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Chapter

3The Accounting CycleC t i E i E tCapturing Economic Events

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Learning ObjectiveLearning Objective

To identify the steps in the accounting cycle

and discuss the role of accounting records in

an organization.

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LO1

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The Role of Accounting RecordsThe Role of Accounting RecordsEstablishes accountability forEstablishes accountability for

assets and transactions.

Keeps track of routine business activities.

Obtains detailed information about a particular transaction.about a particular transaction.

Evaluates efficiency and performance within company.

Maintains evidence of a

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Maintains evidence of a company’s business activities.

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Learning ObjectiveLearning Objective

To describe a ledger account and a ledgeraccount and a ledger.

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LO2

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The LedgerThe Ledger

C hAccounts are

individual recordsCash individual records showing increases

and decreases

The entire group of

Accounts Payable

and decreases.

The entire group of accounts is kept

together in anCapital Stock together in an

accounting record called a ledger

Stock

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called a ledger.

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The Use of AccountsThe Use of Accounts

IIncreases are recorded on one Title of the Account

side of the T-account, and

Left or

Right or ,

decreases are recorded on the

Debit Side

Credit Side

recorded on the other side.

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3-7

Let’s see how debits and creditsdebits and credits are recorded in the Cash account for JJ’s La n CareJJ’s Lawn Care

Service.Service.

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Debit and Credit Entries

C h

Debit and Credit Entries

Cash5/1 8,000 5/2 2,500Receipts P t

, ,5/25 75 5/8 2,0005/29 750 5/28 150

Receipts are on

the debit

Payments are on the

credit5/29 750 5/28 150 5/31 50

the debit side.

credit side.

5/31 4,125Bal.

The balance is the difference between Bal.the debit and credit

entries in the

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account.

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Learning ObjectiveLearning Objective

To understand howTo understand how balance sheet accounts

are increased andare increased and decreased.

LO3© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

LO3

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Debit and Credit RulesDebit and Credit Rules

Debits and credits affect accounts as follows:

AA = LL + OEOEAA = LL + OEOEASSETSASSETS

Debit f

Credit f

EQUITIESEQUITIES

Debit f

Credit f

LIABILITIESLIABILITIES

Debit f

Credit ffor

Increasefor

Decreasefor

Decreasefor

Increasefor

Decreasefor

Increase

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Learning ObjectiveLearning Objective

To explain the double-entry system of

accounting.

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LO4

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Double Entry AccountingThe Equality of Debits and CreditsEquality of Debits and Credits

AA = LL + OEOEAA LL OEOEDebitDebit CreditCreditDebit Debit

balancesbalancesCredit Credit

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

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dollar amounts of debits and credits.

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Let’s recordLet s record selected

transactions for JJ’s Lawn Care Service in theService in the

accountsaccounts.

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May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 sharesin JJ s Lawn Care Service and received 800 shares of stock.

Will C h i Will Capital Stock Will Cash increase or decrease?

pincrease or decrease?

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3-15

May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 sharesin JJ s Lawn Care Service and received 800 shares of stock.

C h i Capital Stock Cash increases $8,000 with a debit.

pincreases $8,000

with a credit.

Capital Stock5/1 8,000

Cash5/1 8,000,

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3-16

May 2: JJ’s purchased a riding lawn mower for $2 500 cashfor $2,500 cash.

Will Cash increase Will Tools & Equipment increaseor decrease? Equipment increase

or decrease?

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3-17

May 2: JJ’s purchased a riding lawn mower for $2 500 cashfor $2,500 cash.

Cash decreases Tools & Equipment increases $2 500$2,500 with a credit. increases $2,500

with a debit.

Tools & EquipmentCash Tools & Equipment5/2 2,500

Cash5/1 8,000 5/2 2,500

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May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2 000 in cash and issued a note payablepaid $2,000 in cash and issued a note payable for the remaining $13,000.

Will Cash and Will Truck increase

or decrease? Notes Payable

increase or decrease?

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May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2 000 in cash and issued a note payablepaid $2,000 in cash and issued a note payable for the remaining $13,000.

Cash decreases $2 000 with a creditTruck increases

$15,000 with a debit.

$2,000 with a credit. Notes Payable

increases $13 000increases $13,000 with a credit.

Truck

Cash5/1 8,000 5/2 2,500

5/8 2 000Truck5/8 15,000 5/8 2,000

Notes Payable

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5/8 13,000

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May 11: JJ’s purchased some repair parts for $300 on accountfor $300 on account.

Will Tools & Will Accounts Equipment increase

or decrease?Payable increase or

decrease?

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May 11: JJ’s purchased some repair parts for $300 on accountfor $300 on account.

Tools & Equipment Accounts Payable increases $300 with

a debit.increases $300 with

a credit.

