The Accounting Cycle

Capturing Economic Events

Chapter 3

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin Copyright © 2012 The McGraw-Hill Companies, Inc.3-1
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.
•• The
The journal
journal is
is aa chronological
chronological record
record
of
of transactions,
transactions, showing
showing for for each
each
transaction
transaction the the debits
debits andand credits
credits to
to
be
be entered
entered in
in specific
specific ledger
ledger
accounts.
accounts.

3-4
 General Journal
Transaction
Transaction
Date
Date Accounts
Accounts Affected
Affected

Journal Page 1
Date Description Debit Credit
Jul 1 Cash 80,000
Capital Stock 80,000
Cash Owner investment

Explanation
Explanation of
of Dollar
Dollar amount
amount ofof
transaction
transaction debits
debits and
and credits
credits 3-5
 Debit and Credit Entries
Debits and credits affect accounts as follows:

Assets = Liabilities + Equity

ASSETS LIABILITIES EQUITIES

Debit Credit Debit Credit Debit Credit

+ - - + - +
Normal
Normal Normal
Normal Normal
Normal

3-6
 Debit and Credit Entries in T
Account
Debit means Credit means

Asset & Increase Decrease

Expenses (left) side of the T- (Right ) side of the T-
account account
( Debit – Credit )
Liabilities and Decrease Increase
equity (left) side of the T- (Right ) side of the T-
& Income account account
( Credit – Debit )

3-7
 Debit and Credit Entries

Equity
Owner’s
Owner’s _ Owner's
Owner's _ Expenses
Capital
Capital Withdrawals
Withdrawals + Revenues
Revenues Expenses

Owner’s Owner's Revenues Expenses

Capital Withdrawals

Debit Credit Debit Credit Debit Credit Debit Credit

- + + - - + + -
3-8
 The first and the The middle three are
last are increased increased with credits
with a debit

Debit Credit
+ A = Assets -
- L = Liabilities +
- I = Income* +
- C = Capital +
+ E = Expenses -

Personal Accounts : Rule : “Debit the receiver and Credit the giver”
[Examples : Account of Mohamad, Drawings Account, Capital Account]

Real Accounts : Rule : “Debit what comes in Credit what goes out”
[ Examples : cash account, furniture account, machinery account, building account, Goodwill account, etc.]

Nominal Accounts : Rule : “Debit the expenses and losses and Credit the
income and gains” [example salaries paid, rent paid, discount allowed, bad debts, Commission
received, interest received discount received]

3-10
 Double Entry AccountingThe Equality
of Debits and Credits

A = L + OE
[ OE = A – L or L = A –
OE ]
In the double-entry accounting system,
In the double-entry accounting 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.
3-11
Golden Rules in Accounting :
1. Personal Accounts : Rule : “Debit the receiver
and Credit the giver”

It means - Debit that person's account who receives

something from the business and credit that person's
account that person's account who gives something to
the business.
[The accounts which relate to an individual, firm,
company or an institution are called Personal
Accounts. Examples : Account of Mohamad, Drawings
Account, Capital Account ]
3-13
Golden Rules in Accounting :
2. Real Accounts : Rule : “Debit what comes in
Credit what goes out”

It means whenever any property comes into the business

it is debited and when it goes outside the business it is
credited.
[ The accounts of all those things whose value can be
measured in terms of money and which are the properties
of the business are termed as Real Accounts. Such as cash
account, furniture account, machinery account,
building account, Goodwill account, etc. ]
3-14
Golden Rules in Accounting :
3. Nominal Accounts : Rule : “Debit the expenses
and losses and Credit the income and gains”
These accounts include the accounts of all expenses and incomes. For example
salaries paid, rent paid, discount allowed, bad debts, Commission received,
interest received discount received, etc.
Nominal accounts are those accounts which are in name only and which do not
really exist. The accounts are open simply to explain the nature of head for which
cash has been paid in the absence of nominal accounts it will be very difficult for
the management to know the amount paid separately on account of salary, rent,
commission, etc. As such the nominal accounts provide information regarding the
following :-
(i) Amount spent on various heads in a particular period;
(ii) Income received on various heads in a particular period.

3-15
The Use of Accounts

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

Increases are Account Title

recorded on one (Left side) (Right side)
side of the T Debit Credit

account, and
decreases are
recorded on the
other side. 3-25
 The Use of Accounts

Account Title
Left Side – Debit Right Side - Credit

Asset + Asset -
Expenses + Expenses -
Liability + Equity - Liability + Equity +
Income - Income +

+ Plus Increases ( - ) Minus Decreases

3-26
 The entire group of accounts is kept
together in an accounting record called
a ledger.
Accounts
Cash
Cash
Receivable

Accounts
Accounts
Notes
Payable
Notes
Payable
Payable
Payable

C.
C.Lapp,
Lapp,
Revenues
Capital
Revenues
Capital

3-27
Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2015
JAN 20 80,000 80,000
21 52,000 28,000

This ledger format is referred to as a

running balance.

