Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems Accounting I BA 104 Lecture 4 The Recording Process Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems

Study Objectives Explain what an account is and how it helps in the recording process. Define debits and credits and explain their use in recording business transactions. Identify the basic steps in the recording process. Explain what a journal is and how it helps in the recording process. Explain what a ledger is and how it helps in the recording process. Explain what posting is and how it helps in the recording process. Prepare a trial balance and explain its purposes. 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)

The Recording Process The Account Steps in the Recording Process The Recording Process Illustrated The Trial Balance Debits and credits Expansion of basic equation Journal Ledger Summary illustration of journalizing and posting Limitations of a trial balance Locating errors Use of dollar signs Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation. Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt. Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets. Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees. Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss: difference between the actual return and the expected return on plan assets and, amortization of the unrecognized net gain or loss from previous periods

The Account Record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. Debit = “Left” Credit = “Right” Account An Account can be illustrated in a T-Account form.

Double-entry accounting system Debits and Credits Double-entry accounting system Each transaction must affect two or more accounts to keep the basic accounting equation in balance. Recording done by debiting at least one account and crediting another. DEBITS must equal CREDITS.

Basic Steps in the Recording Process. When a transaction occurs: Basic Steps in the Recording Process. Analyze Journalize Post

Recording Process Step 1 Analyze each transaction and effect on accounts

Accounting Transactions... are economic events that must be recorded in the financial statements because they affect assets liabilities and/or owners’ equity

Transaction Analysis The process of identifying the specific effects of economic events on the accounting equation. Each transaction has a dual (double-sided) effect on the accounting equation.

Recording Process Step 2 Enter transaction information in a journal, a process called journalizing

The Journal... is an accounting record where the transactions are recorded in chronological order.

Recording Process Step 3 (posting) Copy (post) the journal information to the appropriate accounts in the ledger

“T” Accounts SHAPED LIKE a “T” Debit Credit

“T” Accounts Debit means Left Credit means Right Debit Credit

“T” Accounts Abbreviation for Debit Abbreviation for Credit Dr. Cr.

“T” Accounts ACCOUNT NAME CASH Dr. Cr.

The Ledger Card Cash The T Account

7 RULES OF DEBITS AND CREDITS

RULE #1 + Increase on Debit Side Decrease on Credit Side Dr. Cr. ASSET ACCOUNTS Increase on Debit Side Decrease on Credit Side Dr. Cr. +

EXAMPLE: PURCHASED OFFICE SUPPLIES FOR $800 CASH

STEP #1 Name the accounts affected: OFFICE SUPPLIES CASH

STEP #2 Determine Classification of Accounts ASSET OFFICE SUPPLIES CASH ASSET

STEP #3 Now that we know the classification, we can identify increase and decrease sides. CASH OFFICE SUPPLIES DR. + CR. DR. + CR.

INCREASED OFFICE SUPPLIES DR. CR. + $800

DECREASED CASH DR. CR. + $800

CASH DR. CR. + $800 OFFICE SUPPLIES DR. CR. + $800

IN EVERY TRANSACTION DEBITS MUST EQUAL CREDITS RULE #2 IN EVERY TRANSACTION DEBITS MUST EQUAL CREDITS

DEBITS = CREDITS OFFICE SUPPLIES CASH DR. CR. DR. CR. + + $800 $800

RULE #3 + Decrease on Debit Side Increase on Credit Side Dr. Cr. LIABILITY ACCOUNTS Decrease on Debit Side Increase on Credit Side Dr. Cr. +

EXAMPLE: PURCHASED EQUIPMENT ON ACCOUNT FOR $3,000.

STEP #1 Name the accounts affected: ACCOUNTS PAYABLE EQUIPMENT

STEP #2 Determine Classification of Accounts: LIABILITY ASSET ACCOUNTS PAYABLE ASSET EQUIPMENT

STEP #3 Now that we know the classification, we can identify increase and decrease sides. EQUIPMENT ACCOUNTS PAYABLE DR. + CR. DR. CR. +

INCREASED EQUIPMENT DR. CR. + $3000

INCREASED ACCOUNTS PAYBLE DR. CR. + $3000

DEBITS = CREDITS + + EQUIPMENT ACCOUNTS PAYABLE DR. CR. DR. CR. $3000

RULE #4 Dr. Cr. Decrease on Increase on Debit Side Credit Side CAPITAL ACCOUNT Decrease on Debit Side Increase on Credit Side Dr. Cr. + JUST LIKE LIABILITY ACCOUNTS

EXAMPLE: Mohamed , THE OWNER, INVESTED $25,000 IN THE BUSINESS

STEPS #1 & 2 Name and classify the accounts affected: ASSET OWNER’S EQUITY ASSET Mohamed, CAPITAL CASH DR. CR. DR. CR.

