The Accounting Cycle:

Capturing Economic Events

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
 The Accounting Cycle

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Prepare after-closing Journalize and Prepare Prepare adjusted

trial balance. post closing financial trial balance.
3-2
entries. statements.
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
ofaacompany’s
company’s
business
businessactivities.
activities.
3-3
The Ledger

Accounts
Accounts are
are
Cash individual
individual records
records
showing
showing increases
increases
Accounts and
and decreases.
decreases.
Payable

The
The entire
entire group
group of
of
Capital accounts
accounts is is kept
kept
Stock
together
together in in an
an
accounting
accounting record
record
called
called aa ledger.
ledger.
3-4
The Use of Accounts

Increases are recorded

on one side of the T Title of Account

account, and decreases Left Right

are recorded on the or or
Debit Credit
other side. Side Side

3-5
 Debit and Credit Entries
Cash
Cash
Receipts are 5/1
5/1 8,000
8,000 5/25/2 2,500
2,500 Payments are
on the debit
side. 5/25
5/25 75
75 5/8 2,000
5/8 2,000
on the credit
side.
5/29
5/29 750
750 5/28
5/28 150
150
5/31
5/31 50
50
5/31
5/31 4,125
4,125 The
Thebalance
balanceis
isthe
the
Bal.
Bal. difference
differencebetween
betweenthethe
debit
debitandandcredit
creditentries
entries
in
inthe
theaccount.
account.

3-6
 Debit and Credit Entries
Debits and credits affect accounts as follows:

A = L + OE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase

3-7
 Double Entry AccountingThe Equality
of Debits and Credits

A = L + OE
=
Debit Credit
balances 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.
3-8
 Let’s record
selected
transactions
for JJ’s Lawn
Care Service in
the accounts.

3-9
 May
May 1:
1: Jill
Jill Jones
Jones and
and her
her family
family invested
invested $8,000
$8,000
in
in JJ’s
JJ’s Lawn
Lawn CareCare Service
Service and
and received
received 800
800 shares
shares
of
of stock.
stock.

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

Cash Capital Stock

5/1 8,000 5/1 8,000

3-10
 May
May 2:
2: JJ’s
JJ’s purchased
purchased aa riding
riding lawn
lawn mower
mower
for
for $2,500
$2,500 cash.
cash.

Tools
Will
& Tools
Equipment
&
Will
CashCash
decreases
increase
Equipment
increases increase
$2,500
$2,500
or decrease?
with a credit.
or
with
decrease?
a debit.

Cash Tools & Equipment

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

3-11
  May
May 8: 8: JJ’s
JJ’s purchased
purchased aa $15,000
$15,000 truck.
truck. JJ’s
JJ’s
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.

Will Cash and

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

Cash
5/1 8,000 5/2 2,500
Truck
5/8 2,000
5/8 15,000
Notes Payable
5/8 13,000

3-12
 May
May 11:
11: JJ’s
JJ’s purchased
purchased some
some repair
repair parts
parts
for
for $300
$300 on
on account.
account.

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

Tools & Equipment Accounts Payable

5/2 2,500 5/11 300
5/11 300

3-13

 May
May 18:
18: JJ’s
JJ’s 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 JJ’s
JJ’s cost.
cost.
ABC
ABC Lawns
Lawns agrees
agrees to
to pay
pay JJ’s
JJ’s within
within 30
30 days.
days.

Tools
Will& Tools
Equipment
& Will Accounts
decreases
Equipment$150increase
with Receivable increase
or adecrease?
credit. or decrease?

Tools & Equipment Accounts Receivable

5/2 2,500 5/18 150 5/18 150
5/11 300

3-14
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.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2009
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.
3-15
Posting Journal Entries to the
Ledger Accounts

Posting simply
means updating the
ledger accounts for
the effects of the
transactions
recorded in the
journal.
3-16
 Posting Journal Entries to the
Ledger Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2009
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest Ledger
cash in the business.

Cash
Date Debit Credit Balance
2009
May 1 8,000 8,000
3-17
 Posting Journal Entries to the
Ledger Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2009
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest Ledger
cash in the business.

Capital Stock
Date Debit Credit Balance
2009
May 1 8,000 8,000
3-18
Posting Journal Entries to the
Ledger Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2009
May 2 Tools & Equipment 2,500
Cash 2,500
Purchased lawn mower.

Let’s
Let’s 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 JJ’s
JJ’s Lawn
Lawn Care
Care Service.
Service.
3-19
Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2009
May 1 8,000 8,000
2 2,500 5,500

This ledger format is referred to as a

running balance.

