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Chapter 2 Measuring Business Transactions

Chapter 2 Measuring Business Transactions. Belverd E. Needles, Jr. Marian Powers Sherry K. Mills Henry R. Anderson - - - - - - - - - - - Multimedia Slides by: Dr. Paul J. Robertson New Mexico State University Steve Leask New Mexico State University. LEARNING OBJECTIVES.

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Chapter 2 Measuring Business Transactions

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  1. Chapter 2Measuring Business Transactions Belverd E. Needles, Jr. Marian Powers Sherry K. Mills Henry R. Anderson - - - - - - - - - - - Multimedia Slides by: Dr. Paul J. Robertson New Mexico State University Steve Leask New Mexico State University BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  2. LEARNING OBJECTIVES 1. Explain, in simple terms, the generally accepted ways of solving the measurement issues of recognition, valuation, and classification. 2. Describe the chart of accounts and recognize commonly used accounts. 3. Define double-entry system and state the rules for double entry. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  3. LEARNING OBJECTIVES 4. Apply the steps for transaction analysis and processing to simple transactions. 5. Prepare a trial balance and describe its value and limitations. 6. Record transactions in the general journal. 7. Post transactions from the general journal to the ledger. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  4. Measuring Business Transactions OBJECTIVE 1 Explain, in simple terms, the generally accepted ways of solving the measurement issues of recognition, valuation, and classification. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  5. Measurement Issues • Business transactions are economic events that affect the financial position of a business entity. • To measure a transaction an accountant must decide: 1. When did the transaction occur? 2. What value should be placed on the transaction? 3. How should the components of the transaction be categorized? BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  6. Measurement Issues • Even though GAAP are followed, controversy does exist regarding these questions. • These issues are commonly referred to as: • The recognition issue. • The valuation issue. • The classification issue. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  7. The Recognition Issue • Recognition refers to the difficulty of deciding when a business transaction should be recorded. • The recognition point (RP) is the time at which a transaction should be recorded. • The term recognize is synonymous with recording an event. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  8. The Recognition Issue • EXAMPLE: A company orders, receives, and pays for an office desk. • Traditionally, the transaction is recorded when the title transfers. • In a small business, the RP could be when the bill is received or paid. • The recognition issue is not always solved easily. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  9. The Valuation Issue • Valuation is perhaps the most controversial issue in accounting. • Valuation focuses on assigning a monetary value to a business transaction. • GAAP requires the use of historical cost. • Cost is defined as the exchange price associated with a business transaction at the point of recognition. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  10. The Valuation Issue • Purpose of accounting is to account for value in terms of cost, not in terms of worth, which can change over time. • In the accounting sense, value means the cost at the time of the transaction. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  11. The Cost Principle • The cost principle is the practice of recording transactions at cost. • The market valueof an asset may change over the years, but its recorded cost remains in the accounting records. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  12. The Cost Principle • The market value is the result of the actions of independent buyers and sellers who agree on a price. • The cost principle is used because the cost is verifiable. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  13. The Classification Issue • Classification is assigning all the transactions in which a business engages to appropriate categories or accounts. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  14. The Classification Issue • Proper classification depends on: 1. Correctly analyzing the effect of each transaction on the business, and 2. Maintaining a system of accounts to reflect that effect. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  15. Discussion Q. What three issues underlie most accounting measurement decisions? A. The three issues that underlie most accounting decisions are recognition, valuation, and classification. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  16. Accounts and the Chart of Accounts OBJECTIVE 2 Describe the chart of accounts and recognize commonly used accounts. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  17. Accounts • A filing system consisting of accounts is used to sort out or classify all the transactions that occur in a business. • Accounts are the basic storage unit for accounting data and are used to accumulate amounts from similar transactions. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  18. Accounts • An accounting system has a separate account for each asset, each liability, and each component of owner’s equity, including revenues and expenses. • A small organization may have only a few dozen accounts; a multinational corporation may require thousands of accounts. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  19. Accounts • The group of company accounts is known as the general ledger or simply the ledger. • The general ledger may be manual or computer-based. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  20. The Chart of Accounts • Accounts are numbered to make them easy to find. • The list of all account numbers and names is known as the chart of accounts. • Accounts are numbered for processing and reference purposes. • The account number may be coded to provide information about the account. • For example, an asset account may begin with the number 1; a liability account may begin with the number 2. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  21. Owner’s Equity Accounts • The Capital account represents the owner’s interest in the assets of the company. • The Withdrawals account is used to record assets taken out of the business by the owner for personal use. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  22. Owner’s Equity Accounts • The law requires that the Capital and Withdrawals accounts be separated from revenues and expenses for income tax reporting, financial reporting, and other purposes. • Management needs a detailed breakdown of revenues and expenses for budgeting and operating purposes. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  23. Account Titles • The title should describe what is recorded in the account. • If an account title is not recognizable, examine the context of the name. • Determine if it is an asset, liability, owner’s equity, revenue, or expense. • Look for the kind of transaction that gave rise to the account. