Recording Transactions Lecture 3

Learning Objectives (LO) After studying this chapter, you should be able to Use double-entry accounting Describe the five steps in the recording process Analyze and journalize transactions and post journal entries to the ledgers Prepare and use a trial balance Close revenue and expense accounts and update retained earnings Correct erroneous journal entries and describe how errors affect accounts Explain how computers have transformed the processing of accounting data

LO 1 – Double-Entry System Basic accounting equation + specific accounts (Act.) ASSETS = LIABILITIES + OWNERS’ EQUITY Cash Accounts Payable Paid in Capital Accounts Receivable Notes Payable Retained Earnings Prepaid items Revenue Equipment Expenses Building Gains (later) Land Losses (later) Distributions to owners Dividends At least two entries required to maintain equality NET INCOME

LO 1 – Double-Entry System Analyze transactions, events, circumstances – looking for three things Which accounts are affected? What amounts are involved? In which direction did the accounts change? Up = +; Down = “–” Debits and credits Analogy – check register for cash (the account) Date Reference Description Deposit Withdrawal Balance Beginning balance 1,000 6/20/20X2 6/22/20X2 Paycheck Groceries 200 32 1,200 1.168

LO 1 – Double-Entry System T-account = visualization of every account EVERY ACCOUNT Left side DEBIT Increase (+) or decrease (–)? Right side CREDIT Increase (+) or Decrease (–)? Assets Liabilities Owners’ Equity = + D C D C Paid in Capital Retained Earnings D C Revenue (Expense) (Dividend) D C D C D C

LO 1 – Double-Entry System T-account = visualization of every account EVERY ACCOUNT Left side DEBIT Increase (+) or decrease (–)? Right side CREDIT Increase (+) or Decrease (–)? Assets Liabilities Owners’ Equity = + D + C – D – C + Paid in Capital Retained Earnings D – C + Revenue (Expense) (Dividend) D – C + D – C + D – C +

LO 1 – Double-Entry System Usage as a verb Debit Credit Assets Increase Decrease Liabilities Owners’ Equity Paid-in Capital Retained Earnings Revenues (Expenses) (Dividends) Debits increase these accounts but they also reduce owners’ equity At least two entries are required to keep the accounting equation in balance

LO 2 – Recording Process Transaction Documentation - original records underlying transactions, events, circumstances are analyzed to determine the amounts, accounts, and direction (up/down) each caused Journal – chronological listing of events (diary) Ledger – grouping like events into one record, e.g. cash in minus cash out = cash balance Trial Balance – ledger acts. collectively balance Transactions Documentation Journal Ledger Trial Balance Financial Statements

LO 2 – Recording Process Analyze each transaction to find Accounts – Chart of accounts used in the business Amounts – given/obvious or have to back into Beg.(10) + Purchase (5) less Used (?) = End (4) Direction - Debit Assets Liabilities/owners’ equity - Credit Assets Liabilities/owners’ equity

LO 3 –Posting to Ledger Accounts Posting = copying amounts from the journal to the ledger At least two postings per transaction For complex events, could involve many accounts (called compound journal entries) Cross-referencing - using numbering, dating, and/or some other identification in the ledger to trace it back to the appropriate journal entry or vice versa

LO 3 –Posting to Ledger Accounts Ledger formats may differ

LO 3 – Journal/Ledger Examples Sale of merchandise on credit (Part 1) Transaction: Customer charged purchase $180,000; paid later in full Analysis: Accounts Receivable and ultimately Cash increase Stockholders’ equity increases because Revenue was earned at the time of sale Journal Entry: Accounts Receivable 180,000 Revenue 180,000 Cash 180,000 Accounts Receivable 180,000 Posting: Cash Accounts Receivable Revenue 180,000 180,000 180,000 180,000

LO 3 – Journal/Ledger Examples Sale of merchandise on credit (Part 2) Transaction: Cost of merchandise sold, $100,000 Analysis: Merchandise Inventory decreases Stockholders’ equity decreases because an expense account Cost of Goods Sold (a negative stockholders’ account) increases Journal Entry: Cost of Goods Sold 100,000 Merchandise Inventory 100,000 Posting: Merchandise Inventory Cost of Goods Sold 100,000 100,000

LO 3 – Journal/Ledger Examples Sale of merchandise on credit (Part 3) Transaction: Customer pays for charged purchase $180,000 Analysis: Accounts Receivable decreases and Cash increases Journal Entry: Cash 180,000 Accounts Receivable 180,000 Cash Accounts Receivable Revenue Posting: 180,000 180,000 180,000 180,000

LO 3 – Journal/Ledger Examples Cash is received before it is earned Transaction: Customer paid $5,000 in advance, service later performed Analysis: Cash increases Unearned Revenue (liability) increases then decreases Stockholders’ equity increases when Revenue is earned Journal Entry: Cash 5,000 Unearned Revenue 5,000 Unearned Revenue 5,000 Revenue 5,000 Posting: Cash Unearned Revenue Revenue 5,000 5,000 5,000 5,000

LO 3 – Journal/Ledger Examples Purchased an asset before consuming 1/3 of it Transaction: Cost of assets acquired = $6,000; consumed = $2,000 Analysis: Prepaid Rent increases then decreases when consumed Cash decreases Stockholders’ equity decreases because an expense account Rent Expense (a negative stockholders’ account) increases Journal Entry: Prepaid Rent 6,000 Cash 6,000 Rent Expense 2,000 Prepaid Rent 2,000 Posting: Cash Prepaid Rent Rent Expense 6,000 6,000 2,000 2,000

LO 3 – Journal/Ledger Examples Purchase an asset and depreciate it (Part 1) “Matching” suggests expenses include only those costs that contribute to the production of revenue To deduct total cost of multi-year asset in first year is poor matching Alternative approach – deduct some each year Cost ($1,000) less its salvage value ($0) = amount allocated Estimated useful life (10 years) each year ($100)

LO 3 – Journal/Ledger Examples Purchase an asset and depreciate it (Part 2) Transaction: Buy equipment $10,000; 10 year life; zero salvage value Analysis: Cash decrease, Equipment increases then decreases Stockholders’ equity decreases because an expense account Depreciation Expense (a negative stockholders’ account) increases Journal Entry: Equipment 10,000 Cash 10,000 Depreciation Expense * 1,000 Equipment 1,000 * {10,000 – 0) / 10 year life = 1,000 / year} Posting: Cash Equipment Depreciation Exp. 10,000 10,000 1,000 1,000

LO 3 – Journal/Ledger Examples Purchase an asset and depreciate it (Part 3) Transaction: Buy equipment $10,000; 10 year life; zero salvage value Analysis: If reduce Equipment account directly, lose track of initial Cost. Better to split amounts into two accounts 1) original cost, and 2) amount of cost allocated Accumulated Depreciation (contra asset account) Journal Entry: Depreciation Expense * 1,000 Accumulated Depreciation 1,000 * {10,000 – 0) / 10 year life = 1,000 / year} Posting: Equipment Accumulated Depreciation Depreciation Expense 10,000 1,000 1,000

LO 3 – Journal/Ledger Examples Purchase an asset and depreciate it (Part 4) Equipment 10,000 Less Accumulated Depreciation (1,000) Book Value (appears in the statements) 9,000