Accounting Transactions Process

Accounting Transactions Process

4-2

The Bookkeeping/Accounting Process

Transactions are economic interchanges between entities that are accounted for and reflected in financial

statements.

Borrow cash

from the bank

4-3

AA = = LL + + OEOEThe Balance Sheet Equation—A

Mechanical Key

AA = = LL + + PIC PIC ++ RE REBEGBEG ++ R R -- E E

The basic accounting equation can be expanded to include revenues and

expenses.

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= Liabilities +

Transaction Cash + Accounts

Receivable + Equipment = Notes

Payable + Paid-in Capital +

Retained Earnings + Revenues - Expenses

abcdef

Total

Assets Owners' Equity

Let’s see how some

transactions effect the

operation of this equation.

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Transactions

a. The owners invested $2,000.

b. The company borrowed $6,000 from a bank.

c. Equipment costing $10,000 was purchased for $2,000 cash and signing a note payable for $8,000.

d. Equipment that cost $3,000 was sold for $3,000. The $3,000 will be received within 30 days.

e. The company provided services for $8,000 and received cash.

f. Wages of $2,000 were paid in cash.

= Liabilities +

Transaction Cash + Accounts

Receivable + Equipment = Notes

Payable + Paid-in Capital +

Retained Earnings + Revenues - Expenses

a 2,000 2,000 b 6,000 6,000 c (2,000) 10,000 8,000 d 3,000 (3,000)e 8,000 8,000 f (2,000) 2,000

Total 12,000 + 3,000 + 7,000 = 14,000 + 2,000 + 0 + 8,000 - 2,000 6,000

Assets Owners' Equity

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Revenues 8,000$ Expenses 2,000 Net Income 6,000$

Income Statement

= Liabilities +

Transaction Cash + Accounts

Receivable + Equipment = Notes

Payable + Paid-in Capital +

Retained Earnings + Revenues - Expenses

a 2,000 2,000 b 6,000 6,000 c (2,000) 10,000 8,000 d 3,000 (3,000)e 8,000 8,000 f (2,000) 2,000

Total 12,000 + 3,000 + 7,000 = 14,000 + 2,000 + 0 + 8,000 - 2,000 6,000

Assets Owners' Equity

Beginning Balance -$ Add: Net Income 6,000 Less: Dividends - Ending Balance 6,000$

Statement of Changes in Retained Earnings

Cash 12,000$ Notes Payable 14,000$ Accounts Receivable 3,000 Equipment 7,000 Paid-in Capital 2,000

Retained Earnings 6,000

Total Assets 22,000$ Total Liabilities & Owners' Equity 22,000$

Owners' Equity

Balance SheetAssets Liabilities

4-7

Bookkeeping Jargon

Transactions are initially recorded in a journal.

Cash Equipment

InventoryNotes

Payable

Transactions are then recorded—posted to—individual accounts in

the ledger.

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A A T-accountT-account is a tool used to represent is a tool used to represent an account.an account.

Account NameLeft Right

T-Account

4-9

T-Account

The left side of the T-account is always the

debit side.

Account NameLeft Right

Debit

The right side of the T-account is always the

credit side.

Credit

4-10

Debits and Credits

ASSETSASSETS

Debit for

Increase

Credit for

Decrease

EQUITIESEQUITIES

Debit for

Decrease

Credit for

Increase

LIABILITIESLIABILITIES

Debit for

Decrease

Credit for

Increase

Debits and credits affect the accounting equation as follows:

AA = = LL + + OEOE

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Debits and Credits

ASSETSASSETS

Debit for

Increase

Credit for

Decrease

EQUITIESEQUITIES

Debit for

Decrease

Credit for

Increase

LIABILITIESLIABILITIES

Debit for

Decrease

Credit for

Increase

AA = = LL + + OEOE

Paid-in Capital

Retained Earnings

Remember that Owners’ Equity includes Paid-in Capital and

Retained Earnings.

4-12

Revenue and Expenses

Increases in owners’ equity.

Increases with a credit.

Decreases in owners’ equity.

Increases with a debit.

