Chapter 3 THE ACCOUNTING CYCLE: Capturing Economic Events

The Role of Accounting Records Establishes accountability for assets and transactions. Keeps track of routine business activities. Obtains detailed information about a particular transaction. Evaluates efficiency and performance within company. Maintains evidence of company’s business activities.

The Ledger The entire group of accounts is kept together in an accounting record called a ledger. Cash Accounts Payable Capital Stock Accounts are individual records showing increases and decreases.

The Use of Accounts Increases are recorded on one side of the T- account, and decreases are recorded on the other side. Left or Debit Side Right or Credit Side Title of Account

Let’s see how debits and credits are recorded in the Cash account for JJ’s Lawn Care Service.

Receipts are on the debit side. Payments are on the credit side. The balance is the difference between the debit and credit entries in the account. Debit and Credit Entries

ALOE A = L + OEASSETS Debit for Increase Credit for DecreaseEQUITIES Debit for Decrease Credit for IncreaseLIABILITIES Debit for Decrease Credit for Increase Debits and credits affect accounts as follows: Debit and Credit Rules

ALOE A = L + OE Debit balances Credit balances = In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits. Double Entry Accounting  The Equality of Debits and Credits

Let’s record selected transactions for JJ’s Lawn Care Service in the accounts.

¶ May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Will Cash increase or decrease? Will Capital Stock increase or decrease?

¶ May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Cash increases $8,000 with a debit. Capital Stock increases $8,000 with a credit.

· May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Will Cash increase or decrease? Will Tools & Equipment increase or decrease?

· May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Cash decreases $2,500 with a credit. Tools & Equipment increases $2,500 with a debit.

¸ May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. Will Truck increase or decrease? Will Cash and Notes Payable increase or decrease?

¸ May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. Truck increases $15,000 with a debit. Cash decreases $2,000 with a credit. Notes Payable increases $13,000 with a credit.

¹ May 11: JJ’s purchased some repair parts for $300 on account. Will Tools & Equipment increase or decrease? Will Accounts Payable increase or decrease?

¹ May 11: JJ’s purchased some repair parts for $300 on account. Tools & Equipment increases $300 with a debit. Accounts Payable increases $300 with a credit.

º May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. Will Tools & Equipment increase or decrease? Will Accounts Receivable increase or decrease?

º May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. Tools & Equipment decreases $150 with a credit. Accounts Receivable increases $150 with a debit.

Exhibit 3.1 Overview of the Accounting Cycle 1. Analyze transactions based on source documents Chapter 1 and 2 2. Journalize Chapter 3 3. Post Chapter 3 9. Prepare post-closing trial balance Chapter 5 8. Close Chapter 5 7. Prepare financial statements Chapter 2 through 5 6. Prepare adjusted trial balance Chapter 4 5. Adjust Chapter 4 4. Prepare unadjusted trial balance Chapter 3

Step 1 Examine source documents … Liabilities Equity Assets =+ … and analyze transactions. Remember this step? Now let’s look at some additional steps. Steps in Processing Transactions

Step 4 Prepare unadjusted trial balance. Step 1 Examine source documents… AssetsLiabilitiesEquity =+ … and analyze transactions. Step 2 Record transactions in a journal. Step 3 Post the journal information to a ledger. Exhibit 3.14 Steps in Processing Transactions

In an actual accounting system, transactions are initially recorded in the journal. The Journal

Recording Transactions Also called original book of entry. The process of recording the transactions is called journalizing. An example follows:

How To Record Transactions Step 1 – Enter the year on the first line at the top of the first column.

Recording Transactions Step 2 and 3 – Enter the month in column one on the first line of the journal entry and the day in column two. Note that entries are recorded in chronological order (by date).

Recording Transactions Step 4 – Enter the titles of accounts debited. Account titles are taken from the chart of accounts and are aligned with the left margin of the Account titles and explanation column. Accounts to be debited are always entered before accounts being credited.

Recording Transactions Step 5 – Enter the debit amount in the Debit column on the same line as the accounts to be debited.

Recording Transactions Step 6 – Enter the titles of accounts credited. Account titles are indented from the left margin of the Account Titles and Explanation column to distinguish them from debits.

Recording Transactions Step 7 – Enter the credit amount in the Credit column on the same line as the accounts to be credited.

Recording Transactions Step 8 – Write a brief explanation of the transaction on the line below the entry.

Recording Transactions Step 9 – Skip a line between each journal entry for clarity.

Posting involves copying information from the journal to the ledger accounts. Posting Journal Entries to the Ledger Accounts

Posting Entries Entries are then posted from the journal into the general ledger on a transaction by transaction basis; first the debit, then the credit.

Posting Entries Step 1 – Identify the ledger account that was debited in the journal entry and find it in the general ledger. Example – first entry on Jan. 1 had a debit to the cash account for $30,000.

Posting Entries Step 2 – Enter the date of the journal entry in this ledger account.

Posting Entries Step 3 – Enter the amount debited from the journal entry into the Debit column of the ledger account.

Posting Entries Step 4 – Enter the source of the debit in the PR (post-reference) column. The letter G indicates the entry came from the general journal.

Posting Entries Step 5 – Compute and enter the account’s new balance in the Balance column. Remember, a debit balance would be increased by a debit and decreased by a credit.

Recording Transactions Step 6 – Finally, enter the ledger account number in the PR column of the journal entry.

Posting Journal Entries to the Ledger Accounts

Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service. Posting Journal Entries to the Ledger Accounts

This ledger format is referred to as a running balance (as opposed to simple T accounts). Ledger Accounts After Posting

Generally, dollar signs and Rs. Signs are not used in the journals or ledgers. Rounding Round numbers in financial statements to the nearest dollar. Formatting Conventions