STEP #3 Now that we know the classification, we can identify increase and decrease sides. Mohamed, CAPITAL CASH + + DR. CR. DR. CR.

INCREASED OR DECREASED? Mohamed, CAPITAL CASH + DR. CR. DR. CR. + $25,000 $25,000

DEBITS = CREDITS CASH Mohamed, CAPITAL DR. CR. DR. CR. $25,000 $25,000 + + $25,000 $25,000

DIVIDEND / DRAWING ACCOUNT RULE #5 DIVIDEND / DRAWING ACCOUNT Increase on the Debit Side Decrease on the Credit Side Dr. Cr. + JUST LIKE ASSET ACCOUNTS

EXAMPLE: Mohamed WITHDREW $1,500 FOR PERSONAL EXPENSES

STEPS #1 & #2 Name and classify the accounts affected: ASSET OWNER’S EQUITY ASSET Mohamed, DRAWING CASH DR. CR. DR. CR.

INCREASED OR DECREASED? Mohamed, DRAWING CASH DR. CR. DR. CR. + + $1,500 $1,500

DEBITS = CREDITS Mohamed, DRAWING CASH DR. CR. DR. CR. $1,500 $1,500 +

RULE #6 Dr. Cr. Decrease on Increase on Debit Side Credit Side REVENUE ACCOUNTS Decrease on Debit Side Increase on Credit Side Dr. Cr. + JUST LIKE LIABILITY & CAPITAL ACCOUNTS

EXAMPLE: Mohamed PERFORMED SERVICES AND RECEIVED $4,500 IN CASH

STEPS #1 & #2 Name and classify the accounts affected: ASSET REVENUE ASSET CONSULTING FEES CASH DR. CR. DR. CR.

STEP #3 Now that we know the classification, we can identify increase and decrease sides. CONSULTING FEES CASH DR. CR. DR. CR. + +

INCREASED OR DECREASED? CONSULTING FEES CASH DR. CR. DR. CR. + + $4,500 $4,500

DEBITS = CREDITS CASH CONSULTING FEES DR. CR. DR. CR. $4,500 $4,500 +

EXAMPLE: Mohamed PERFORMED $6,000 OF SERVICES ON ACCOUNT

DEBITS = CREDITS ACCOUNTS RECEIVABLE CONSULT. FEES DR. CR. DR. CR. + + $6,000 $6,000 ACCOUNTS RECEIVABLE INSTEAD OF CASH

RULE #7 Dr. Cr. JUST LIKE ASSET ACCOUNTS EXPENSE ACCOUNTS Increase on the Debit Side Decrease on the Credit Side Dr. Cr. + JUST LIKE ASSET ACCOUNTS

Mohamed PAID HER ASSISTANT $750 IN WAGES EXAMPLE Mohamed PAID HER ASSISTANT $750 IN WAGES

STEPS #1 & #2 Name and classify the accounts affected: ASSET CASH EXPENSE ASSET WAGES EXPENSE CASH DR. CR. DR. CR.

STEP #3 Now that we know the classification, we can identify increase and decrease sides. WAGES EXPENSE CASH DR. CR. DR. CR. + +

INCREASED OR DECREASED? WAGES EXPENSE CASH DR. CR. DR. CR. + + $750 $750

DEBITS = CREDITS WAGES EXPENSE CASH DR. CR. DR. CR. + + $750 $750

What is the normal balance for the following accounts? Review What is the normal balance for the following accounts? Cash Debit Accounts Payable Credit Accounts Receivable Debit Service Revenue Credit Common Stock Credit Salaries Expense Debit

What is the normal balance for the following accounts? Review What is the normal balance for the following accounts? Dividends Debit Building Debit Taxes Payable Credit Revenue Credit Prepaid Insurance Debit Rent Expense Debit

Debits and Credits If Debits are greater than Credits, the account will have a debit balance. Transaction #1 $10,000 $3,000 Transaction #2 Transaction #3 8,000 Balance $15,000

Debits and Credits Transaction #1 $10,000 $3,000 Transaction #2 8,000 If Credits are greater than Debits, the account will have a credit balance. Transaction #1 $10,000 $3,000 Transaction #2 8,000 Transaction #3 Balance $1,000

Debits and Credits Summary Normal Balance Debit Normal Balance Credit SO 2

Debits and Credits Summary Balance Sheet Income Statement Asset = Liability + Equity Revenue - Expense Debit Credit

Debits and Credits Summary Review Question Debits: increase both assets and liabilities. decrease both assets and liabilities. increase assets and decrease liabilities. decrease assets and increase liabilities.

Assets and Liabilities Assets - Debits should exceed credits. Liabilities – Credits should exceed debits. The normal balance is on the increase side.

