Lesson 3 Analyzing and Recording Transactions

1. Lesson 3Analyzing and Recording Transactions Task team of Fundamental Accounting School of Business, Sun Yat-sen University

2. Outline • Accounts • Detailed Description of Various • Accounts • T-Accounts • Rules of Debits and Credits • Double-entry Accounting • Illustrated Application of Rules

3. Opening Story • Do you have any idea about how your parents keep an “account” of how much the family spends? • What a good family accountant!

4. Opening Story • A global demand for accountants – where can the “Big Four” find accountants with talent and virtues? • Mr.Land, E&Y British president (indirect quote) In the recent 18 months, the shortage of accounting talents has been scarcely satisfied. The most valuable in the 21st century is accountants to special accounting firms like us. （2005－7－21）

5. The Account Accounting’s main summary device is the account, the record of changes. Accounts are grouped in 3 broad categories, according to the accounting equation: Assets = Liabilities + Stockholders' Equity Cash

6. Assets are the economic resources that benefit the business now and in the future Cash Accounts receivable Inventory Notes receivable Prepaid expenses Supplies Properties Buildings Equipment The Assets Account

7. Liabilitiesare the debts of the company. Notes payable Accounts payable Accrued liabilities (for expenses incurred but not paid) Long-term liabilities (bonds) The Liabilities Account

8. The Equity Account Stockholders’ (owners’) equity is the owners’ claims to the assets of a corporation. A proprietorship uses a single account. A partnership uses separate accounts for each owner’s capital balance and withdrawals. A corporation uses separate capital accounts for each source of capital.

9. Retained Earnings Common Stock Dividends Revenues Expenses Details of Equity Account

10. Account Title Debit Credit RIGHT SIDE LEFT SIDE The T-Account

11. Accounting Equation: Assets = Liabilities + Stockholders’ Equity Rules of Debit and Credit: Debit + Credit – Debit – Credit + Debit – Credit + Increases and Decreasesin the Accounts

12. Assets = Liabilities + Stockholders’ Equity Common Stock Cash Debit for Increase, 50,000 Credit for Increase, 50,000 Rules of Debit and Credit Air & Sea received $50,000 and issued stock.

13. Assets = Liabilities + Stockholders’ Equity Common Stock Cash Bal. 50,000 Credit for Decrease, 40,000 Bal. 50,000 Land Debit for Increase, 40,000 Rules of Debit and Credit Air & Sea purchased land for $40,000 cash.

14. + Common Stock + Retained Earnings – Dividends + Revenues – Expenses Assets Liabilities Stockholders’ Equity Expansion of theAccounting Equation

15. Recording Transactions • Record transactions first in the journal (analyses) • Ledger • Posting • Trial balance

16. Analysis of each transaction • Identify the transaction from the source document, such as a sales invoice or check stub • Determine which accounts increase and which decrease • Apply the rules of debit and credit • Enter the transaction in the journal, listing first the debit and then the credit • Verify that total debits equal total credits

17. A journal entry • A journal entry would appear as follows:Account Name XX (debit amount) Account Name XX (credit amount) Brief explanation of the transaction.

18. Ledger • A group of accounts. • All the accounts of a business grouped together form a book called the ledger (or general ledger).

19. Posting • The process of copying (transferring) data from the journal to accounts in the ledger. • Debits in the journal are posted as debits to the appropriate accounts; credits in the journal are posted as credits to the appropriate accounts. • All transactions must be keyed by date or number to provide a link between the journal and the ledger. • Ledger accounts appear after a series of transactions have been posted and account balances calculated.

20. Trial balance • The trial balance is a listing, in general ledger order (assets, liabilities, then stockholders’ equity), of the debit or credit balance in each account

21. Transactions, Accounts and Rules of Debits & Credits • Owners’ investment of cash increases both assets and stockholders’ equity. • Purchase of an asset for cash increases assets and decreases assets (no effect on total assets). • Purchase of an asset on credit (on account) increases both assets and liabilities. • Receipt of cash for service revenue increases both assets and stockholders’ equity. • Performance of services on account increases both assets and stockholders’ equity. • Cash payment of expenses decreases both assets and stockholders’ equity.

22. Transactions, Accounts and Rules of Debits & Credits (cont) • Payment on account decreases both assets and liabilities. • Personal transactions of the owner do not affect the business, per the entity concept. • Collection of cash on account increases assets and decreases assets. • Sale of an asset at a price equal to its cost increases assets and decreases assets. • Declaration and payment of cash dividends decreases both assets and stockholders’ equity.