3-20
Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2009
May 1 8,000 8,000
2 2,500 5,500

TT accounts
accounts areare 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.
3-21
 What is Net Income?
Net
Net income
income is
is not
not an asset it’s
an asset it’s an
an increase
increase
in
in owners’
owners’ equity
equity from
from profits
profits of
of the
the
business.
business.

A = L + OE
Increase Decrease Increase

As income is earned, Net income

either an asset is always results in
increased or a liability is the increase of
decreased. Owners’ Equity
3-22
Retained Earnings

A = L + OE
Capital Retained
Stock 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.
3-23
The Income Statement: A Preview
JJ's Lawn Care Service
Income Statement
For the Month Ended May 31, 2009

Sales Revenue $ 750

Operating Expense:
Gasoline Expense 50
Net Income $ 700

The
Theincome
incomestatement
statementsummarizes
summarizesthe the
profitability
profitabilityof
ofaabusiness
businessfor
foraa specified
specifiedperiod
period
of
oftime.
time. 3-24
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.

3-25
Revenue and Expenses
The price for
goods sold
and services Increases
rendered during a owners’ equity.
given accounting
period.

The costs of
goods and Decreases
services used up owner’s equity.
in the process of
earning revenue.
3-26
 The Revenue Principle: When
To Record Revenue

Revenue Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.

3-27
 The Matching Principle: When
To Record Expenses

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

3-28
The Accrual Basis of Accounting
Current Future
Accounting Period Accounting Period

Jan.
Jan. 1,
1, 2009
2009 Dec.
Dec. 1,
1, 2009
2009 Jan.
Jan. 1,
1, 2010
2010 Dec.
Dec. 1,
1, 2010
2010

The
The income
income statement
statement
Cash
Cash is
is received
received or
or paid
paid But . . .
reports
reports revenue
revenue or
or
here
here expense
expense here
here

OR
The
The income
income statement
statement But . . . Cash
Cash is
is received
received or
or paid
paid
reports
reports revenue
revenue oror here
here
expenses
expenses here
here
3-29
Debit and Credit Rules for
Revenue and Expenses
Expenses EQUITIES Revenues
decrease Debit Credit increase
owners’ for for owners’
equity. Decrease Increase equity.

EXPENSES REVENUES
Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

3-30
 Dividends
Payments to Owners’
EQUITIES
owners investments
decrease Debit Credit increase
for for
owners’ Decrease Increase owners’
equity. equity.

DIVIDENDS CAPITAL STOCK

Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

3-31
 Let’s
Let’s analyze
analyze the
the
revenue
revenue and
and
expense
expense
transactions
transactions forfor
JJ’s
JJ’s Lawn
Lawn Care
Care
Service
Service for
for the
the
month
month ofof May.
May.
We
We will
will also
also
analyze
analyze aa dividend
dividend
transaction.
transaction.
3-32
 May
May 29:
29: JJ’s
JJ’s provided
provided lawn
lawn care
care services
services for
for
aa client
client and
and received
received $750
$750 in
in cash.
cash.

Will Sales Revenue

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

Cash Sales Revenue

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

3-33

 May
May 31:
31: JJ’s
JJ’s purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
mower
mower and
and the
the truck
truck for
for $50
$50 cash.
cash.

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

Cash Gasoline Expense

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

3-34

 May
May 31:
31: JJ’s
JJ’s Lawn
Lawn Care
Care paid
paid Jill
Jill Jones
Jones and
and
her
her family
family aa $200
$200 dividend.
dividend.

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

Cash Dividends
5/1 8,000 5/2 2,500 5/31 200
5/29 750 5/8 2,000
5/31 50
5/31 200
3-35
 Now,
Now, let’s
let’s look
look at
at
the
the Trial
Trial Balance
Balance
for
for JJ’s
JJ’s Lawn
Lawn
Care
Care Service
Service forfor
the
the month
month of of May.
May.

3-36
 JJ's Lawn Care Service
Unadjusted Trial Balance
May 31, 2009
Cash $ 3,925
Accounts receivable 75
Tools & equipment 2,650
Truck 15,000
Notes payable $ 13,000
Accounts payable 150
Capital stock 8,000
Dividends 200
Sales revenue 750
Gasoline expense 50
Total $ 21,900 $ 21,900

All balances are taken from the ledger accounts on May

31 after considering all of JJ’s transactions for the
month. 3-37
The Accounting Cycle in
Perspective

Accountants spend
much of their time
focusing on the
more analytical
aspects of their
discipline.

3-38
End of Chapter 3

3-39