1. ACCT 2310 Accounting Principles I Chapter 2 Dr. Robert R. Oliva Professor and Chairperson Department of Accounting University of Arkansas at Little Rock

2. Questions: How do you find out the answer to the following questions? –Does the business have enough cash to buy a $5000 piece of equipment? –Why was a $750 check written on March 28? –How much have you spent on salaries so far this month? –How much did you spend for an ad placed in the Arkansas Democrat Gazette during the first week in July?

3. You need to have an appropriate accounting system in place JOURNAL: Records daily transactions, describing date, amount, brief explanation. –Pages 62-64. LEDGER: Keeps a running balance showing increases and decreases of each financial statement item in a separate record, e.g., –Balance sheet: Cash, accounts receivable, etc. –Income Statement: Revenues and expenses. –Pages 65-68

4. Each business transaction must be recorded Recording involves a 3-step approach: –Determine which “accounts” are affected. –As the Accounting Equation requires constant balancing, one “account” increases while other “account” decreases. Double-entry accounting –Translate each increase and decrease into a debit or a credit transaction. Initial recording done in a “Journal” –The book of original entry Ledger: After all business transactions are recorded (journalized) then they are posted in the “Ledger”

5. Flow of business transactions Exhibit 2, page 56

6. Will proper recording prevent fraud? Bottom of page 54

7. But before we can record in a journal or post to a ledger We need to know what to call each business transaction –We need to separate business transactions into “Accounts”

8. Account classification Classification depends on the business transaction and the type of business. Business transactions may be classified as affecting –Assets –Liabilities –Owners’ Equity –Revenues –Expenses

9. Chapter 1: Lawn Mowing example Many transactions were recorded in Owner’s Equity –Hard to separate and analyze –OK for a very small business. But in reality not very efficient. More efficient approach: Separate “Owner’s Equity” into various accounts.

10. Owner’s Equity is separated into four (4) separate “accounts”: Capital –To record owner’s investments Drawing –To record owner’s withdrawals Revenue –To record revenues from customers Expense –To record expenses incurred in business

11. Examples of other “accounts”: Cash Supplies Accounts Payable

12. Accounts Organization Chart of Accounts Accounts can be classified/organized into 5 major groups/categories: –Assets –Liabilities –Owner’s Equity –Revenues –Expenses All business have these types, but names and/or numbers given to them will vary. –Unique: The Chart reflects the business transactions.

13. In-class exercise: Create a Chart of Accounts for Larry Sharp, M.D. Consider Dr. Sharp’s practice and divide business transactions among the following –Assets –Liabilities –Owners’ Equity –Revenues –Expenses

14. Larry Sharp, M.D. (a sole proprietorship) Dr. Sharp’s practice has a bank account, supplies, and equipment. He buys supplies on credit and pays in 30 days His patients either pay same day or get bills He rents the office and pays for utilities He has malpractice insurance which he pays on on 1/1/xx He has 2 employees and buys them flowers on their birthdays He attends medical seminars to keep current in his practice.

15. Larry Sharp, M.D. Chart of Accounts Assets: # 1x –10: Cash –11: Accounts Receivable –12:Supplies –13: Prepaid Insurance –14: Medical equipment Liabilities: # 2x –21: Accounts Payable Owners’ Equity: # 3x –31: Larry Sharp, Capital –32: Larry Sharp, Drawing Revenues: # 4x –41: Fees earned Expenses; # 5x –51: Wage expenses –52: Rent expenses –53: Utilities expenses –54: Medical Seminars expenses –55: Supplies expenses –56: Miscellaneous expenses Later we will consider two other accounts: Insurance expense; Depreciation

16. Recall: Why are we classifying the accounts? To record the business transactions into a journal –Each business transaction requires at least 2 entries to keep the Accounting Equation on balance.

