Accounting Cycle (I)

- Recording Economic
Transactions
Lecture 2

3-1

Learning Objectives:

Explain common forms of business

organization sole proprietorship,
partnership, corporation
Understand how balance sheet
accounts are increased or
decreased.
Explain the double-entry system of
accounting.
Explain the purpose of a journal
and its relationship to the ledger.
3-2

Learning Objectives:

Explain the nature of net income,

revenue, and expenses.
Apply the realization and
matching principles in recording
revenue and expense.
Understand how revenue and
expense transactions are recorded
in an accounting system.
Prepare a trial balance and
explain its uses and limitations.
3-3

Forms of Business
Organization
Sole
Sole
Proprietorships
Proprietorships

Partnerships
Partnerships

Corporations
Corporations

3-4

Reporting Ownership Equity

in the Statement of
Ow
ner's equity:
Financial
Position
Sole
Sole

Proprietorships
Proprietorships

Partnerships
Partnerships

Corporations
Corporations

Jill Jones, capital

8,000

Partners' equity
Jill Jones, capital $ 4,000
Bill Jones, capital
4,000
Total partners' equity

$ 8,000

Owners' equity
Capital stock
$ 7,000
Retained earnings
1,000
Total stockholders' equity

$ 8,000
3-5

The Role of Accounting

Records
Establishes
Establishesaccountability
accountabilityfor
forassets
assets
and
andtransactions.
transactions.

Keeps
Keepstrack
trackof
ofroutine
routinebusiness
business
activities.
activities.
Obtains
Obtainsdetailed
detailedinformation
informationabout
aboutaa
particular
particulartransaction.
transaction.
Evaluates
Evaluatesefficiency
efficiencyand
and
performance
performancewithin
withincompany.
company.
Maintains
Maintainsevidence
evidenceof
ofaacompanys
companys
business
businessactivities.
activities.

3-6

3-7

Accounts
An
An organized
organized format
format used
used by
by
companies
companies to
to accumulate
accumulate the
the dollar
dollar
effects
effects of
of transactions.
transactions.

Cash

Inventory

Equipment

Notes
Payable

3-8

The Ledger
Cash

Accounts
Payable

Capital
Stock

Accounts
Accounts are
are
individual
individual records
records
showing
showing increases
increases
and
and decreases.
decreases.
The
The entire
entire group
group of
of
accounts
accounts is
is kept
kept
together
together in
in an
an
accounting
accounting record
record
called
called aa ledger.
ledger.
3-9

3-10

The Use of Accounts

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

3-11

3-12

3-13

Double Entry Accounting The

Equality of Debits and Credits

A = L + OE
=

Debit
balances

Credit
balances

In
In the
the double-entry
double-entry accounting
accounting system,
system,
every
every transaction
transaction is
is recorded
recorded by
by equal
equal
dollar
dollar amounts
amounts of
of debits
debits and
and credits.
credits.
3-14

Debit and Credit Entries

Debits and credits affect accounts as follows:

A = L + OE
ASSETS

LIABILITIES

EQUITIES

Debit
Credit
for
for
Increase Decrease

Debit
Credit
for
for
Decrease Increase

Debit
Credit
for
for
Decrease Increase

3-15

Debit and Credit Entries

Receipts are
on the debit
side.

5/1
5/1
5/25
5/25
5/29
5/29
5/31
5/31
Bal.
Bal.

Cash
Cash
8,000
8,000 5/2
5/2 2,500
2,500 Payments are
on the credit
75
5/8
2,000
75
5/8 2,000
side.
750
150
750 5/28
5/28
150
5/31
50
5/31
50
4,125
4,125
The
Thebalance
balanceis
isthe
the
difference
differencebetween
betweenthe
the
debit
debitand
andcredit
creditentries
entries
in
inthe
theaccount.
account.

3-16

Lets record
selected
transactions
for JJs Lawn
Care Service in
the accounts.

