The Mechanics of Accounting

1. C H A P T E R 3 The Mechanics of Accounting

2. Learning Objective 1 Understand the process of transforming transaction data into useful accounting information.

3. Exchange Transactions What Are the Different Exchange Transactions? Borrow and invest money. Purchase land, buildings, and equipment. Buy and sell goods or services. Pay wages to employees. Pay taxes to the government. Distribute earnings to owners.

4. Business Documents • Examples: Sales invoice, purchase order, check stub. • Business documents are used • to confirm that an arm’s-length transaction has occurred. • to establish the amounts to be recorded. • to facilitate the analysis of business events. • These documents must be analyzed.

5. What is the Sequence of the Accounting Cycle? 1 Step 2 Step Record the effects of the transactions. 3 Summarize the effects of transactions. 1. Posting journal entries. 2. Preparing a trial balance. Step 4 Prepare reports. 1. Adjusting entries. 2. Preparing financial statements. 3. Closing the books. Step Analyze transactions.

6. Learning Objective 2 Analyze transactions and determine how those transactions affect the accounting equation (step one of the accounting cycle).

7. Transaction analysis: • breaks down complex transactions into manageable pieces. • provides a self-checking mechanism. Step 1: Analyze Transactions Transaction analysis framework • What accounts are involved? • Did each account increase or decrease? • By how much?

8. Resources Creditors’ claims against resources Owners’ claims against resources = + What Is the Accounting Equation? Assets = Liabilities + Owners’ Equity

9. Describe Effect of the Following Transactions on a Company. A = L + OE Borrow money Invest in company Pay off a note Purchase equipment Borrow funds to settle a debt

10. What Is the Rule of Double-Entry Accounting? The debits must always equal the credits. Debits = Credits

11. Name of Account Credit Debit Using Accounts • Accounts provide an efficient method to categorize transactions. • A T-account is a simplified depiction of an account.

12. Cash 23 Using a T-Account The cash account has a beginning balance of $35. A check for $12 is written to pay for supplies. Using a T-account, what is the ending balance of the cash account? 12 35

13. Debits and Credits Debits are simply entries on the left. Remember: Credits are simply entries on the right.

14. Debits and Credits Assets = Liabilities + Owners’ Equity DR CR DR CR DR CR (+) (-) (-) (+) (-) (+) Asset accounts: Debit is an increase. Credit is a decrease. • Liabilities and owners’ equity accounts: • Debit is a decrease. • Credit is an increase.

15. Expanding the Equation Revenues Increases in a company’s resources from the sale of goods or the performance of services. Expenses Decreases in a company’s resources incurred in the normal course of business to generate revenues. Dividends Distributions to owners, which reduce Owners’ Equity.

16. Assets DR CR + – Liabilities DR CR – + Owners’ Equity DR CR – + = + Capital Stock DR CR – + Retained Earnings DR CR – + Expenses DR CR + – Dividends DR CR + – Revenues DR CR – + Expanded Accounting Equation

17. Learning Objective 3 Record the effects of transactions using journal entries (step two of the accounting cycle).

18. Journal -- book of original entry Step 2: Record Transactions • Record the results of the transactions in a journal. • Journalizing provides a chronological record of all business activities. What is another name for the journal?

19. General Journal Entry Format: Date Debit Entry . . . . . . . . . . . . . . . xx Credit Entry . . . . . . . . . . . . xx Explanation. Step 2: Record Transactions • Record the results of the transactions in a journal. • Journalizing provides a chronological record of all business activities.

20. Journal Entries What is the three-step process? 1Identify which accounts are involved. 2For each account, determine if it is increased or decreased. 3For each account, determine by how much it will change.

21. Jan. 1 Supplies . . . . . . . . . . . . . . . . . . 25 Accounts Payable . . . . . . . . 25 Purchased supplies on account. Example 1: Journal Entry Supplies purchased for $25 are purchased “on account.” Prepare the correct journal entry. What do we mean by purchased “on account”? We purchase on credit and use accounts payable.

