The Mechanics of Accounting The Mechanics of Accounting C H A P T E R 3

Learning Objective 1 Understand the process of transforming transaction data into useful accounting information.

What Are the Different Exchange Transactions? Distribute earnings to owners. Buy and sell goods or services. Borrow and invest money. Pay wages to employees. Purchase land, buildings, and equipment. Pay taxes to the government. Exchange Transactions

Business Documents n Examples: Sales invoice, purchase order, check stub. n Business documents are used u to confirm that an arm’s-length transaction has occurred. u to establish the amounts to be recorded. u to facilitate the analysis of business events. n These documents must be analyzed.

What is the Sequence of the Accounting Cycle? Step 1 Record the effects of the transactions. Step 2 Summarize the effects of transactions. 1. Posting journal entries. 2. Preparing a trial balance. Summarize the effects of transactions. 1. Posting journal entries. 2. Preparing a trial balance. Step 3 Prepare reports. 1. Adjusting entries. 2. Preparing financial statements. 3. Closing the books. Prepare reports. 1. Adjusting entries. 2. Preparing financial statements. 3. Closing the books. Step 4 Analyze transactions.

Learning Objective 2 Analyze transactions and determine how those transactions affect the accounting equation (step one of the accounting cycle).

Step 1: Analyze Transactions À What accounts are involved? Á Did each account increase or decrease? Â By how much? Transaction analysis framework Transaction analysis : u breaks down complex transactions into manageable pieces. u provides a self-checking mechanism.

What Is the Accounting Equation? Assets = Liabilities + Owners’ Equity Resources Creditors’ claims against resources =+ Owners’ claims against resources

A = L + OE Describe Effect of the Following Transactions on a Company. Borrow money Invest in company Pay off a note Purchase equipment Borrow funds to settle a debt

What Is the Rule of Double-Entry Accounting? The debits must always equal the credits. Debits = Credits

n Accounts provide an efficient method to categorize transactions. n A T-account is a simplified depiction of an account. Using Accounts Name of Account Debit Credit

The cash account has a beginning balance of $35. A check for $12 is written to pay for supplies. Using a T-account, what is the ending balance of the cash account? Using a T-Account Cash 23

Debits and Credits Debits are simply entries on the left. Credits are simply entries on the right. Remember:

DR CR DR CR DR CR (+) (-) (-) (+) (-) (+) Debits and Credits Assets = Liabilities + Owners’ Equity Asset accounts: Debit is an increase. Credit is a decrease. Liabilities and owners’ equity accounts: Debit is a decrease. Credit is an increase.

Revenues Increases in a company’s resources from the sale of goods or the performance of services. Expenses Decreases in a company’s resources incurred in the normal course of business to generate revenues. Dividends Distributions to owners, which reduce Owners’ Equity. Expanding the Equation

Expanded Accounting Equation Assets DR CR + – = Liabilities DR CR – + + Owners’ Equity DR CR – + Capital Stock DR CR – + Retained Earnings DR CR – + Expenses DR CR + – Dividends DR CR + – Revenues DR CR – +

Learning Objective 3 Record the effects of transactions using journal entries (step two of the accounting cycle).

Step 2: Record Transactions n Record the results of the transactions in a journal. n Journalizing provides a chronological record of all business activities. Journal -- book of original entry What is another name for the journal?

Step 2: Record Transactions n Record the results of the transactions in a journal. n Journalizing provides a chronological record of all business activities. General Journal Entry Format: DateDebit Entry xx Credit Entry xx Explanation.

Journal Entries What is the three-step process? 1 Identify which accounts are involved. 2 For each account, determine if it is increased or decreased. 3 For each account, determine by how much it will change.

Supplies purchased for $25 are purchased “on account.” Prepare the correct journal entry. What do we mean by purchased “on account”? Example 1: Journal Entry Jan. 1Supplies Accounts Payable Purchased supplies on account. We purchase on credit and use accounts payable.

Example 2: Journal Entry Feb. 1Cash Revenue Received cash for services. A check for $100 is received in payment for services rendered. Make the correct journal entry.

Example 3: Journal Entry Mar. 1Accounts Receivable Sales Revenue Sold merchandise on account. Merchandise is sold to a customer on account for $75. The cost of the product was $60. Make the journal entries. Mar. 1Cost of Goods Sold Inventory To record cost and reduce inventory.

DateTransactionRef.DebitsCredits Jan. 1 Supplies 25 Accounts Payable25 Purchased supplies on account. Feb. 1 Cash Revenue100 Received cash for services. Mar. 1 Accounts Receivable 75 Sales Revenue75 Sold merchandise on account. Journal 1 Page 1 Entered when posted to ledger.

Learning Objective 4 Summarize the resulting journal entries through posting and prepare a trial balance (step three of the accounting cycle).

Step 3: Posting Journal Entries and Preparing a Trial Balance Define the Following Terms Posting transferring amounts from the journal to the ledger. Ledger a book of accounts where journal transactions are posted and thereby summarized. Posting reference a cross-reference number between the general journal and the accounts in the general ledger. Chart of accounts a systematic listing of all accounts used by a company.

General Ledger DateExplanationRef.DebitsCredits Balance Jan. 1Balance100 2Issued 100 shares of capital stock at $10 per shareGJ11,0001,100 3Purchased equipmentGJ Sold inventoryGJ Monthly payment on loanGJ RevenueGJ12,5003,130 ACCOUNT: CashAccount No. 101

ASSETS ( ): Current Assets ( ): 101 Cash 105 Accounts Receivable 107 Inventory Long-Term Assets ( ): 151 Land 152 Buildings LIABILITIES ( ): Current Liabilities ( ): 201 Notes Payable 202 Accounts Payable Long-Term Liabilities ( ): 222 Mortgage Payable OWNERS’ EQUITY ( ): 301 Capital Stock 330 Retained Earnings SALES ( ): 400 Sales Revenue EXPENSES ( ): 500 Cost of Goods Sold 501 Sales Salaries and Commissions 523 Rent Expense 528 Advertising Expense 573 Utilities Expense 579 Accounting and Legal Fees Chart of Accounts

Determining Account Balances Name of Account Debit Credit Accounts with typical debit balances are? Accounts with typical credit balances are? Expenses Assets Dividends Owners’ Equity Revenues or Income Liabilities An account’s balance is usually on the side that increases the account. It is referred to as the “Normal Balance.” Do you see the mnemonic memory device, DEAD COIL?

A listing of all account balances; provides a means to assure that debits equal credits. Define The Trial Balance From the data in the trial balance, the balance sheet and income statement can be prepared. What is the Trial Balance used for?

The Example Company Trial Balance December 31, 2003 DebitsCredits Cash$ 21 Accounts Receivable15 Inventory12 Land200 Accounts Payable$ 30 Capital Stock150 Retained Earnings24 Sales Revenue919 Cost of Goods Sold850 Advertising Expense10 Miscellaneous Expenses 15______ Total$ 1,123$ 1,123 Sample Trial Balance The trial balance shows that debits equal credits.

Learning Objective 5 Describe how technology has affected the first three steps of the accounting cycle.

Advantages of Computers 9 Large amounts of information can be quickly processed without mathematical errors. 9 More documents can be produced than humanly possible in the same amount of time. 9 Common tasks can be automated for increased efficiency.

Disadvantages of Computers – Computer hardware and software require human judgment and input. – GIGO (garbage in, garbage out). – Once an error is identified, fixing the problem may require many adjustments.

End Chapter 3