CHAPTER 5 Business Accounting Cycle Part I

Let’s review the basic principle of revenue and expense recognition

Revenue and Expense Recognition - Question Which of the following is true when a customer pays for a service at the time it is provided? Revenue cannot be recognized even though cash has been collected Revenue should be recognized evenly over the year Revenue should be recognized because the service was provided The revenue account should be increased along with accounts receivable

Revenue and Expense Recognition - Question Which of the following is true when a customer pays for a service before it has been provided? Revenue cannot be recognized even though cash has been collected Revenue should be recognized evenly over the year Revenue should be recognized because the service was provided The revenue account should be increased along with accounts receivable

Revenue and Expense Recognition - Question XYZ Co. collected $3,000 cash for services to be provided next month. How should this transaction be recorded? Increase Cash; Increase Revenue Increase Cash; Increase Unearned Revenue Increase Accounts Receivable; Increase Revenue Increase Cash; Decrease Accounts Receivable

Revenue and Expense Recognition - Question Which of the following is true when a company pays an expense before it has been incurred? The expense should be recognized because cash has been paid Cash should be decreased and expenses should be increased The expense should be recognized evenly over the next year An asset should be recorded

Revenue and Expense Recognition - Question Which of the following accounts does not require adjusting entries? Depreciation Prepaid Expenses Unearned Revenue Cash

Checklist Chapter 5 Transition to Debits and Credits Journal General Ledger Trial Balance

Transition to Debits and Credits We have been using “increases” and “decreases” to record transactions. Formal accounting requires the use of debits and credits. Debits are recorded on the left side of the T-Account. Credits are recorded on the right side of the T-Account. In accounting there are always two entries of equal value for every transaction, called the double entry to ensure that each transaction balances.

Debit and Credit Guide The following table shows how debits and credits will increase or decrease different accounts. Note that debit does not always mean an increase and that credit does not always mean a decrease.

The basic principle of debits and credits Test Your Knowledge The basic principle of debits and credits

Debits and Credits - Question In the debit and credit system, debits are always recorded on the: Left Right Left or right depending on the financial transaction Income statement only

Debits and Credits - Solution Debits are always on the left Credits are always on the right

Debits and Credits - Question What is the logic of debits and credits? Just another name for increases and decreases To make sure that you record every entry twice To ensure that every left entry is always associated with a right entry to balance the balance sheet To ensure that all assets are equal to all liabilities

Debits and Credits - Solution Debit = left Credit = right $100,000 $70,000 = $30,000 $100,000 $100,000 The left must always balance with the right 15 15

Debits and Credits - Question An increase to an asset should normally be a: Credit Debit Debit or credit depending on the asset

Debits and Credits - Solution

Debits and Credits - Question An increase to an expense is normally a: Debit Credit Debit or credit depending on the type of expense

Debits and Credits - Solution

Debits and Credits - Question True or False? Depending on the type of transaction, you can have either have only two debits or only have two credits. True False

Debits and Credits - Solution To keep the balance sheet in balance, every left entry (which is a debit) must always be associated with a right entry, being the credit. There is never an exception to this rule. 100,000 100,000

Debits and Credits - Question An increase to a liability is normally: A debit A credit Depends on the type of liability

Debits and Credits - Solution

Entry to Record Paying Cash for Rent Rent Expense If you are recording a payment towards your rent, it increases (DR) your expenses and decreases (CR) your cash, as you have just made a cash payment. Equity would also decrease.

Entry for Paying Accounts Payable If you are recording a payment towards your Accounts Payable, it decreases (DR) because you now owe less to that supplier and cash decreases (CR) because you have used cash to make that payment. Cash Accounts Payable

Debits and Credits - Question The entry to record the payment of bank loan principal requires: Debit expense, credit cash Debit bank loan, credit cash Debit cash, credit bank loan There are no entries as this transaction has no effect on owner’s equity

Debits and Credits - Solution Cash Bank Loan

Debits and Credits - Question Complete the following transactions in table format. The first transaction has been completed as an example. Provided services for a customer and received $4,000 cash. Received a bank loan of $6,000 cash. Received a $400 bill for utilities which will be paid later. Provided services to a customer who will pay $2,000 next month. Paid the utilities bill recorded earlier with $400 cash.