3-28
Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2015
JAN 20 80,000 80,000
21 52,000 28,000

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.
3-29
 Posting to The Ledger
Cash Capital Stock
80000 80000

GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT

Jan 20 Supplies
Medical Cash 80000
80000
Capital Stock 80000
80000
Issued stock
3-30
 Posting to The Ledger
Cash Land
80000 52000 52000

GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT

Jan 21 Supplies
Medical LAND 52000
52000
CASH 52000
52000
purchased land
3-31
 Posting to The Ledger
Cash
80000 52000
6000

GENERAL JOURNAL
Accounts
DATE Receivable M. Brown, Capital
DESCRIPTION REF Rent
DEBITExpense
CREDIT

JAN 22 Building 25,000 36000

36000
Cash 6000
6000 30000
Note payable
30000 Building Note payable
36000 30000

3-32
 Balancing The Ledger
The
Thebalance
balanceisisthe
thedifference
differencebetween
betweenthe
thedebit
debitand
andcredit
creditentries
entries
in
inthe
theaccount.
account.
Cash Note Payable Tools & Equipment
80,000 52,000 30,000 13,800 1,800
600 6,000 Bal 30,000
Bal 12,000
6,800
Bal 15,800
Land A/P
52,000 6,800 13,800
Bal 52,000 Bal 7,000

Accounts Receivable Capital Stock Building

1,800 600 80,000 36,000
Bal 1,200 Bal 80,000 Bal 36,000
3-33
 Debit and Credit Entries
Cash
Cash

Payments are on
20/1
20/1 80,000 21/1
21/1 52,000

the credit side.

Receipts are 80,000 52,000
on the debit 26/1
26/1 600
600 22/1
22/1 6,000
6,000
side.
27/1
27/1 6,800
6,800

5/31
5/31 15,800
15,800 The
Thebalance
balanceisisthe
the
Bal.
Bal. difference
differencebetween
betweenthethe
debit
debitandandcredit
creditentries
entries
in
inthe
theaccount.
account.

3-34
 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

Net income
always results in
the increase of
Owners’ Equity
3-35
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.

3-36
The Income Statement: A Preview

The
Theincome
incomestatement
statementsummarizes
summarizesthetheprofitability
profitability
of
ofaabusiness
businessfor
foraa specified
specifiedperiod
periodof
oftime.
time. 3-37
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.

3-38
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.
3-39
 The Matching Principle

Matching Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.
Matching Principle
Expenses should be
recorded in the
period in which they
are used up. 3-40
 The Accrual Basis of Accounting
The policy of recognizing revenue in the accounting records when
it is earned and recognizing expenses when the related goods or
services are used is called the accrual basis of accounting.
Current Future
Accounting Period Accounting Period
Jan.
Jan. 1,
1, 2011
2011 Dec.
Dec. 1,
1, 2011
2011 Jan.
Jan. 1,
1, 2012
2012 Dec.
Dec. 1,
1, 2012
2012

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
3-41
 The Accrual Basis of Accounting
Under the cash basis of accounting, revenues are reported on the income
statement when the cash is received.)

Under the accrual basis of accounting, expenses are matched with the
related revenues and/or are reported when the expense occurs, not when
the cash is paid.

Accruals are adjustments for

1)revenues that have been earned but are not yet recorded in the accounts,
and

2)expenses that have been incurred but are not yet recorded in the
accounts.

The accruals need to be added via adjusting entries so that the financial
statements report these amounts
3-42
 Let’s
Let’s analyze
analyze thethe
revenue
revenue and
and
expense
expense
transactions
transactions forfor
Overnight
Overnight Auto
Auto
Service
Service for
for the
the
month
month ofof February.
February.

We
We will
will also
also
analyze
analyze aa dividend
dividend
transaction.
transaction. 3-43
 Transactions
Jan 31, Record revenue of $2,200 which was
received in cash
Jan 31, paid employees salaries $1200
Jan 31, Paid utilities used in January $200

3-44
 
Jan
Jan 31,
31, Record
Record revenue
revenue of
of $2,200
$2,200 which
which was
was received
received
in
in cash
cash

1-Jan Cash 2,200

Sales revenue 2,200

Cash Sales Revenue

Cash
20/1 31/1 2,200
20/1 80,000
80,000 21/1
21/1 52,000
52,000
26/1
26/1 600
600 22/1
22/1 6,000
6,000
31/1
31/1 2,200
2,200 27/1
27/1 6,800
6,800

5/31
5/31 18,000
18,000
Bal.
Bal. 3-45
 
Jan
Jan 31,
31, paid
paid employees
employees salaries
salaries $1200
$1200

1-Jan Salaries expenses 1,200

Cash 1,200

Cash Salary Expense

Cash
20/1 31/1 1,200
20/1 80,000
80,000 21/1
21/1 52,000
52,000
26/1
26/1 600
600 22/1
22/1 6,000
6,000
31/1
31/1 2,200
2,200 27/1
27/1 6,800
6,800
31/1
31/1 1,200
1,200
5/31
5/31 16,800
16,800
Bal.
Bal. 3-46
 
Jan
Jan 31,
31, Paid
Paid utilities
utilities used
used in
in January
January $200
$200

1-Jan utilities expenses 200

Cash 200

Cash utilities
Cash
20/1 31/1 200
20/1 80,000
80,000 21/1
21/1 52,000
52,000
26/1
26/1 600
600 22/1
22/1 6,000
6,000
31/1
31/1 2,200
2,200 27/1
27/1 6,800
6,800
31/1
31/1 1,200
1,200
31/1
31/1 200
200
31/1
31/1 17,800
17,800 3-47
Now,
Now, let’s
let’s look
look at
at
the
the Trial
Trial Balance
Balance
for
for Overnight
Overnight
Auto
Auto Service
Service for
for
the
the month
month of of
February.
February.

3-48
A trial balance lists the balances of all accounts in the ledger.
Remember that all transactions have an equal debit and credit
impact.
The total debit balance should be equal to the total credit

All balances are taken from the ledger accounts on May 31 after
considering all of JJ’s transactions for the month.
3-49
The Accounting Cycle in
Perspective

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

3-50