Humanities and International Exchange Faculty Shanghai Second Polytechnic University Lesson 2 Analyzing and Recording Transactions

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 2 Outline  Accounts  Detailed Description of Various  Accounts  T-Accounts  Rules of Debits and Credits  Double-entry Accounting  Illustrated Application of Rules

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 3 Opening Story  Do you have any idea about how your parents keep an “account” of how much the family spends?  What a good family accountant!

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 4 Opening Story  A global demand for accountants – where can the “Big Four” find accountants with talent and virtues? Mr.Land, E&Y British president (indirect quote) In the recent 18 months, the shortage of accounting talents has been scarcely satisfied. The most valuable in the 21st century is accountants to special accounting firms like us. In the recent 18 months, the shortage of accounting talents has been scarcely satisfied. The most valuable in the 21st century is accountants to special accounting firms like us.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 5 The Account Cash Accounting’s main summary device is the account, the record of changes. Accounting’s main summary device is the account, the record of changes. Accounts are grouped in 3 broad categories, according to the accounting equation: Accounts are grouped in 3 broad categories, according to the accounting equation:

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 6 The Assets Account Assets are the economic resources that benefit the business now and in the future benefit the business now and in the future Cash Accounts receivable Inventory Notes receivable Prepaid expenses SuppliesPropertiesBuildingsEquipment

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 7 The Liabilities Account Liabilities are the debts of the company. Notes payable Accounts payable Accrued liabilities (for expenses incurred but not paid) (for expenses incurred but not paid) Long-term liabilities (bonds)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 8 The Equity Account Stockholders’ (owners’) equity is the owners’ claims to the assets of a corporation. Stockholders’ (owners’) equity is the owners’ claims to the assets of a corporation. A proprietorship uses a single account. A partnership uses separate accounts for each owner’s capital balance and withdrawals. A partnership uses separate accounts for each owner’s capital balance and withdrawals. A corporation uses separate capital accounts for each source of capital. A corporation uses separate capital accounts for each source of capital.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 9 Details of Equity Account Common Stock Retained Earnings DividendsRevenues Expenses

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 10 The T-Account Account Title Debit LEFT SIDE RIGHT SIDE Credit

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 11 Increases and Decreases in the Accounts AccountingEquation:Assets=Liabilities+Stockholders’Equity Rules of Debit and Credit: Debit + Debit – Debit – Credit – Credit + Credit +

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 12 Rules of Debit and Credit Air & Sea received $50,000 and issued stock. Assets=Liabilities+Stockholders’Equity DebitforIncrease,50,000CreditforIncrease,50,000 Cash Common Stock

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 13 Rules of Debit and Credit Air & Sea purchased land for $40,000 cash. Common Stock Bal. 50,000 Cash CreditforDecrease,40,000 Land DebitforIncrease,40,000 Assets =Liabilities +Stockholders’Equity

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 14 Expansion of the Accounting Equation + Common Stock + Retained Earnings –Dividends+Revenues–Expenses+ Common Stock + Retained Earnings –Dividends+Revenues–ExpensesAssetsAssets Stockholders’EquityStockholders’Equity LiabilitiesLiabilities

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 15 Recording Transactions  Record transactions first in the journal (analyses)  Ledger  Posting  Trial balance

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 16 Analysis of each transaction  Identify the transaction from the source document, such as a sales invoice or check stub  Determine which accounts increase and which decrease  Apply the rules of debit and credit  Enter the transaction in the journal, listing first the debit and then the credit  Verify that total debits equal total credits

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 17 A journal entry  A journal entry would appear as follows: Account Name XX (debit amount) Account Name XX (credit amount) Account Name XX (credit amount) Brief explanation of the transaction.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 18 Ledger  A group of accounts.  All the accounts of a business grouped together form a book called the ledger (or general ledger).

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 19 Posting  The process of copying (transferring) data from the journal to accounts in the ledger. Debits in the journal are posted as debits to the appropriate accounts; credits in the journal are posted as credits to the appropriate accounts. All transactions must be keyed by date or number to provide a link between the journal and the ledger. Ledger accounts appear after a series of transactions have been posted and account balances calculated.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 20 Trial balance  The trial balance is a listing, in general ledger order (assets, liabilities, then stockholders’ equity), of the debit or credit balance in each account

