BAF3M1 The Expanded Ledger: Revenue, Expenses, and Drawings Chapter 5, Section 5.1

Expanding the Ledger To date, any change in the equity of the business was recorded in that one account Now, you must become familiar with a system in which the ledger has a number of accounts in an equity section Each of the new accounts reflects a particular kind of transaction that affects owner’s equity

Recall: Four transactions that affect equity: Owner invests cash into the business Increases Cash, Decreases Equity Owner withdraws cash from the business Decreases Cash, Decreases Equity Firm makes a sale on goods or services Increases Cash or A/R, Increases Equity Firm pays for expenses (i.e. Rent, utilities, wages, hydro)

The Expanded Ledger- New Accounts ______________________: related to the sale of goods or services; increase in equity ______________________: the costs related to the revenues; decrease in equity ______________________: the owner’s withdrawals for personal use; decrease in equity

The Expanded Ledger- New Accounts cont’d THEN NOW Accounts Used Owner invests cash in business Cash (increase) Equity Owner withdraws cash from business (decrease) Drawings (decreases Equity) Firm makes sale of goods/services Cash or A/R Revenue (increases Equity) Firm pays for expenses (decreases) Expenses

Purpose of Expanding the Ledger To provide essential information about the progress of the business (profitability, decision-making) J. Smith’s Questions: How much money did the firm make this month? How much was spent on advertising? Are the wages fair? Is the rent too high? How much money did I withdraw from the business for personal expenses?

Purpose of Expanding the Ledger cont’d Debit Credit left right Revenues represent an increase in equity. Equity increases on the right side. So, the Fees Earned (Revenue) account is credited Expenses and drawings represent decreases in equity. Equity decreases on the left side So, the Expenses and Drawings accounts are debited

GAAP – The Revenue Recognition Convention The revenue recognition convention states that revenue must be ___________________ in the accounts (recognized) ______ ______ _________the _____________________ ______ ___________________

BAF3M1 The Expanded Ledger: Revenue, Expenses, and Drawings Chapter 5, Section 5.2

The Income Statement A financial statement that summarizes the items of _________________ ________ ______________, and shows ________ ___________or _______ __________ of a business for a given period of time See handout “Steps in Preparing The Income Statement”

GAAP – The Time Period Concept The time period concept provides that accounting will take place over _____________ _________ ________________ known as fiscal periods The fiscal year does not have to be the same as the calendar year (Jan to Dec). For example, a fiscal year could begin on July 1, 2009 and end on June 30, 2010. Half-yearly, quarterly, or monthly fiscal periods are used by some businesses.

GAAP – The Matching Principle The matching principle states that each ____________ ___________ related to _______________ ____________ must be recorded in the ________ _____________ as the revenue it helped to earn For example, suppose a business purchases $30 000 of advertising on credit (terms 30 days) for a Boxing Day sale to be held on December 26, 2001. If the fiscal period ends December 31, 2001, the cost of the advertisement will be recorded in December, not January 2002 when the bill is to be paid. Suppose the advertisement was for a number of days to promote a 2 week sale (last week of Dec 2001 and first week of Jan 2002). Since the ad now helps generate revenue in two different fiscal periods, a portion of the ad expense will be recorded in each year.

Chart of Accounts To help organize the expanded ledger, it is customary to number the accounts in the ledger. These numbers are used for identification and reference A chart of accounts is a list of the ledger accounts and their numbers arranged in ledger order Assets 100-199 Liabilities 200-299 Owner’s Equity Capital Drawings 300-399 Revenues 400-499 Expenses 500-599

BAF3M1 The Expanded Ledger: Revenue, Expenses, and Drawings Chapter 5, Section 5.3

Equity Relationships and the Balance Sheet RECALL: Four types of accounts in the equity section of the ledger—a) capital, b) revenue, c) expense, and d) drawings. _______________ in ______________are recorded in the ____________, _______________, and _________________ accounts. The difference between total revenues and total expenses is the net income or the net loss. The net income (or net loss) figure along with the drawings figure, _____________ _____ ________________(___ ________________) in ______________.

Equity Relationships and the Balance Sheet cont’d Today, we are going to learn about the relationship between the income statement and the balance sheet. We’ve established: The net income (or net loss) figure along with the drawings figure, shows the increase (or decrease) in equity. Let’s take a look at three scenarios showing how these figures impact equity on the balance sheet

Changes in Equity Owner’s Equity J. Smith, Capital, January 1, 2009 $ 20 000 Net income $ 4 000 Drawings 500 Increase in Capital 3 500 J. Smith, Capital, December 31, 2009 $ 16 500 Scenario 1: Net income greater than drawings results in an increase in capital Scenario 2: A net loss results in a decrease in capital Owner’s Equity J. Smith, Capital, January 1, 2009 $10 000 Net loss $ 2 000 Drawings 300 Decrease in Capital 2 300 J. Smith, Capital, December 31, 2009 $ 7 700

Changes in Equity cont’d Owner’s Equity J. Smith, Capital, January 1, 2009 $ 30 000 Net income $ 400 Drawings 5 000 Decrease in Capital 4 600 J. Smith, Capital, December 31, 2009 $ 25 400 Scenario 3: Drawings greater than net income results in a decrease in capital