Introduction to Accounting in Action

Introduction to Accounting in Action

What is Accounting? Purpose of accounting is to: identify, record, and
communicate the economic events of an organization to interested users.

What is Accounting? Three Activities The accounting process includes
Illustration 1-1 Accounting process The accounting process includes the bookkeeping function.

Questions that internal users ask
Who Uses Accounting Data Internal Users Illustration 1-2 Questions that internal users ask

Questions that external users ask
Who Uses Accounting Data External Users Illustration 1-3 Questions that external users ask

Generally Accepted Accounting Principles (GAAP)
Financial Statements Balance Sheet Income Statement Statement of Owner’s Equity Statement of Cash Flows Note Disclosure Various users need financial information The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced. Generally Accepted Accounting Principles (GAAP)

Forms of Business Ownership
Proprietorship Partnership Corporation Generally owned by one person. Often small service-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts. Owned by two or more persons. Often retail and service-type businesses Generally unlimited personal liability Partnership agreement Ownership divided into shares of stock Separate legal entity organized under state corporation law Limited liability 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 Basic Accounting Equation
Assets Liabilities Owner’s Equity = + Provides the underlying framework for recording and summarizing economic events. Assets are claimed by either creditors or owners. Claims of creditors must be paid before ownership claims.

Assets Resources a business owns. Provide future services or benefits. Cash, Supplies, Equipment, etc. Assets Liabilities Owner’s Equity = +

Liabilities Claims against assets (debts and obligations). Creditors - party to whom money is owed. Accounts payable, Notes payable, etc. Assets Liabilities Owner’s Equity = +

Owner’s Equity Ownership claim on total assets. Referred to as residual equity. Investment by owners and revenues (+) Drawings and expenses (-). Assets Liabilities Owner’s Equity = +

Financial Statements Companies prepare four financial statements :
Income Statement Owner’s Equity Statement Balance Sheet

Financial Statements Income Statement
Reports the revenues and expenses for a specific period of time. Lists revenues first, followed by expenses. Shows net income (or net loss).

Financial Statements Owner’s Equity Statement
Reports the changes in owner’s equity for a specific period of time. The time period is the same as that covered by the income statement.

Financial Statements Balance Sheet
Reports the assets, liabilities, and owner’s equity at a specific date. Lists assets at the top, followed by liabilities and owner’s equity. Total assets must equal total liabilities and owner’s equity. Is a snapshot of the company’s financial condition at a specific moment in time (usually the month-end or year- end).

APPENDIX 1A Accounting Career Opportunities
Public Accounting Careers in auditing, taxation, and management consulting serving the general public. Private Accounting Careers in industry working in cost accounting, budgeting, accounting information systems, and taxation. Government Careers with the IRS, the FBI, the SEC, and in public colleges and universities. Forensic Accounting Uses accounting, auditing, and investigative skills to conduct investigations into theft and fraud.

The Accounting Information System
Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.
Study Objectives Analyze the effect of business transactions on the basic accounting equation. Explain what an account is and how it helps in the recording process. Define debits and credits and explain how they are used to record business transactions. Identify the basic steps in the recording process. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Study Objectives 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. Explain the purposes of a trial balance. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Accounting Information System The system of collecting and processing transaction data and communicating financial information to interested parties. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. 5 5

#1 Analyze the Effect of Business Transactions on the Basic Accounting Equation. Assets = Liabilities + Stockholders’ Equity Recall: must always balance! Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Accounting Transactions
Accounting Transactions: economic events that must be recorded in the financial statements. Event must affect assets, liabilities or stockholders’ equity Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Accounting Transactions?
Purchase computer Is the financial position (assets, liabilities or stockholders’ equity changed? YES! Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Transaction Analysis Transaction Analysis: the process of identifying the specific effects of economic events on the accounting equation. Each transaction has a dual (double-sided) effect Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Transaction Analysis If an individual asset is increased, there must be a corresponding: Decrease in another asset, or Increase in a specific liability, or Increase in stockholders’ equity Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Transaction Analysis Two or more items can be affected Example: purchase computer for $10,000 by paying $6,000 in cash and signing a note for $4,000 Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 1 – Investment of Cash by Stockholders
Oct. 1 - Owner invested $10,000 Cash in business in exchange for $10,000 of Sierra Corporation Common Stock Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 2 – Note Issued in Exchange for Cash
Oct. 1 – Sierra issued a 3-month, 12%, $5,000 Note Payable to Castle Bank. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 3 – Purchase of Office Equipment for Cash
Oct. 2 – Sierra acquired office equipment by paying $5,000 cash to Superior Sales Co. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 4 – Receipt of Cash in Advance from Customer
Oct. 2 – Sierra received a $1,200 cash advance from R. Knox, a client. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 5 – Services Rendered for Cash
Oct. 3 – Sierra received $10,000 in cash from Copa Co. for advertising services performed Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 7 – Purchase of Insurance Policy with Cash
Oct. 4 – Sierra paid $600 for a one-year insurance policy that will expire next year on Sept. 30. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 8 – Purchase of Supplies on Credit
Oct. 5 – Sierra purchases a three-month supply of advertising materials on account from Aero Supply for $2,500. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 9 – Hiring of New Employees
Oct. 9 – Sierra hired four new employees to begin work on Oct. 15. Accounting transaction has NOT occurred! Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 10 – Payment of Dividend
Oct. 20 – Sierra paid a $500 dividend. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Event 11 – Payment of Cash for Employee Salaries
Oct. 26 – Paid employees working two weeks, who have earned $4,000 in salaries. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

