Accounting: What the Numbers Mean

1. Accounting: What the Numbers Mean Study Outlines and Overhead Masters Chapter 4

2. TRANSACTIONS AND THE FINANCIAL STATEMENTS • KEY IDEAS • TRANSACTIONS AFFECT THE BALANCE SHEET AND/OR THE INCOME STATEMENT. • THE BALANCE SHEET MUST BE IN BALANCE AFTER EVERY TRANSACTION. • THE RETAINED EARNINGS ACCOUNT ON THE BALANCE SHEET INCLUDES NET INCOME FROM THE INCOME STATEMENT. • BALANCE SHEET ACCOUNTS MAY HAVE BALANCES AT THE END OF A FISCAL PERIOD, AND BEFORE TRANSACTIONS OF THE SUBSEQUENT PERIOD ARE RECORDED. • KEY TERMINOLOGY • EACH INDIVIDUAL ASSET, LIABILITY, OWNERS' EQUITY, REVENUE, OR EXPENSE “ACCOUNT” MAY ADDITIONALLY BE DESCRIBED WITH ITS CATEGORY TITLE. EXAMPLES: • “CASH ASSET ACCOUNT” • “ACCOUNTS PAYABLE LIABILITY ACCOUNT” • “COMMON STOCK OWNERS' EQUITY ACCOUNT” • “SALES REVENUE ACCOUNT” • “WAGES EXPENSE ACCOUNT” • KEY RELATIONSHIP • TRANSACTIONS DURING A FISCAL PERIOD CAUSE THE BALANCE OF THE AFFECTED ACCOUNT(S) TO INCREASE OR DECREASE. BOOKKEEPING IS THE PROCESS OF KEEPING TRACK OF THESE CHANGES.

3. BOOKKEEPING PROCEDURES • WHAT THE BOOKS ARE CALLED • THE JOURNAL IS A CHRONOLOGICAL RECORD OF EACH TRANSACTION. • THE LEDGER IS A BOOK OF ALL OF THE ACCOUNTS;ACCOUNTS ARE USUALLY ARRANGED IN THE SEQUENCE FOUND ON THE BALANCE SHEET AND INCOME STATEMENT, RESPECTIVELY. • HOW TRANSACTIONS ARE RECORDED • ACCOUNTS ARE FREQUENTLY IN THE SHAPE OF A T. • THE LEFT-HAND SIDE OF THE “T ACCOUNT” IS CALLED THE DEBIT SIDE. • THE RIGHT-HAND SIDE OF THE “T ACCOUNT” IS CALLED THE CREDIT SIDE. • AN INCREASE IN AN ASSET OR AN EXPENSE ACCOUNT IS RECORDED AS A DEBIT; A DECREASE IN EITHER AN ASSET OR AN EXPENSE ACCOUNT IS RECORDED AS A CREDIT. • AN INCREASE IN A LIABILITY, OWNERS' EQUITY OR REVENUE ACCOUNT IS RECORDED AS A CREDIT; A DECREASE IN EITHER A LIABILITY, OWNERS' EQUITY, OR REVENUE ACCOUNT IS RECORDED AS A DEBIT.

4. BOOKKEEPING PROCEDURES • A TRANSACTION IS INITIALLY RECORDED IN A JOURNAL ENTRY. • THE JOURNAL ENTRY IS THEN POSTED TO THE LEDGER ACCOUNTS THAT HAVE BEEN AFFECTED BY THE TRANSACTION. • KEY IDEAS • A TRANSACTION WILL AFFECT AT LEAST TWO ACCOUNTS, AND CAN AFFECT MANY ACCOUNTS. • BECAUSE THE BALANCE SHEET MUST BALANCE AFTER EVERY TRANSACTION, THE DEBIT(S) AND CREDIT(S) AMOUNTS OF EACH JOURNAL ENTRY MUST BE EQUAL. • DEBITS = CREDITS • KEY OBSERVATION • EACH ACCOUNT HAS A "NORMAL BALANCE" SIDE - DEBIT OR CREDIT - THAT IS CONSISTENT WITH THE KIND OF ENTRY THAT CAUSES THE ACCOUNT BALANCE TO INCREASE. • DEBITCREDIT • ASSETS LIABILITIES • EXPENSES OWNERS’ EQUITY • REVENUES

5. TRANSACTION ANALYSIS METHODOLOGY • FIVE QUESTIONS OF TRANSACTION ANALYSIS • KEY IDEA • TO UNDERSTAND EITHER THE BOOKKEEPINGPROCEDURE FOR A TRANSACTION, OR THE EFFECT • OF A TRANSACTION ON THE FINANCIAL STATEMENTS, THE FOLLOWING QUESTIONS MUST BE ANSWERED: • 1. WHAT'S GOING ON? • (WHAT IS THE NATURE OF THE TRANSACTION?) • 2. WHAT ACCOUNTS ARE AFFECTED? • (WHAT IS THE FINANCIAL STATEMENT CATEGORY OF EACH ACCOUNT - ASSET, LIABILITY, OWNERS' EQUITY, REVENUE OR EXPENSE?) • 3. HOW IS EACH ACCOUNT AFFECTED? • (IS THE BALANCE INCREASING OR DECREASING?) • 4. DOES THE BALANCE SHEET BALANCE?(DO THE DEBITS EQUAL THE CREDITS? IS THE BALANCE SHEET EQUATION STILL IN BALANCE AFTER RECORDING THE TRANSACTION?) • DEBITS = CREDITS? • ASSETS = LIABILITIES + OWNERS’ EQUITY? • 5. DOES MY ANALYSIS MAKE SENSE? • (DO THE ACCOUNT BALANCES OR THE FINANCIAL STATEMENTS REFLECT THE EFFECT OF THE TRANSACTION?)

6. ADJUSTING ENTRIES • WHAT ARE THEY? WHY DO THEM? • ADJUSTING ENTRIES, OR ADJUSTMENTS, ARE “UPDATES” AND "CORRECTIONS" MADE TO INCREASE THE ACCURACY OF THE INFORMATION IN THE FINANCIAL STATEMENTS. • RECLASSIFICATIONS: • THE BOOKKEEPING FOR THE ORIGINAL TRANSACTION WAS APPROPRIATE WHEN IT WAS RECORDED, BUT THE PASSAGE OF TIME REQUIRES A RECLASSIFICATION OF THE ORIGINAL BOOKKEEPING TO REFLECT CORRECT ACCOUNT BALANCES AS OF THE DATE OF THE FINANCIAL STATEMENTS. • ACCRUALS: • REVENUES WERE EARNED OR EXPENSES WERE INCURRED DURING THE PERIOD, BUT NO TRANSACTION WAS RECORDED, (BECAUSE NO CASH WAS RECEIVED OR PAID). THEREFORE, IT IS NECESSARY TO ACCRUE THE EFFECT OF THE TRANSACTION AS OF THE DATE OF THE FINANCIAL STATEMENTS. • KEY IDEAS • ACCRUAL ACCOUNTING MEANS THAT REVENUES ARE RECOGNIZED WHEN EARNED (NOT WHEN CASH IS • RECEIVED) AND THAT EXPENSES ARE REFLECTED IN THE PERIOD IN WHICH THEY ARE INCURRED (NOT WHEN CASH IS PAID). • ADJUSTING ENTRIES RESULT IN MATCHING REVENUES AND EXPENSES, WHICH IS THE OBJECTIVE OF ACCRUAL ACCOUNTING.