23. An Practical Illustration • Do you still remember the example of Beauty Photo Store? We are using it again here! • Remember always:The accounting equation must remain in balance after each transaction has been recorded.

24. An Practical Illustration (cont) • Wang Fang invests $30,000 cash to start her business of Beauty Photo Store.The accounts involved are:(1)Cash (asset) (2)Owner’s Equity (equity)

25. An Practical Illustration (cont) Wang Fang invests $30,000 cash to start her business.

26. An Practical Illustration (cont) • Purchased supplies paying $2,500 cash. Theaccounts involved are: (1) Cash (asset) (2) Supplies (asset)

27. An Practical Illustration (cont) Purchased supplies paying $2,500 cash.

28. An Practical Illustration (cont) • Purchased camera and producing equipment for the store for $20,000 cash. The accounts involved are: (1) Cash (asset) (2) equipment (asset)

29. An Practical Illustration (cont) Purchased equipment for the store for $20,000 cash.

30. An Practical Illustration (cont) • Purchased supplies of $1,100 on account and equipment of $6,000 by signing a note. The accounts involved are: (1) Supplies (asset) (2) Equipment (asset) (3) Accounts payable (liability) (4) Notes payable (liability)

31. An Practical Illustration (cont) Purchased supplies of $1,100 on account and equipment of $6,000 by signing a note.

32. An Practical Illustration (cont) Now let’s look at transactions involvingrevenues and expenses.

33. An Practical Illustration (cont) • Performed wedding-photo and graduation ceremony photo-taking services, receiving $2,200 cash.The accounts involved are: (1) Cash (asset) (2) Owner’s capital (equity)

34. An Practical Illustration (cont) Performed wedding photo-taking services, receiving $2,200 cash.

35. An Practical Illustration (cont) • Paid rent for January, $1,000 and salaries to the store’s employees, $700 cash.The accounts involved are: (1) Cash (asset) (2) Owner’s capital (equity) (Rent expense) (3) Owner’s capital (equity) (Salaries expense )

36. An Practical Illustration (cont) Paid rent for the month, $1,000 and salary to employees, $700 cash.

37. An Practical Illustration (cont) • Provided wedding photo services of $1,600 and rented equipment for $300 to another store. The accounts involved are: (1) Cash (asset) (2) Owner’s capital (equity) (Sales revenue) (3) Owner’s capital (equity) (Rental revenue)

38. An Practical Illustration (cont) Provided photo-taking services of $1,600 and rented equipment for $300 to another store.

39. An Practical Illustration (cont) Received $1,900 cash on account. The accounts involved are: (1) Cash (asset) (2) Account receivable (asset)

40. An Practical Illustration (cont) Received cash of $1,900 on account.

41. An Practical Illustration (cont) Paid $900 on account. The accounts involved are: (1) Cash (asset) (2) Account payable (liability)

42. An Practical Illustration (cont) Paid $900 cash on account.

43. An Practical Illustration (cont) • Wang Fang withdrew $600 cash for personal living expenses. The accounts involved are: (1) Cash (asset) (2) Owner’s capital (equity) Withdrawals

44. An Practical Illustration (cont) Wang Fang withdrew $600 for personal living expenses.

45. Summary • Accounts are used to appropriately categorize transactions. • T-accounts are a simplified version used in practice. • The type of account determines the side on which increases and decreases are recorded; the rules of debit and credit keep the accounting equation in balance • In the double-entry accounting system, at least two accounts are always affected by a transaction. After a transaction is recorded, the accounting equationmust remain in balance. • Economic transactions of a business will impact various asset, liability, and/or equity accounts; but, they will not disturb the equality of the accounting equation. 

46. Case for Discussion • In order for all accounts to look the same, and to simultaneously make sure that the accounting equation stays in balance with double-entry bookkeeping, the debit and credit system was devised. Luca Pacioli first described it in 1494, and the basic system is so sound and efficient, we still use it today. Tradition aside, we would not still be using this ancient system if it did not work extremely well and efficiently. One could set up a system with pluses and minuses, but it would not be as efficient at generating the data needed for financial statements while making sure that the accounting equation was still in balance. One is more likely to make mistakes in entering data with plus and minus signs, although this is a secondary concern to theissues of uniformity and efficiency. • Why use debits and credits rather than pluses andminuses?

47. The End of Lesson 3