Owners’ Equity Owner’s investments and revenues increase owner’s equity (credit). Owner’s drawings and expenses decrease owner’s equity (debit).

Revenue and Expense The purpose of earning revenues is to benefit the owner(s). The effect of debits and credits on revenue accounts is the same as their effect on Owner’s Capital. Expenses have the opposite effect: expenses decrease owner’s equity.

Debits and Credits Summary Review Question Accounts that normally have debit balances are: assets, expenses, and revenues. assets, expenses, and owner’s capital. assets, liabilities, and owner’s drawings. assets, owner’s drawings, and expenses.

Expansion of the Basic Equation Relationship among the assets, liabilities and owner’s equity of a business: Illustration 2-11 Basic Equation Assets = Liabilities + Owner’s Equity Expanded Basic Equation The equation must be in balance after every transaction. For every Debit there must be a Credit.

Steps in the Recording Process Illustration 2-12 Transfer journal information to ledger accounts Analyze each transaction Enter transaction in a journal Business documents, such as a sales slip, a check, a bill, or a cash register tape, provide evidence of the transaction.

The Journal Book of original entry. Transactions recorded in chronological order. Contributions to the recording process: Discloses the complete effects of a transaction. Provides a chronological record of transactions. Helps to prevent or locate errors because the debit and credit amounts can be easily compared.

Journalizing Journalizing - Entering transaction data in the journal. Illustration: On September 1, Mr. Ahmed invested $15,000 cash in the business, and purchased computer equipment for $7,000 cash. General Journal Sept. 1 Cash 15,000 Mr.Ahmed, Capital 15,000 Computer equipment 7,000 Cash 7,000

Journalizing Simple and Compound Entries Illustration: Assume that on July 1, Butler Company purchases a delivery truck costing $14,000. It pays $8,000 cash now and agrees to pay the remaining $6,000 on account. Illustration 2-14 General Journal July 1 Delivery equipment 14,000 Cash 8,000 Accounts payable 6,000

The Ledger A General Ledger contains the entire group of accounts maintained by a company. The General Ledger includes all the asset, liability, owner’s equity, revenue and expense accounts. Illustration 2-15

Standard Form of Account T-account form used in accounting textbooks. In practice, the account forms used in ledgers are much more structured. Illustration 2-16

Posting Posting – the process of transferring amounts from the journal to the ledger accounts. Illustration 2-17

Review Question Posting Posting: normally occurs before journalizing. transfers ledger transaction data to the journal. is an optional step in the recording process. transfers journal entries to ledger accounts.

Chart of Accounts Accounts and account numbers arranged in sequence in which they are presented in the financial statements. Illustration 2-18

The Recording Process Illustrated Follow these steps: 1. Determine what type of account is involved. 2. Determine what items increased or decreased and by how much. 3. Translate the increases and decreases into debits and credits. Illustration 2-19 LO 6 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Illustration 2-20 LO 6 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Illustration 2-21

The Recording Process Illustrated Illustration 2-22

The Recording Process Illustrated Illustration 2-23

The Recording Process Illustrated Illustration 2-24

The Recording Process Illustrated Illustration 2-25

The Recording Process Illustrated Illustration 2-26

The Recording Process Illustrated Illustration 2-27

The Recording Process Illustrated Illustration 2-28

The Trial Balance Illustration 2-31 A list of accounts and their balances at a given time. Purpose is to prove that debits equal credits. LO 7 Prepare a trial balance and explain its purposes.

Limitations of a Trial Balance The Trial Balance Limitations of a Trial Balance The trial balance may balance even when a transaction is not journalized, a correct journal entry is not posted, a journal entry is posted twice, incorrect accounts are used in journalizing or posting, or offsetting errors are made in recording the amount of a transaction. LO 7 Prepare a trial balance and explain its purposes.

Review Question The Trial Balance A trial balance will not balance if: a correct journal entry is posted twice. the purchase of supplies on account is debited to Supplies and credited to Cash. a $100 cash drawing by the owner is debited to Owner’s Drawing for $1,000 and credited to Cash for $100. a $450 payment on account is debited to Accounts Payable for $45 and credited to Cash for $45.

Discussion Question Recording Process Q2-19. Jim Benes is confused about how accounting information flows through the accounting system. He believes the flow of information is as follows. Debits and credits posted to the ledger. Business transaction occurs. Information entered in the journal. Financial statements are prepared. Trial balance is prepared. Is Jim correct? If not, indicate to Jim the proper flow of the information. See notes page for discussion Question 2-19 (textbook) No, Jim is not correct . The proper sequence is as follows : ( b ) Business transaction occurs. ( c ) Information entered in the journal. ( a ) Debits and credits are posted to the ledger. ( e ) Trial balance is prepared. ( d ) Financial statements are prepared.

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