3-17


May
May 1:
1: Jill
Jill Jones
Jones and
and her
her family
family invested
invested $8,000
$8,000
in
in JJs
JJsLawn
Lawn Care
Care Service
Service and
and received
received 800
800 shares
shares
of
of stock.
stock.

Will
Cash
Cash
increases
increase
$8,000
or decrease?
with a debit.

Cash
5/1 8,000

Will
Capital
Capital
Stock
Stock
increases
increase$8,000
or
with
decrease?
a credit.
Capital Stock
5/1 8,000

3-18


May
May 2:
2: JJs
JJs purchased
purchased aa riding
riding lawn
lawn mower
mower
for
for $2,500
$2,500 cash.
cash.

Will
Cash
Cash
decreases
increase
$2,500
or decrease?
with a credit.

Cash
5/1 8,000
5/2 2,500

Tools
Will
& Equipment
Tools &
Equipment
increases increase
$2,500
or
with
decrease?
a debit.
Tools & Equipment
5/2 2,500

3-19


May
May 8:
8: JJs
JJs purchased
purchased aa $15,000
$15,000 truck.
truck. JJs
JJs
paid
paid $2,000
$2,000 in
in cash
cash and
and issued
issued aa note
note payable
payable
for
for the
the remaining
remaining $13,000.
$13,000.

Truck
increases
Will
Truck
increase
$15,000
with a debit.
or decrease?

Truck
5/8 15,000

Will Cash and

Notes Payable
increase or
decrease?
Cash
5/1 8,000
5/2 2,500
5/8 2,000
Notes Payable
5/8 13,000
3-20


May
May 11:
11: JJs
JJs purchased
purchased some
some repair
repair parts
parts for
for
$300
$300 on
on account.
account.

Tools
Will
& Tools
Equipment
&
Equipment
increases $300
increase
with
or decrease?
a debit.

Will Accounts
Payable increase or
decrease?

Tools & Equipment

5/2 2,500
5/11
300

Accounts Payable
5/11
300

3-21


May
May 18:
18: JJs
JJs sold
sold half
half of
of the
the repair
repair parts
parts to
to
ABC
ABC Lawns
Lawns for
for $150,
$150, aa price
price equal
equal to
to JJs
JJs cost.
cost.
ABC
ABC Lawns
Lawns agrees
agrees to
to pay
pay JJs
JJs within
within 30
30 days.
days.
Tools
Will
& Tools
Equipment
&
decreases
Equipment$150
increase
with
or adecrease?
credit.
Tools & Equipment
5/2 2,500 5/18
150
5/11
300

Will Accounts
Receivable increase
or decrease?
Accounts Receivable
5/18
150

3-22

The Journal
In
In an
an actual
actual accounting
accounting system,
system,
transactions
transactions are
are initially
initially recorded
recorded in
in the
the
journal.
journal.

3-23

Posting Journal Entries to

the Ledger Accounts
Posting simply
means updating the
ledger accounts for
the effects of the
transactions
recorded in the
journal.
3-24

Posting Journal Entries to

the Ledger Accounts

3-25

Posting Journal Entries to

the Ledger Accounts

3-26

Posting Journal Entries to

the Ledger Accounts

Lets
Lets see
see what
what the
the cash
cash account
account looks
looks like
like
after
after posting
posting the
the cash
cash portion
portion of
of this
this
transaction
transaction for
for JJs
JJs Lawn
Lawn Care
Care Service.
Service.
3-27

Ledger Accounts After

Posting

This ledger format is referred to as a

running balance.
3-28

Ledger Accounts After

Posting

TT accounts
accounts are
are simplified
simplified versions
versions of
of
the
the ledger
ledger account
account that
that only
only show
show the
the
debit
debit and
and credit
credit columns.
columns.
3-29

What is Net Income?

Net
Net income
income is
is not
not an
an asset
asset its
its an
an increase
increase
in
in owners
ownersequity
equity from
from profits
profits of
of the
the
business.
business.

A = L + OE
Increase

Decrease

As income is earned,
either an asset is
increased or a liability is
decreased.

