Chapter 4

ACCOUNTING RECORDS AND SYSTEMS

Account An account is an individual accounting

record of increases and decreases labeled as debits and credits.

There are separate accounts for each classification type such as cash, salaries expense, accounts payable, etc.

Permanent Accounts real accounts = balance sheet accounts. Reported on balance sheet. Carried forward into next period:

In this sense, they are permanent.

Temporary Accounts

Revenue and expense accounts. Details of income statement and changes

in retained earnings (RE). Helps summarize operating activity. Avoids cluttering RE account. At end of accounting period, amounts are

totaled, combined and transferred to RE.

General Ledger General ledger contains all accounts. Some accounts may be in summary form.

E.g. accounts receivable, inventory, fixed assets. Detail or subsidiary ledgers kept for above.

Accounting Cycle/Process1. Identify the transactions. 2. Record the entries by making entries in the

appropriate journal3. Post journal entries to ledger account4. Prepare trial balance to make sure that debit

equals credit5. Pass necessary entries for closing of the

books6. Prepare adjusted trial balance7. Prepare financial statements – Income

statement, Balance Sheet, Cash Flow Statement

Debit & Credit Two of the most familiar accounting

terms are “debits and credits.” In the double-entry system, debits must always equal credits for the accounting equation.

Debit (from the Latin word debere) means “left.” It is often abbreviated as “dr.”

Credit (from the Latin word credere) means “right.” It is often abbreviated as “cr.”

Debit & Credit Recording $s on the left side of an

account is debiting the account Recording $s on the right side is

crediting the account For individual accounts:

• If the total of debit amounts is bigger than credits, the account has a debit balance

• If the total of credit amounts is bigger than debits, the account has a credit balance

Tabular Summary Vs. Account Form

Basic Form Of Account The simplest form an account consists of1 the title of the account2 a left or debit side3 a right or credit side The alignment of these parts resembles the letter

T, therefore the name “T account”

Left or debit side

Title of Account

Right or credit side

Debit balance Credit balance

Normal Balances-Assets & Liabilities

AssetsIncrease Decrease Debit CreditDecrease Increase Debit Credit

Liabilities

Normal Balance- Owners Capital

Owner’s Capital

Decrease Increase Debit Credit

Normal Balance

T Accounts for Revenue & Expenses

ANY EXPENSE

NORMALBALANCE

ANY REVENUE

NORMALBALANCE

Summarizing Rules of Debit & Credit

Normal

Increase Decrease Balance

Assets DR CR DRLiabilities CR DR CROwners’ equity CR DR CRRevenues CR DR CRExpenses DR CR DR

Double Entry System total debits always equal the total credits accounting equation always stays in

balanceAssets= Liabilities + Equity

LiabilitiesAssets Owner’s Equity

= + -

+=

+ -

Assets

Dr. Cr.+ -

Liabilities

Dr. Cr.- +

Dr. Cr.

Owner’s Dividend

s

+ -

Dr. Cr.

Revenues

- +Dr. Cr.

Expenses

+ -

Dr. Cr.

Owner’s Capital

- +

Expanded Basic Equation & Debit Credit Rules & Effect

To summarize.. Debit: Increase in Assets

Decrease in Liabilities All Expenses (losses)

Credit: Decrease in Assets Increase in liabilities All Income (gains)

 

Example Mr. A started business with an initial capital of Rs.5,000. Mr. A

purchased goods worth Rs.10,000 from Mr. Y on credit. He sold Rs.8,000 worth of goods at Rs.10,000 to Mr. X. Mr. X paid Rs.4,500 in settlement of Rs.5,000. Mr. A paid Rs. 4,000 to Mr. Y.

The transactions involved in the above transaction in the books of A (in the books of A means that all transactions will be analyzed from A’s perspective) are as follows:

1. Mr. A started business with a capital of Rs. 5,0002. Mr. A purchased goods worth Rs. 10,000 from Mr. Y on credit3. Mr. A sold goods worth Rs.8,000 for Rs. 10,000 to Mr. X on

credit4. Mr. A received Rs.4,500 from X in settlement of Rs.5,000

(the difference of Rs.500 will be treated as Discount)5. Mr. A paid Rs. 4,000 to Mr. Y

Sr No Assets Liabilities Owner’s

Equity (excl

P/L for the

period)

Income/

Gains/

Revenue

Expenses/

Losses

Total

1 + 10,000 Cash + 10,000

Capital

0

2 + 10,000 Inventory + 10, 000

A/cs Payable

0

3 + 10,000 A/cs

Receivable

- 8,000 Inventory

+ 10,000

Sales

-8,000 Cost

of Goods

Sold

0

4 - 5,000 A/cs

Receivable

+ 4,500 Cash

- 500

Discount

0

5 - 4,000 Cash - 4,000 A/cs

Payable

0

Transactions are initially recorded (journalized) in chronological order before they are transferred to the ledger accounts.