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  24. Discussion Q. What is an account, and how is it related to the ledger? A. An account is the means by which management accumulates the effects of transactions; it is the basic storage unit for accounting data. The ledger is the file or book in which the company’s accounts are kept. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  25. The Double-Entry System: The Basic Method of Accounting OBJECTIVE 3 Define double-entry system and state the rules for double entry. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  26. The Double-Entry System • Evolved during the Renaissance. • Described by Fra Luca Pacioli, Italy, 1494. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  27. Features of the Double-Entry System • Principle of duality. • Each transaction must be recorded with at least one debit and one credit so that the monetary value of debits and credits is equal. • The whole system is always in balance. • All accounting systems are based on the principle of duality. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  28. Title of Account Debit (left) side Credit (right) side The T Account BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  29. The T Account Illustrated Cash (1) 50,000 (2) 35,000 (5) 1,500 (4) 200 (7) 1,000 (8) 1,000 (9) 400 (11) 600 52,500 37,200 Bal. 15,300 BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  30. The T Account Illustrated • Footings, which are the total of each side, are computed. • The difference between the debit side and the credit side is the account’s balance, either debit or credit. • Debit is commonly abbreviated Dr. • Credit is commonly abbreviated Cr. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  31. Assets = Liabilities + O/E Debit for increases (+) Credit for decreases (-) Debit for decreases (-) Credit for increases (+) Debit for decreases (-) Credit for increases (+) Analyzing and Processing Transactions • Every transaction affects at least two accounts. • Total debits must equal total credits. • Assets = Liabilities + Owner’s Equity. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  32. Assets = Liabilities + Owner’s Capital - Withdrawals + Revenues - Expenses Accounting Equation (Expanded Version) BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  33. Another Arrangement of the Accounting Equation • The accounting equation can be rearranged to shift withdrawals and expenses to the left side. Assets + Withdrawals + Expenses = Liabilities + Owner’s Capital + Revenues BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  34. Steps in Analyzing and Processing Transactions 1. Analyze the transaction to determine its effect on assets, liabilities, and owner’s equity. • Supported by a source document. 2. Apply the rules of double entry. • Dr. increases an asset. • Cr. increases a liability. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  35. Steps in Analyzing and Processing Transactions 3. Record the entry. • Enter in chronological order in a journal. • Enter the date, debit account, and debit amount on one line. • Enter the credit account and credit amount, indented, on the next line. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  36. Steps in Analyzing and Processing Transactions Dr.Cr. June 1 Cash 100,000 Notes Payable 100,000 • This form is called journal form and usually is followed by an explanation. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  37. Steps in Analyzing and Processing Transactions 4. Post the entry. • Post the entry to the general ledger by transferring the date and amount to the proper account. 5. Prepare the trial balance to confirm the balance of the accounts. • Confirm that the accounts are still in balance after recording and posting transactions. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  38. Discussion Q. Explain why debits, which decrease owner’s equity, also increase expenses, which are a component of owner’s equity. A. Decreases in owner’s equity are shown by debits. Because expenses are decreases in owner’s equity, increases in expenses are shown by debits. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  39. Transaction Analysis Illustrated OBJECTIVE 4 Apply the steps for transaction analysis and processing to simple transactions. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  40. Dr.Cr. Jan. 1 Cash 10,000 Joan Miller, Capital 10,000 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 Joan Miller, Capital Jan. 1 10,000 Joan Miller begins business. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  41. Dr.Cr. Jan. 2 Prepaid Rent 800 Cash 800 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 Jan. 2 800 Prepaid Rent Jan. 2 800 Rents an office, pays $800 rent in advance. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  42. Dr.Cr. Jan. 4 Art Equipment 4,200 Cash 4,200 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 Jan. 2 800 4 4,200 Art Equipment Jan. 4 4,200 Purchases art equipment, $4,200, with cash. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  43. Dr.Cr. Jan. 5 Office Equipment 3,000 Cash 1,500 Accounts Payable 1,500 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 Jan. 2 800 4 4,200 5 1,500 Office Equipment Jan. 5 3,000 Accounts Payable Jan. 5 1,500 Purchases office equipment, $3,000, pays $1,500 in cash. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  44. Dr.Cr. Jan. 6 Art Supplies 1,800 Office Supplies 800 Accounts Payable 2,600 Art Supplies • Transaction • Analysis • Rules • Entry Jan. 6 1,800 Office Supplies Jan. 6 800 Accounts Payable Jan. 5 1,500 6 2,600 Purchases art supplies, $1,800, and office supplies, $800, on credit. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  45. Dr.Cr. Jan. 8 Prepaid Insurance 480 Cash 480 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 Jan. 2 800 4 4,200 5 1,500 8 480 Prepaid Insurance Jan. 8 480 Pays for a one-year insurance policy with cash. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  46. Dr.Cr. Jan. 9 Accounts Payable 1,000 Cash 1,000 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 Jan. 2 800 4 4,200 5 1,500 8 480 9 1,000 Accounts Payable Jan. 5 1,500 6 2,600 Jan. 9 1,000 Pays $1,000 of amount owed to Taylor Supply Co. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  47. Dr.Cr. Jan. 10 Cash 1,400 Advertising Fees Earned 1,400 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 10 1,400 Jan. 2 800 4 4,200 5 1,500 8 480 9 1,000 Advertising Fees Earned Jan. 10 1,400 Collects a fee of $1,400 for placing advertisements. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  48. Dr.Cr. Jan. 12 Wages Expense 600 Cash 600 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 10 1,400 Jan. 2 800 4 4,200 5 1,500 8 480 9 1,000 12 600 Wages Expense Jan. 12 600 Pays the secretarytwo weeks’ wages, $600. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  49. Dr.Cr. Jan. 15 Cash 1,000 Unearned Art Fees 1,000 Cash • Transaction • Analysis • Rules • Entry Jan. 1 10,000 10 1,400 15 1,000 Jan. 2 800 4 4,200 5 1,500 8 480 9 1,000 12 600 Unearned Art Fees Jan. 15 1,000 Accepts $1,000 for art workto be done for another agency. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

  50. Dr.Cr. Jan. 19 Accounts Receivable 2,800 Advertising Fees Earned 2,800 Accounts Receivable • Transaction • Analysis • Rules • Entry Jan. 19 2,800 Advertising Fees Earned Jan. 10 1,400 19 2,800 Performs a service for $2,800. Fee to be collected next month. BASIC ACCOUNTING LABORATORY GUNADARMA UNIVERSITY

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