17. What account increases and what account decreases?

18. The hijacking receivable Page 53

19. Account Characteristics: pp. 49- 50 Form: The “T’ account Two sides of the “T” –Left side: The debit side –Right side: The credit side Some accounts increase by “debit” entries Some account increase by “credit” entries

20. The top of the “T” Describes type of account Based on the Accounting Equation: Assets = Liabilities + Owner’s Equity The Accounting Equation determines the recording of an account’s increases and decreases, e.g., Debits and Credits Page 52

21. Assets’ Accounts: Assets increase with “debits”, e.g., increases recorded on the left side of the “T”. –AID Assets decrease with “credits”, e.g., decreases recorded on the left side of the “T” –ADC

22. Liabilities’ Accounts Liabilities and Owner’s Equity increase with “credits”, e.g., increases recorded on the left side of the “T”. –LIC Liabilities and Owners’ Equity decrease with “debits”, e.g., decreases recorded on the left side of the “T” –LDD Note: Rules mirror each other –Memorize only one

23. A different approach After eating dinner, let’s read the comics Using the “T”: –Left: After Eating Dinner: Accounts increasing with debits: Assets Expenses Drawings –Right: Let’s Read the Comics: Accounts increasing with credits: Liabilities Revenues Capital

24. In-class Exercise: Posting entries into “T” accounts (a) Dr. Sharp deposits $7000 cash in business account (b) Buys $5700 in medical equipment on account. (c) Pays $500 cash for ad in newspaper (d) Pays $75 for supplies. (e) Receives $1000 from patients (f) Pays for the $5700 in equipment. (g) Patients are billed $300 (h) Paid employee $150 (i) Patients in (g) send $300 check in payment. (j) Dr. Sharp withdraws $575 for personal use

25. Solution Left: After Eating Dinner: Accounts increasing with debits: –Assets –Expenses –Drawings Right: Let’s Read the Comics: Accounts increasing with credits: –Liabilities –Revenues –Capital

26. Solution: Assets: Cash account –Debit: (a), (e); and (i) –Credit: (c); (d); (f); (h); (j) Account receivable –Debit: (g) –Credit: (i) Supplies: –Debit: (d) Equipment: –Debit: (b)

27. Solution: Liabilities Accounts Payable –Credit: (b) –Debit: (f)

28. Solution: Capital, Revenues, Expenses Capital Account –M. Gordon, Capital: Credit: (a) –M. Gordon, Drawing: Debit: (j) Revenues –Fees earned: Credit: (e); (g) Expenses: –Wages Debit: (h) –Advertising Debit; (c)

29. But many times proper recoding requires through analysis Payments in advance

30. Pre-payments paid Difference between paying for 2-year in advance v. 1-month in advance: –Page 56: Pre-payment of a 2-year policy on December 1 st. Credit cash Debit an asset –Page 58: Pre-payment of 1-month rent on December 1 st. Credit cash Debit an expense

31. Pre-payments received Receiving $360 for prepaid rent 3-months in advance –Page 58 –Debit receipt of $360 cash –Credit a liability: Unearned Revenue Each month –Debit the liability –Credit revenues

32. Answers to Earlier Questions: How do you know whether the business has enough cash to buy the equipment? –Ledger: Current balance in the CASH ACCOUNT. Why was a $750 check written on March 28? –Journal: The journal will show a brief description as to why the check was written. How much have you spent on salaries so far this month? –Ledger: WAGE EXPENSE ACCOUNT shows balance to date. How much did you spend for an ad placed in the Arkansas Democrat Gazette during the first week in July? –Journal: Look for entries during the first week in July and look for description indicating the Arkansas Democrat Gazette.

33. TRIAL BALANCE Reports the balance of each ledger account Aim: TO show that Debits = Credits

34. In-Class Exercise Trial balance for Dr. Sharp

35. Dr. Larry Sharp, M.D. Trail Balance May 31, 20xx Cash………… 1300 Supplies…….. 75 Equipment…. 5700 Dr. L Sharp, Capital 7000 Dr. L. Sharp, Drawing 575 Fees earned 1300 Wages Expense 150 Advertising Expense 500 _______ ______ 8300 8300

36. Possible errors Exhibit 6 Transposition Slide

37. Error Correction Exhibit 7

38. Errors undetected by a Trial Balance Failing to record or post a transaction Recording the same erroneous amounts as debits and credits Recording the same transaction more than once Correct debit accompanied by crediting wrong account –Would the trial balance be off if you record a $500 sale on account as follows? Debited Cash for $500 Credited Fees earned for $500 –Answer: No!

39. FINANCIAL ANALYSIS Horizontal analysis –Comparing time periods Exhibit 8