Increase

Net income
always results in
the increase of
Owners Equity
3-30

Retained Earnings

A = L + OE
Capital
Stock

Retained
Earnings

The balance in the Retained Earnings account

represents the total net income of the corporation
over the entire lifetime of the business, less all
amounts which have been distributed to the
stockholders as dividends.
3-31

3-32

The Income Statement: A

Preview

The
Theincome
incomestatement
statement summarizes
summarizesthe
the
profitability
profitabilityof
of aabusiness
businessfor
foraa specified
specifiedperiod
period
of
of time.
time.

3-33

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

3-34

Revenue and Expenses

The price for
goods sold
and services
rendered during a
given accounting
period.

Increases
owners equity.

The costs of
goods and
services used up
in the process of
earning revenue.

Decreases
owners equity.
3-35

The Matching Principle:

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

3-36

The Matching Principle:

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

3-37

The Accrual Basis of

Accounting
Current
Accounting Period
Jan.
Jan. 1,
1,
2009
2009

Future
Accounting Period

Dec.
Dec. 1,
1,
2009
2009

Cash
Cash is
is received
received or
or
paid
paid here
here
OR
The
The income
income
statement
statement reports
reports
revenue
revenue or
or
expenses
expenses here
here

Jan.
Jan. 1,
1,
2010
2010

But . . .

But . . .

Dec.
Dec. 1,
1,
2010
2010

The
The income
income
statement
statement reports
reports
revenue
revenue or
or expense
expense
here
here

Cash
Cash is
is received
received or
or
paid
paid here
here
3-38

Debit and Credit Rules for

Revenue and Expenses
Expenses
decrease
owners
equity.

EQUITIES
Debit
Credit
for
for
Decrease Increase

Revenues
increase
owners
equity.

EXPENSES

REVENUES

Debit
Credit
for
for
Increase Decrease

Debit
Credit
for
for
Decrease Increase
3-39

Dividends
Payments to
owners
decrease
owners
equity.

EQUITIES
Debit
Credit
for
for
Decrease Increase

DIVIDENDS
Debit
Credit
for
for
Increase Decrease

Owners
investments
increase
owners
equity.
CAPITAL STOCK

Debit
Credit
for
for
Decrease Increase
3-40

3-41

Lets
Lets analyze
analyze the
the
revenue
revenue and
and
expense
expense
transactions
transactions for
for
JJs
JJs Lawn
Lawn Care
Care
Service
Service for
for the
the
month
month of
of May.
May.
We
We will
will also
also
analyze
analyze aa dividend
dividend
transaction.
transaction.
3-42


May
May 29:
29: JJs
JJs provided
provided lawn
lawn care
care services
services for
for
aa client
client and
and received
received $750
$750 in
in cash.
cash.

Will
Cash
Cash
increases
increase
$750
or decrease?
with a debit.

Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000

Will Sales Revenue

increase or
decrease?
Sales Revenue
5/29
750

3-43


May
May 31:
31: JJs
JJs purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
mower
mower and
and the
the truck
truck for
for $50
$50 cash.
cash.

Cash
Will Cash
decreases
increase
$50
or
with
decrease?
a credit.

Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
5/31
50

Will Gasoline
Expense increase or
decrease?
Gasoline Expense
5/31
50

3-44


May
May 31:
31: JJs
JJs Lawn
Lawn Care
Care paid
paid Jill
Jill Jones
Jones and
and
her
her family
family aa $200
$200 dividend.
dividend.

Will Dividends
increase or
decrease?

Will
Cash
Cash
decreases
increase
$200
or decrease?
with a credit.

Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
5/31
50
5/31
200

5/31

Dividends
200

3-45

3-46

Now,
Now, lets
lets look
look at
at
the
the Trial
Trial Balance
Balance
for
for JJs
JJs Lawn
Lawn
Care
Care Service
Service for
for
the
the month
month of
of May.
May.

3-47

All balances are taken from the ledger accounts on May

31 after considering all of JJs transactions for the
month.

3-48

3-49