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 21 Transactions, Accounts and Rules of Debits & Credits 1.Owners’ investment of cash increases both assets and stockholders’ equity. 2.Purchase of an asset for cash increases assets and decreases assets (no effect on total assets). 3.Purchase of an asset on credit (on account) increases both assets and liabilities. 4.Receipt of cash for service revenue increases both assets and stockholders’ equity. 5.Performance of services on account increases both assets and stockholders’ equity. 6.Cash payment of expenses decreases both assets and stockholders’ equity.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 22 Transactions, Accounts and Rules of Debits & Credits (cont) 7.Payment on account decreases both assets and liabilities. 8.Personal transactions of the owner do not affect the business, per the entity concept. 9.Collection of cash on account increases assets and decreases assets. 10.Sale of an asset at a price equal to its cost increases assets and decreases assets. 11.Declaration and payment of cash dividends decreases both assets and stockholders’ equity.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 23  Do you still remember the example of Beauty Photo Store? We are using it again here!  Remember always: The accounting equation must remain in balance after each transaction has been recorded. An Practical Illustration

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 24  Wang Fang invests $30,000 cash to start her business of Beauty Photo Store. The accounts involved are: (1)Cash (asset) (2)Owner’s Equity (equity) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 25 Wang Fang invests $30,000 cash to start her business. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 26  Purchased supplies paying $2,500 cash. The accounts involved are: (1) Cash (asset) (2) Supplies (asset) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 27 Purchased supplies paying $2,500 cash. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 28  Purchased camera and producing equipment for the store for $20,000 cash. The accounts involved are: (1) Cash (asset) (2) equipment (asset) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 29 Purchased equipment for the store for $20,000 cash. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 30  Purchased supplies of $1,100 on account and equipment of $6,000 by signing a note. The accounts involved are: (1) Supplies (asset) (2) Equipment (asset) (3) Accounts payable (liability) (4) Notes payable (liability) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 31 An Practical Illustration (cont) Purchased supplies of $1,100 on account and equipment of $6,000 by signing a note.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 32 Now let’s look at transactions involving revenues and expenses. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 33  Performed wedding-photo and graduation ceremony photo-taking services, receiving $2,200 cash. The accounts involved are: (1) Cash (asset) (2) Owner’s capital (equity) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 34 Performed wedding photo-taking services, receiving $2,200 cash. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 35  Paid rent for January, $1,000 and salaries to the store’s employees, $700 cash. The accounts involved are: (1) Cash (asset) (2) Owner’s capital (equity) (Rent expense) (3) Owner’s capital (equity) (Salaries expense ) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 36 Paid rent for the month, $1,000 and salary to employees, $700 cash. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 37  Provided wedding photo services of $1,600 and rented equipment for $300 to another store. The accounts involved are: (1) Cash (asset) (2) Owner’s capital (equity) (Sales revenue) (3) Owner’s capital (equity) (Rental revenue) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 38 Provided photo-taking services of $1,600 and rented equipment for $300 to another store. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 39 Received $1,900 cash on account. The accounts involved are: (1) Cash (asset) (2) Account receivable (asset) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 40 Received cash of $1,900 on account. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 41 Paid $900 on account. The accounts involved are: (1) Cash (asset) (2) Account payable (liability) An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 42 Paid $900 cash on account. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 43  Wang Fang withdrew $600 cash for personal living expenses. The accounts involved are: (1) Cash (asset) (2) Owner’s capital (equity) Withdrawals An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 44 Wang Fang withdrew $600 for personal living expenses. An Practical Illustration (cont)

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 45 Summary  Accounts are used to appropriately categorize transactions.  T-accounts are a simplified version used in practice.  The type of account determines the side on which increases and decreases are recorded; the rules of debit and credit keep the accounting equation in balance  In the double-entry accounting system, at least two accounts are always affected by a transaction. After a transaction is recorded, the accounting equation must remain in balance.  Economic transactions of a business will impact various asset, liability, and/or equity accounts; but, they will not disturb the equality of the accounting equation.  Economic transactions of a business will impact various asset, liability, and/or equity accounts; but, they will not disturb the equality of the accounting equation.

Humanities and International Exchange Faculty Shanghai Second Polytechnic University 46 Case for Discussion  In order for all accounts to look the same, and to simultaneously make sure that the accounting equation stays in balance with double-entry bookkeeping, the debit and credit system was devised. Luca Pacioli first described it in 1494, and the basic system is so sound and efficient, we still use it today. Tradition aside, we would not still be using this ancient system if it did not work extremely well and efficiently. One could set up a system with pluses and minuses, but it would not be as efficient at generating the data needed for financial statements while making sure that the accounting equation was still in balance. One is more likely to make mistakes in entering data with plus and minus signs, although this is a secondary concern to the issues of uniformity and efficiency.  Why use debits and credits rather than pluses and minuses?

Humanities and International Exchange Faculty Shanghai Second Polytechnic University The End of Lesson 2