A journal makes several contributions to recording process:

discloses in one place the complete effect of a transaction

provides a chronological record of transactions

helps to prevent or locate errors as debit and credit amounts for each entry can be compared

The Journal

Journalizing

Entering transaction data in the journal is known as journalizing.

Separate journal entries are made for each transaction.

A complete entry consists of:1 the date of the transaction,2 the accounts and amounts to be debited and credited,3 a brief explanation of transaction.

Technique of Journalizing

The date of the transaction is entered into the date column.

The debit account title is entered at the extreme left margin of the Account Titles and Explanation column. The credit account title is indented on the next line.

The date of the transaction is entered into the date column.

The debit account title is entered at the extreme left margin of the Account Titles and Explanation column. The credit account title is indented on the next line.

GENERAL JOURNAL J1

Date Account Titles and Explanation Lf. Debit Credit 2005 Sept. 1 Cash a/c dr. 15,000 To R. Neal, Capital 15,000 (Invested cash in business) 1 Computer Equipment a/c dr. 7,000 To Cash a/c 7,000 (Purchased equipment for cash)

When three or more accounts are required in one journal entry, the entry is referred to as a compound entry.

When three or more accounts are required in one journal entry, the entry is referred to as a compound entry.

Compound Journal Entry

2

1

3

GENERAL JOURNAL J1

Date Account Titles and Explanation Lf. Debit Credit 2005

July 1 Delivery Equipment a/c dr 14,000 To Cash 8,000 To Accounts Payable 6,000 (Purchased truck for cash with balance on account)

The Trial Balance

The trial balance is a list of accounts and their balances at a given time.

The primary purpose of a trial balance is to prove debits = credits after posting.

If debits and credits do not agree, the trial balance can be used to uncover errors in journalizing and posting.

PIONEER ADVERTISING AGENCY

Trial Balance

October 31, 2005

Debit Credit Cash $ 15,200 Advertising Supplies 2,500 Prepaid Insurance 600 Office Equipment 5,000 Notes Payable $ 5,000 Accounts Payable 2,500 Unearned Fees 1,200 C. R. Byrd, Capital 10,000 C. R. Byrd, Drawing 500 Fees Earned 10,000 Salaries Expense 4,000 Rent Expense 900 $ 28,700 $ 28,700

The total debits must equal the total credits.

The total debits must equal the total credits.

A Trial Balance

Profit & Loss Account, Balance Sheet Just as you have programming languages with

different syntax to write programme, accounting language is used to find out two things:

What is the profit/loss I made during the period?

What are the assets I own and liabilities I owe as on a particular date?

The first question is answered by preparing a Profit & Loss Account and the second question is answered through a Balance Sheet.

All other statements etc. that you make are aimed at facilitating the process of preparing these two statements.

Accounting System Consists of:

Journals. Ledgers. Rules for using them.

Manual, computerized, or anything between. In a computerized system:

Bookkeeping steps are done electronically.

Objectives of Accounting System To process information efficiently (low cost). To obtain reports quickly. To ensure a high degree of accuracy. To minimize possibility of theft or fraud.

Internal Accounting Controls Basic Principle: make it as difficult as is

practical for people to be dishonest or careless.

Activities that reduce possibility of theft, or intentional or unintentional mistakes.

Examples of Internal Controls Separation of duties:

Record keeping. Custody of assets. Authorization of transactions.

Reconciliations. Bank accounts. Detail ledgers to control accounts in general ledger.

What a Computer Based Accounting System Does Mechanical steps are bookkeeping. A computer based system performs some or

all bookkeeping steps: Records and stores data. Performs arithmetic operations on data. Sorts and summarizes data. Prepares reports.

Inputs Data entry clerk using a keyboard. Point of origin: Factory time records, inventory

counts, receiving records. Scanning device reading bar codes. Purchase orders from customer transmitted

electronically.

Processing and Output Examples Processing:

Only accept entries if debits equal credits. Assigning seat numbers for airline, or concert.

Outputs Reports including tables and graphs.

Routine or customized.

Modules Interconnected software programs. Examples:

Order entry. Processes sales orders, records shipments, and related accounts receivable.

Purchasing: Issues purchase orders. Personnel and Payroll: Keeps employee records

and issues paychecks.

Opportunities and Problems with Computer Systems

Efficiency over manual systems. Off the shelf systems available for small

companies. Modifying to unique complexities of a

company may be costly. Paper trail replaced by electronic

records. Technological advances making systems

obsolete. Challenge of educating users.