Debits and Credits - Solution Account Name Increase or Decrease Debit Credit 1 Cash Increase 4,000 Service Revenue 2 6,000 Bank Loan 3 Utilities Expense 400 Accounts Payable 4 Accounts Receivable 2,000 5 Decrease

Checklist Chapter 5 Transition to Debits and Credits Journal General Ledger Trial Balance

Chart of Accounts Each account (cash, telephone expenses, rent, maintenance, accounts receivable, etc.) is assigned a unique identifying account number. For example: 100 to 199 = Asset accounts 200 – 299 = Liability accounts 300 – 399 = Equity accounts 400 – 499 = Revenue accounts 500 – 599 = Expense accounts

Chart of Accounts Here is an example of a chart of accounts for a small service company.

Transition to Journal Entries Jan 1: Received $2,000 cash for providing services to a customer Jan 4: Pay $180 cash for telephone bill Debit Credit Cash 2,000 Service Revenue 2,000 Cash 180 Telephone Expense 180 2,180 We now need to formally enter these transactions in an accounting record. 33

Journal Entries JOURNAL Page 1 Date Account Title and Explanation PR Debit Credit 2011 Jan 1 Cash 101 2,000 Service Revenue 400 Provided services for cash Jan 4 Telephone Expense 550 180 Paid telephone bill Date & year: Journal entries are in chronological order. Debited accounts will always be listed first. Credited accounts will always be listed after the debited accounts. The amount of the transaction entered in the appropriate debit and credit column. A brief explanation will follow each transaction. Unique account identifying number for each account. These numbers are from the chart of accounts.

Journal Entries JOURNAL Page 1 Date Account Title and Explanation PR Debit Credit 2011 Jan 1 Cash 101 2,000 Service Revenue 400 Provided services for cash Jan 4 Telephone Expense 550 180 Paid telephone bill While entering transactions into a journal you will notice that the transactions for each account are scattered (e.g. increases and decreases to cash will appear many times without providing the total balance of cash). All the activities need to be grouped into their own accounts, which is done in the general ledger.

Journal Entries - Question True or False? Every journal entry will have at least one debit and one credit. True False

Journal Entries - Question Which of the following is normally true about the order of line entries within each journal entry? Income statement accounts appear after balance sheet accounts The line entries are listed throughout the journal entry in order of the PR number Debits appear together, before credits

Checklist Chapter 5 Transition to Debits and Credits Journal General Ledger Trial Balance

General Ledger The general ledger organizes each account and tracks the balance of each account. Information is extracted from the journal and grouped together into the various accounts. Records can be easily accessed and sorted by account.

General Ledger Transfer the date. Transfer the journal page number. Enter the amount in the proper column. Account: GL No. Date Description PR Debit Credit Balance   Cash 101 Notice the running balance Jan 1 J1 2,000 2,000 DR Jan 4 J1 180 1,820 DR Update the account balance. Enter the account number in the journal. Repeat the steps for all lines in the journal. Account: GL No. Date Description PR Debit Credit Balance   Service Revenue 400 Jan 1 J1 2,000 2,000 CR Account: GL No. Date Description PR Debit Credit Balance   Telephone Expenses 550 Jan 4 J1 180 180 DR 40

General Ledger - Question True or False? All journal entries should be posted to the general ledger. True False

Checklist Chapter 5 Transition to Debits and Credits Journal General Ledger Trial Balance

The Trial Balance Every debit must have a credit entry to keep the balance sheet in balance. To ensure that this has been done, it is necessary to complete a trial balance. The closing balance from each general ledger account must be transferred to the trial balance. All debit balances are transferred to the debit side and all credits are transferred to the credit side.

Creating a Trial Balance Account: Cash GL No. 101 Date Description PR Debit Credit Balance Jan 1 J1 2,000   DR Jan 4 180 1,820 List the account name. Transfer the ending balance to the proper side of the trial balance. Repeat for each account. Total the debit and credit columns to ensure the trial balance balances. Account: Service Revenue GL No. 400 Date Description PR Debit Credit Balance Jan 1 J1 2,000 CR   Account: Telephone Expense GL No. 550 Date Description PR Debit Credit Balance Jan 4 J1 180   DR This slide has numerous animations. Trial Balance January 31, 2013 Account Debit Credit Total Cash 1,820 Service Revenue 2,000 Telephone Expense 180 2,000 2,000

Trial Balance - Question What is the main purpose of the trial balance? To ensure the financial statements will be accurate To ensure that total debits equals total credits To prepare adjusting entries To see what caused the changes in an account balance

Trial Balance - Question True or False? A general ledger can be prepared after the trial balance has been prepared. True False

Checklist Chapter 5 Transition to Debits and Credits Journal General Ledger Trial Balance

Complete the following exercise.