Tools & Equipment5/2 2,500

Accounts Payable5/11 300

5/11 300

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May 18: JJ’s sold half of the repair parts to ABC Lawns for $150 a price equal to JJ’s costABC Lawns for $150, a price equal to JJ s cost. ABC Lawns agrees to pay JJ’s within 30 days.

Will Tools & Will AccountsWill Tools & Equipment increase

or decrease?

Will Accounts Receivable increase

or decrease?or decrease? or decrease?

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May 18: JJ’s sold half of the repair parts to ABC Lawns for $150 a price equal to JJ’s costABC Lawns for $150, a price equal to JJ s cost. ABC Lawns agrees to pay JJ’s within 30 days.

Tools & Equipment Accounts ReceivableTools & Equipment decreases $150 with

a credit

Accounts Receivable increases $150 with

a debita credit. a debit.

Tools & Equipment5/2 2,500 5/18 150

Accounts Receivable5/18 150

5/11 300

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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Learning ObjectiveLearning Objective

To explain the purposeTo explain the purpose of a journal and its relationship to therelationship to the

ledger.

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LO5

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The JournalThe Journal

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

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit2007

May 1 Cash 8,000Capital Stock 8,000

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Owners invest cash in the business.

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Posting Journal Entries to the Ledger Accounts

Posting

Accounts

Postinginvolves copying

informationinformation from the

journal to the ledgerledger

accounts.

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Posting Journal Entries to the Ledger AccountsAccounts

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit2007

May 1 Cash 8,000Capital Stock 8,000

Owners invest cash in the business.General LedgerCash

Date Debit Credit Balance2007

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May 1 8,000 8,000

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Posting Journal Entries to the Ledger AccountsAccounts

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit2007

May 1 Cash 8,000Capital Stock 8,000

Owners invest cash in the business.General LedgerCapital Stock

Date Debit Credit Balance2007

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

May 1 8,000 8,000

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Posting Journal Entries to the Ledger AccountsAccounts

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit2007

May 2 Tools & Equipment 2,500Cash 2,500

Purchased lawn mower.

Let’s see what the cash account looks like afterLet s see what the cash account looks like after posting the cash portion of this transaction for

JJ’s Lawn Care Service© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

JJ s Lawn Care Service.

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Ledger Accounts After PostingLedger Accounts After Posting

General LedgerCash

Date Debit Credit Balance2007

May 1 8,000 8,000 2 2,500 5,500

This ledger format is referred to as a grunning balance.

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Ledger Accounts After PostingLedger Accounts After Posting

General LedgerCash

Date Debit Credit Balance2007

May 1 8,000 8,000 2 2,500 5,500

T accounts are simplified versions of pthe ledger account that only show the

debit and credit columns© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

debit and credit columns.

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Learning ObjectiveLearning Objective

To explain the nature of net income, revenue,

and expenses.

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LO6

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What is Net Income?What is Net Income?

Net income is not an asset it’s an increase in owners’ equity from profits of the business.q y p

AA LL + OEOEAA = LL + OEOEI D IIncrease Decrease Increase

Either (or both) of these effects occur as net income

. . . but this is what “net income”

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is earned . . . really means.

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Retained Earnings

OORetained Earnings

AA = LL + OEOEAA LL OEOEC it l R t i dCapital Stock

Retained Earnings

The balance in the Retained Earnings account representsThe 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

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been distributed to the stockholders as dividends.

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The Income Statement: A Preview

JJ's Lawn Care Service

The Income Statement: A Preview

JJ's Lawn Care ServiceIncome Statement

F th M th E d d M 31 2007For the Month Ended May 31, 2007

Sales Revenue 750$ Operating Expense: Gasoline Expense 50 Net Income 700$

The income statement summarizes the profitability

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of a business for a specified period of time.

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Accounting PeriodsAccounting Periods

Time Period Principle

To provide users of financial pstatements with timely

information, net income is d f l ti l h tmeasured for relatively short

accounting periods of equal lengthlength.

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Revenue and ExpensesRevenue and Expenses

The price forThe price for goods sold and services Increases and services rendered during a given accounting

owners’ equity.

period.

The costs of goods andgoods and services used up in the process of

Decreases owner’s equity.

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pearning revenue.

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Learning ObjectiveLearning Objective

To apply the realizationTo apply the realization and matching principles

in recording revenuein recording revenue and expenses.

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LO7

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The Realization Principle: When To The Realization Principle: When To Record RevenueRecord Revenue

Realization PrincipleRealization Principle

Revenue should beRevenue should be recognized at the

time goods are soldtime goods are sold and services are

d drendered.

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The Matching Principle: When To Record ExpensesRecord Expenses

Matching PrincipleMatching Principle

Expenses should beExpenses should be recorded in the

period in which theyperiod in which they are used up.