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Debits and Credits

AA = = LL + + OEOENormal balance for: Normal balance for:

Assets LiabilitiesExpenses Owners' equity

RevenuesDebit entries increase: Credit entries increase:

Assets LiabilitiesExpenses Owners' equity

RevenuesDebit entries decrease: Credit entries decrease:

Liabilities AssetsOwners' equity ExpensesRevenues

Account NameDebit side Credit side

4-14

Journal Entry Format

Date Debit Credit6/30 Cash 2,000

Paid-in Capital 2,000 To record an investmentby the owners.

Description

A typical journal entry might look like this.

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Journal Entry Format

Date Debit Credit6/30 Cash 2,000

Paid-in Capital 2,000 To record an investmentby the owners.

Description

Provide a referencedate for each transaction.

Debits are written first.

Credits are indented andwritten after debits.

Total debits must equaltotal credits.

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The Bookkeeping Process

Date Debit Credit6/30 Cash 2,000

Paid-in Capital 2,000 To record an investmentby the owners.

Description

Recorded in the Journal

Account NameDebit Credit

Posted to the Ledger

Transactions

Source Documents

4-17

Transaction Analysis Illustrated

Let’s prepare some journal entries for Let’s prepare some journal entries for and post them to the ledger.and post them to the ledger.

Transactions

a. The owners invested $2,000.

b. The company borrowed $6,000 from a bank.

c. Equipment costing $10,000 was purchased for $2,000 cash and signing a note payable for $8,000.

d. Equipment that cost $3,000 was sold for $3,000. The $3,000 will be received within 30 days.

e. The company provided services for $8,000 and received cash.

f. Wages of $2,000 were paid in cash.

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The owners invested $2,000.

(a) 2,000

2,000

Cash2,000 (a)

2,000

Paid-in Capital

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6,000 (b)

6,000

Notes Payable

The company borrowed $6,000 from a bank.

(a) 2,000 (b) 6,000

8,000

Cash

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Let’s see how to post this entry . . .

Equipment costing $10,000 was purchased for $2,000 cash and signing a note payable

for $8,000.

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(c) 10,000

10,000

Equipment

6,000 (b)8,000 (c)

14,000

Notes Payable(a) 2,000 2,000 (c)(b) 6,000

6,000

Cash

Equipment costing $10,000 was purchased for $2,000 cash and signing a note payable

for $8,000.

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Equipment that cost $3,000 was sold for $3,000. The $3,000 will be received within 30

days.

(d) 3,000

3,000

Accounts Receivable(c) 10,000 3,000 (d)

7,000

Equipment

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The company provided services for $8,000 and received cash.

8,000 (e)

8,000

Revenue(a) 2,000 2,000 (c)(b) 6,000 (e) 8,000

14,000

Cash

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Wages of $2,000 were paid in cash.

(f) 2,000

2,000

Wages Expense(a) 2,000 2,000 (c)(b) 6,000 2,000 (f)(e) 8,000

12,000

Cash

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At the end of the period, we need to

make adjusting entries to get the accounts up to date for the financial

statements.

4-26

Adjusting entries are

needed whenever revenue or expenses affect more than one

accounting period.

Every adjusting

entry involves a change in either a

revenue or expense and an asset

or liability.

Adjustments/Adjusting Entries

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Types of Adjusting Entries

The initial recording of a transaction does not result in assigning

revenues to the period in which they were earned

or expenses to the period in which they

were incurred..

Reclassifications

Transactions for which cash has NOT yet been

received or paid, but the effect of which must be

recorded in the accounts in order to accomplish a

matching of revenues and expenses.

Accruals

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Examples Include:

Interest

Wages and Salaries

Property Taxes

Hey, when do we get

paid?

Accruing Expenses

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Monday,May 29

Friday, June 2

$3,000 Wages Expense

On May 31, Webb Co. owes wages of $3,000. Pay day is Friday, June 2.

Wednesday,May 31

Accruing Expenses

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

May 31 Wages Expense 3,000Wages Payable 3,000

To accrue wages owed to employees.

Initially, an expense and a liability are recorded.

Accruing Expenses

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Wages Expense5/31 3,000

Wages Payable5/31 3,000

Income Statement

Cost incurred this period to generate

revenue.

Balance Sheet

Liability to be paid in a future

period.