#2 Explain what an account is and how it helps in the recording process. Account: individual accounting record of increases and decreases in a specific Asset, Liability, or Stockholders’ Equity item. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Account Consists of three parts: Title of the account Left side, the debit side, Dr. Right side, the credit side, Cr. We call this the T - account Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

#3 Define debits and credits and explain how they are used to record business transactions. Recall Debit means left thus, entry on left side is debiting Recall Credit means right thus, entry on right side is crediting Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Total the Balances on T-Account
Title of Account Debit Credit Total Debits > Credits, then you have a Debit Balance! Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. 52 52

Total the Balances on T-Account
Title of Account Debit Credit Total Credits > Debits, then you have a Credit Balance! Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. 52 52

Normal Balances for Assets and Liabilities

Normal Balances for Stockholders’ Equity

Normal Balances for Expenses and Revenues

Expansion of Basic Equation

Let’s 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 Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Let’s Review What is the normal balance for the following accounts? Dividends? Debit Building? Debit Taxes Payable? Credit Service Revenue? Credit Prepaid Insurance? Debit Rent Expense? Debit Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Let’s Review Using Sierra’s Transactions
Cash Common Stock 10,000 10,000 Oct. 1 - Owner invested $10,000 Cash in business in exchange for $10,000 of Sierra Corporation Common Stock Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. 52 52

#5 Explain what a journal is and how it helps in the recording process. An accounting record where the transactions are initially recorded in chronological order. For each transaction journal shows the debit and credit Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Journals Help Recording Process
Discloses in one place the complete effect of a transaction Provides a chronological record of transactions Helps prevent or locate errors because debit and credit amounts can be readily compared Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. 58 58

Journalizing Complete entry consists of: Date of transaction Accounts titles and dollar amounts to be debited and credited Brief explanation Let’s use the first three Sierra transactions . . . Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Account Titles and Explanations
GENERAL JOURNAL Account Titles and Explanations Oct. 1 Cash , Common Stock , (Invested cash in business) Date Debit Credit 1 Cash , Notes Payable , (Issued 3-month, 12% note payable for cash) 2 Office Equipment , Cash , (Purchased office equipment for cash) 59

#6 Explain what a ledger is and how it helps in the recording process.
Ledger is the entire group of accounts maintained by a company Ledger contains all the asset, liability, & stockholders’ equity accounts Keeps all the information about current account balances and changes in specific account balances Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Chart of Accounts List of company accounts Number and type used depends upon size and complexity of business Small business might use 20 to 30 accounts Large business could use thousands worldwide Computerized systems assign number sequence to each unique account and group Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

#7 Explain what posting is and how it helps in the recording process.
Procedure of transferring journal entries to ledger is called posting Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Recall: Basic Steps in the Recording Process.
Analyze the transaction, identify the type of accounts involved? Journalize, debit or credit what? Post Let’s use some of Sierra’s data to demonstrate the recording process . . . Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Posting in Data File or Paper Files
GENERAL JOURNAL Account Titles and Explanations Oct. 1 Cash , Common Stock ,000 Acct 1010 Account CASH Date Balance ref debit credit debit credit Oct 1 GJ 1 10,000 10,000 Account COMMON STOCK Acct 3010 Date Balance ref debit credit debit credit Oct 1 GJ 1 10,000 10,000 66

#8 Explain the purposes of a trial balance.
Lists all the accounts and their balances at a given time. Proves mathematical equality of debits and credits after posting. Useful in the preparation of financial statements. Does not tell you ledger is correct! Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Sierra Corporation Trial Balance October 31, 2005 Debit Credit
Cash $15,200 Advertising Supplies ,500 Prepaid Insurance Office Equipment ,000 Notes Payable $ 5,000 Accounts Payable ,500 Unearned Service Revenue ,200 Common Stock ,000 Dividends Service Revenue ,000 Salaries Expense ,000 Rent Expense $28,700 $28,700 68

Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that named in Section 117 of the United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Introduction to Accounting in Action

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