general, computers Increase Speed of processing data Accuracy of data/reports Reduce Processing costs (perhaps) Errors 35 of of 37 6

7 4/9/212 LO 7 Computers effect on Accounting Specific to accounting, computers Capture cost of goods sold and inventory changes Activate an order to a supplier Check credit limits and update accounts receivable Prepare invoices/statements to buyers Process journal entries and post to ledger accounts Prepare trial balances and financial statements Extensible Business Reporting Language (XBRL) Facilitate reporting and analyzing financial data 37 of 37 7