22. Feb. 1 Cash . . . . . . . . . . . . . . . . . . . . . 100 Revenue . . . . . . . . . . . . . . . . 100 Received cash for services. Example 2: Journal Entry A check for $100 is received in payment for services rendered. Make the correct journal entry.

23. Mar. 1 Accounts Receivable. . . . . . . . 75 Sales Revenue . . . . . . . . . . . 75 Sold merchandise on account. Mar. 1 Cost of Goods Sold . . . . . . . . . 60 Inventory. . . . . . . . . . . . . . . . 60 To record cost and reduce inventory. Example 3: Journal Entry Merchandise is sold to a customer on account for $75. The cost of the product was $60. Make the journal entries.

24. Entered when posted to ledger. Journal 1 Page 1 Date Transaction Ref. Debits Credits Jan. 1 Supplies 25 Accounts Payable 25 Purchased supplies on account. Feb. 1 Cash 101 100 Revenue 100 Received cash for services. Mar. 1 Accounts Receivable 75 Sales Revenue 75 Sold merchandise on account.

25. Learning Objective 4 Summarize the resulting journal entries through posting and prepare a trial balance (step three of the accounting cycle).

26. Step 3: Posting Journal Entries and Preparing a Trial Balance Define the Following Terms Posting transferring amounts from the journal to the ledger. Ledger a book of accounts where journal transactions are posted and thereby summarized. Posting reference a cross-reference number between the general journal and the accounts in the general ledger. Chart of accounts a systematic listing of all accounts used by a company.

27. ACCOUNT: Cash Account No. 101 Date Explanation Ref. Debits Credits Balance Jan. 1 Balance 100 2 Issued 100 shares of capital stock at $10 per share GJ1 1,000 1,100 3 Purchased equipment GJ1 300 800 4 Sold inventory GJ1 60 860 5 Monthly payment on loan GJ1 230 630 6 Revenue GJ1 2,500 3,130 General Ledger

28. Chart of Accounts ASSETS (100-199): Current Assets (100-150): 101 Cash 105 Accounts Receivable 107 Inventory Long-Term Assets (151-199): 151 Land 152 Buildings LIABILITIES (200-299): Current Liabilities (200-219): 201 Notes Payable 202 Accounts Payable Long-Term Liabilities (220-239): 222 Mortgage Payable OWNERS’ EQUITY (300-399): 301 Capital Stock 330 Retained Earnings SALES (400-499): 400 Sales Revenue EXPENSES (500-599): 500 Cost of Goods Sold 501 Sales Salaries and Commissions 523 Rent Expense 528 Advertising Expense 573 Utilities Expense 579 Accounting and Legal Fees

29. Name of Account Credit Debit An account’s balance is usually on the side that increases the account. It is referred to as the “Normal Balance.” • Accounts with typical debit balances are? • Accounts with typical credit balances are? Determining Account Balances • Owners’ Equity • Revenues or Income • Liabilities • Expenses • Assets • Dividends Do you see the mnemonic memory device, DEAD COIL?

30. Define The Trial Balance A listing of all account balances; provides a means to assure that debits equal credits. What is the Trial Balance used for? From the data in the trial balance, the balance sheet and income statement can be prepared.

31. The trial balance shows that debits equal credits. Sample Trial Balance The Example Company Trial Balance December 31, 2003 Debits Credits Cash $ 21 Accounts Receivable 15 Inventory 12 Land 200 Accounts Payable $ 30 Capital Stock 150 Retained Earnings 24 Sales Revenue 919 Cost of Goods Sold 850 Advertising Expense 10 Miscellaneous Expenses 15______ Total $ 1,123 $ 1,123

32. Learning Objective 5 Describe how technology has affected the first three steps of the accounting cycle.

33. Advantages of Computers • Large amounts of information can be quickly processed without mathematical errors. • More documents can be produced than humanly possible in the same amount of time. • Common tasks can be automated for increased efficiency.

34. Disadvantages of Computers • Computer hardware and software require human judgment and input. • GIGO (garbage in, garbage out). • Once an error is identified, fixing the problem may require many adjustments.

35. End Chapter 3 "Failure is the opportunity to begin again with more knowledge." Henry Ford