Exercise We will enter 5 transactions, one step at a time: Use the chart of accounts shown earlier in this presentation, which is also found on page 105 of your textbook. Date Description Amount June 2 Received and deposited payment from repair work $2,000 June 3 Paid employee salary 600 June 4 Paid rent with cash 400 June 5 Purchased equipment to be paid next month 9,000 June 6 Paid cash towards accounts payable

Exercise June 2. Received and deposited payment from repair work: $2,000 JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 2 Cash 101 2,000 Service Revenue 400 2,000 Performed services for cash

Exercise June 3. Paid employee salary: $600 JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 3 Salaries Expense 545 600 Cash 101 600 Paid employee salary

Exercise June 4. Paid rent with cash: $400 JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 4 Rent Expense 540 400 Cash 101 400 Paid rent with cash

Exercise June 5. Purchased equipment to be paid next month: $9,000 JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 5 Property, Plant & Equipment 120 9,000 Accounts Payable 200 9,000 Purchased equipment on account

Exercise June 6. Paid cash towards accounts payable: $400 JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 6 Account Payable 200 400 Cash 101 400 Paid a portion of accounts payable

Exercise The information from the journal must now be posted to the general ledger. We will examine each journal transaction in turn and post the amounts to the general ledger.

Exercise JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 2 Cash 101 2,000 Service Revenue 400 Performed services for cash Account: Cash GL No. 101 Date Description PR Debit Credit Balance Jun 2 J1 2,000 2,000 DR Account: Service Revenue GL No. 400 Date Description PR Debit Credit Balance Jun 2 J1 2,000 2,000 CR

Exercise Notice the running total in the Cash account balance. JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 3 Salaries Expense 545 600 Cash 101 Paid employee salary Notice the running total in the Cash account balance. Account: Cash GL No. 101 Date Description PR Debit Credit Balance Jun 2 J1 2,000 DR Jun 3 J1 600 1,400 DR Account: Salaries Expense GL No. 545 Date Description PR Debit Credit Balance Jun 3 J1 600 600 DR

Exercise JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 4 Rent Expense 540 400 Cash 101 Paid rent with cash Account: Cash GL No. 101 Date Description PR Debit Credit Balance Jun 2 J1 2,000 DR Jun 3 600 1,400 Jun 4 J1 400 1,000 DR Account: Rent Expense GL No. 540 Date Description PR Debit Credit Balance Jun 4 J1 400 400 DR

Exercise JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 5 Property, Plant & Equipment 120 9,000 Accounts Payable 200 Purchased equipment on account Account: Property, Plant & Equipment GL No. 120 Date Description PR Debit Credit Balance Jun 5 J1 9,000 9,000 DR Account: Accounts Payable GL No. 200 Date Description PR Debit Credit Balance Jun 5 J1 9,000 9,000 CR

Exercise JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jun 6 Accounts Payable 200 400 Cash 101 Paid a portion of accounts payable Account: Cash GL No. 101 Date Description PR Debit Credit Balance Jun 2 J1 2,000 DR Jun 3 600 1,400 Jun 4 400 1,000 Jun 6 J1 400 600 DR Account: Accounts Payable GL No. 200 Date Description PR Debit Credit Balance Jun 5 J1 9,000 CR Jun 6 J1 400 8,600 CR

Exercise The information from the ledger must now be used to create a trial balance. The ledger balances will be given to you to create the trial balance.

Property, Plant & Equipment Exercise Account: Cash GL No. 101 Date Description PR Debit Credit Balance Jun 2 J1 2,000 DR Jun 3 600 1,400 Jun 4 400 1,000 Jun 6 Trial Balance January 31, 2013 Account Debit Credit Total Cash $600 Account: Property, Plant & Equipment GL No. 120 Date Description PR Debit Credit Balance Jun 5 J1 9,000 DR Property, Plant & Equipment 9,000 Accounts Payable $8,600 Service Revenue 2,000 Account: Accounts Payable GL No. 200 Date Description PR Debit Credit Balance Jun 5 J1 9,000 CR Jun 6 400 8,600 Rent Expense 400 Salaries Expense 600 $10,600 $10,600 Account: Service Revenue GL No. 400 Date Description PR Debit Credit Balance Jun 2 J1 2,000 CR Account: Rent Expense GL No. 540 Date Description PR Debit Credit Balance Jun 4 J1 400 DR Account: Salaries Expense GL No. 545 Date Description PR Debit Credit Balance Jun 3 J1 600 DR

End of Chapter 5