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Debits and Credits for Revenue and Debits and Credits for Revenue and ExpenseExpense

EQUITIESEQUITIES

DebitDebit CreditCredit

Expenses Expenses decrease decrease

Revenues Revenues increase increase Debit Debit

for for DecreaseDecrease

Credit Credit for for

IncreaseIncreaseowners’ owners’ equity.equity.

owners’ owners’ equity.equity.

EXPENSESEXPENSES

CreditCreditDebitDebit

REVENUESREVENUES

DebitDebit CreditCreditCredit Credit for for

DecreaseDecrease

Debit Debit for for

IncreaseIncrease

Debit Debit for for

DecreaseDecrease

Credit Credit for for

IncreaseIncrease

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Investments by and Payments to Owners

Payments to Owners’

Owners

EQUITIESEQUITIES

Debit Debit Credit Credit

Payments to owners

decrease

Owners investments

increaseeb teb tfor for

DecreaseDecrease

C ed tC ed tfor for

IncreaseIncrease

decrease owners’ equity

increase owners’ equityequity. equity.

DIVIDENDSDIVIDENDS

CreditCreditDebitDebit

CAPITAL STOCKCAPITAL STOCK

DebitDebit CreditCreditCredit Credit for for

DecreaseDecrease

Debit Debit for for

IncreaseIncrease

Debit Debit for for

DecreaseDecrease

Credit Credit for for

IncreaseIncrease

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Learning ObjectiveLearning Objective

To understand how revenue and expense

transactions are recorded in an

accounting system.

LO8© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

LO8

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Let’s analyze theLet’s analyze the revenue and

expense transactions fortransactions for JJ’s Lawn Care Service for the month of Maymonth of May.

We will alsoWe will also analyze a dividend

t ti© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

transaction.

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May 29: JJ’s provided lawn care services for a client and received $750 in casha client and received $750 in cash.

Will Cash increase Will Sales Revenue increase oror decrease? increase or decrease?

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May 29: JJ’s provided lawn care services for a client and received $750 in casha client and received $750 in cash.

Cash increases Sales Revenue increases $750 with$750 with a debit. increases $750 with

a credit.

Sales RevenueCash Sales Revenue5/29 750

Cash5/1 8,000 5/2 2,500

5/29 750 5/8 2 0005/29 750 5/8 2,000

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May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cashmower and the truck for $50 cash.

Will Cash increase Will Gasoline E iWill Cash increase

or decrease? Expense increase or decrease?

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3-48

May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cashmower and the truck for $50 cash.

Cash decreases $50 Gasoline Expense i $50 ithCash decreases $50

with a credit. increases $50 with a debit.

Gasoline ExpenseCash Gasoline Expense5/31 50

Cash5/1 8,000 5/2 2,500

5/29 750 5/8 2 0005/29 750 5/8 2,000 5/31 50

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3-49

May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividendher family a $200 dividend.

Will Cash increase Will Dividends iWill Cash increase

or decrease? increase or decrease?

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3-50

May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividendher family a $200 dividend.

Cash decreases Dividends increase Cash decreases $200 with a credit.

Dividends increase $200 with a debit.

DividendsCash Dividends5/31 200

Cash5/1 8,000 5/2 2,500

5/29 750 5/8 2 0005/29 750 5/8 2,000 5/31 50 5/31 200

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

5/31 200

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Learning ObjectiveLearning Objective

To prepare a trial balance and explain its

uses and limitations.

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LO9

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Now, let’s look at the Trial Balancethe Trial Balance

for JJ’s Lawn Care Service for the month of Maymonth of May.

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3-53

All balancesJJ's Lawn Care Service

Unadjusted Trial Balance

All balances are taken from

the ledgerMay 31, 2007Cash 3,925$ Accounts receivable 75

the ledger accounts on May 31 afterAccounts receivable 75

Tools & equipment 2,650 Truck 15 000

May 31 after considering all

of JJ’sTruck 15,000 Notes payable 13,000$ Accounts payable 150

of JJ s transactions

for the monthp yCapital stock 8,000 Dividends 200

for the month.

Proves equality Sales revenue 750 Gasoline expense 50

T t l 21 900$ 21 900$

of debits and credits.

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Total 21,900$ 21,900$

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Learning ObjectiveLearning Objective

To distinguish between accounting cycle

procedures and the knowledge of accounting.

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LO10

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The Accounting Cycle

Journalize t ti Post entries to Prepare trial

Make end-of-year

transactions. Post entries to the ledger accounts.

Prepare trial balance. adjustments.

Prepare adjustedPrepareJournalize and

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Prepare adjusted trial balance.

Prepare financial

statements.

Prepare after-closing trial balance.

Journalize and post closing

entries.

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End of Chapter 3End of Chapter 3

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