Accruing Unpaid Expenses

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Monday,May 29

Friday, June 2

$5,000 Weekly Wages

Let’s look at the entry for June 2.

Wednesday,May 31

$2,000 Wages Expense

$3,000 Wages Expense

Accruing Expenses

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The liability is extinguished when the debt is paid.

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

June 2 Wages Expense (for June) 2,000Wages Payable (accrued in May) 3,000

Cash 5,000Weekly payroll for May 29-June 2.

Accruing Expenses

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Examples Include:

Interest Earned

Work Completed But Not Yet Billed to Customer

Accruing Revenues

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Saturday,Jan. 15

Tuesday, Feb. 15

$170 Interest Revenue

On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the 15th

day of each month.

Monday,Jan. 31

Accruing Revenues

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Jan. 31 Interest Receivable 170Interest Revenue 170

To recognize interest revenue.

Initially, the revenue is recognized and a receivable is created.

Accruing Revenues

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Interest Revenue1/31 170

Interest Receivable1/31 170

Income Statement

Revenue earned this period.

Balance Sheet

Receivable to be collected in a

future period.

Accruing Revenues

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Saturday,Jan. 15

Tuesday, Feb. 15

$320 Monthly Interest

$170 Interest Revenue

Let’s look at the entry for February 15.

Monday,Jan. 31

$150 Interest Revenue

Accruing Revenues

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The receivable is collected in a future period.

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Feb. 15 Cash 320Interest Revenue (for February) 150Interest Receivable (accrued Jan. 31) 170

To record interest received.

Accruing Revenues

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Examples Include:

Supplies

Expiring Insurance Policies

Reclassifying Assets to Expenses

4-41

Jan. 1 Dec. 31

$2,400 Insurance Policy Coverage for 12 Months

$200 Monthly Insurance Expense

On January 1, Webb Co. purchased a one-year insurance policy for $2,400.

Reclassifying Assets to Expenses

4-42

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Jan. 1 Unexpired Insurance 2,400Cash 2,400

Purchase a one-year insurance policy.

Initially, costs that benefit more than one accounting period are recorded as assets.

Reclassifying Assets to Expenses

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The costs are expensed as they are used to generate revenue.

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Monthly Adjusting Entry for InsuranceJan. 31 Insurance Expense 200

Unexpired Insurance 200Insurance expense for January.

Reclassifying Assets to Expenses

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Insurance Expense1/31 200

Unexpired Insurance1/1 2,400 1/31 200

Bal. 2,200

Income Statement

Cost of assets used this period to generate revenue.

Balance Sheet

Cost of assets that benefit

future periods.

Reclassifying Assets to Expenses

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Examples Include:

Airline Ticket Sales

Sports Teams’ Sales of Season Tickets

Reclassifying Liabilities to Revenues

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Jan. 1 Dec. 31

$6,000 Rental Contract Coverage for 12 Months

$500 Monthly Rental Revenue

On January 1, Webb Co. received $6,000 in advance for a one-year rental contract.

Reclassifying Liabilities to Revenues

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Jan. 1 Cash 6,000Unearned Rental Revenue 6,000

Collected $6,000 in advance for rent.

Initially, revenues that benefit more than one accounting period are recorded as liabilities.

Reclassifying Liabilities to Revenues

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Over time, the revenue is recognized as it is earned.

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Monthly Adjusting Entry for Rent RevenueJan. 31 Unearned Rental Revenue 500

Rental Revenue 500Rental revenue for January.

Reclassifying Liabilities to Revenues

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Rental Revenue1/31 500

Unearned Rental Revenue1/31 500 1/1 6,000

Bal. 5,500

Income Statement

Revenue earned this period.

Balance Sheet

Liability for future periods.

Reclassifying Liabilities to Revenues

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Closing the Books

The closing process simply transfers the year-end balances of all income statement accounts (e.g.,

revenues, expenses, gains and losses) to the retained earnings account.

In addition, the dividends account is also closed to retained earnings.

4-51

Transaction Analysis Methodology

Answer Five Questions:

1. What’s going on?

2. What accounts are affected?

3. How are they affected?

4. Does the balance sheet balance? (Do the debits equal the credits?)

5. Does my analysis make sense?

4-52

Questions ?