The Accounting Cycle: Capturing Economic Events

1. The Accounting Cycle:Capturing Economic Events Chapter 3

2. The Role of Accounting Records Establishes accountability for assets and transactions. Keeps track of routine business activities. Obtains detailed information about a particular transaction. Evaluates efficiency and performance within company. Maintains evidence of a company’s business activities.

3. The Ledger Accounts are individual records showing increases and decreases. Cash Accounts Payable The entire group of accounts is kept together in an accounting record called a ledger. Share Capital

4. Increases are recorded on one side of the T account, and decreases are recorded on the other side. Title of Account Left or Debit Side Right or Credit Side The Use of Accounts

5. Receipts are on the debit side. Payments are on the credit side. The balance is the difference between the debit and credit entries in the account. Debit and Credit Entries

6. ASSETS LIABILITIES EQUITIES Debit for Increase Credit for Decrease Debit for Decrease Credit for Increase Debit for Decrease Credit for Increase Debit and Credit Entries Debits and credits affect accounts as follows: A=L+E

7. Double Entry AccountingThe Equality of Debits and Credits A=L+E = Debit balances Credit balances In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.

8. Let’s record selected transactions for JJ’s Lawn Care Service in the accounts.

9. Will Share Capital increase or decrease? Share Capital increases $8,000 with a credit. Will Cash increase or decrease? Cash increases $8,000 with a debit. • 1 May: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. 3-9

10. Will Tools & Equipment increase or decrease? Tools & Equipment increases $2,500 with a debit. Will Cash increase or decrease? Cash decreases $2,500 with a credit. • 2 May: JJ’s purchased a riding lawn mower for $2,500 cash. 3-10

11. Cash decreases $2,000 with a credit. Notes Payable increases $13,000 with a credit. Will Cash and Notes Payable increase or decrease? Will Truck increase or decrease? Truck increases $15,000 with a debit. • 8 May: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000. 3-11

12. Will Tools & Equipment increase or decrease? Tools & Equipment increases $300 with a debit. Will Accounts Payable increase or decrease? Accounts Payable increases $300 with a credit. • 11 May: JJ’s purchased some repair parts for $300 on account. 3-12

13. Will Tools & Equipment increase or decrease? Tools & Equipment decreases $150 with a credit. Will Accounts Receivable increase or decrease? Accounts Receivable increases $150 with a debit. • 18 May: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. 3-13

14. The Journal In an actual accounting system, transactions are initially recorded in thejournal.

15. Posting Journal Entries to the Ledger Accounts Postingsimply means updating the ledger accounts for the effects of the transactions recorded in the journal.

16. Posting Journal Entries to the Ledger Accounts

17. Posting Journal Entries to the Ledger Accounts

18. Posting Journal Entries to the Ledger Accounts Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service.

19. Ledger Accounts After Posting This ledger format is referred to as a running balance.

20. Ledger Accounts After Posting T accounts are simplified versions of the ledger account that only show the debit and credit columns.

21. Increase Decrease Increase As income is earned, either an asset is increased or a liability is decreased. Profit always results in the increase of Equity What is Profit? Profit is not an asset it’s an increase in equity from profits of the business. A =L+E

22. Retained Earnings A =L + E ShareCapital Retained Earnings The balance in the Retained Earnings account represents the profit of the corporation over the entire lifetime of the business, less all amounts which have been distributed to the shareholders as dividends.

23. The Income Statement: A Preview The income statement summarizes the profitability of a business for a specified period of time.

24. Accounting Periods Time Period Principle To provide users of financial statements with timely information, profit is measured for relatively short accounting periods of equal length.

25. The costs of goods and services used up in the process of earning revenue. Decreases equity. Revenue and Expenses The price for goods sold and services rendered during a given accounting period. Increases equity.

26. The Matching Principle: When To Record Revenue Matching Principle Revenue should be recognized at the time goods are sold and services are rendered.

27. The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up.

28. The Accrual Basis of Accounting Current Accounting Period FutureAccounting Period 1 Jan. 2009 1 Dec. 2009 1 Jan. 2010 1 Dec. 2010 Cash is received or paid here The income statement reports revenue or expense here But . . . OR The income statement reports revenue or expenses here Cash is received or paid here But . . .

29. EXPENSES REVENUES Debit for Increase Credit for Decrease Debit for Decrease Credit for Increase Debit and Credit Rules for Revenue and Expenses Expenses decrease equity. Revenues increase equity. EQUITIES Debit for Decrease Credit for Increase

30. EQUITIES Debit for Decrease Credit for Increase DIVIDENDS SHARE CAPITAL Debit for Increase Credit for Decrease Debit for Decrease Credit for Increase Dividends Payments to owners decrease equity. Owners’ investments increase equity.

31. Let’s analyze the revenue and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction.

32. Will Sales Revenue increase or decrease? Sales Revenue increases $750 with a credit. Will Cash increase or decrease? Cash increases $750 with a debit. • 29 May: JJ’s provided lawn care services for a client and received $750 in cash. 3-32

33. Will Gasoline Expense increase or decrease? Gasoline Expense increases $50 with a debit. Will Cash increase or decrease? Cash decreases $50 with a credit. • 31 May: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. 3-33

34. Will Dividends increase or decrease? Dividends increase $200 with a debit. Will Cash increase or decrease? Cash decreases $200 with a credit. • 31 May: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. 3-34

35. Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May.

36. All balances are taken from the ledger accounts on 31 May after considering all of JJ’s transactions for the month.

37. The Accounting Cycle in Perspective Accountants spend much of their time focusing on the more analytical aspects of their discipline.

38. End of Chapter 3