1. (c) Craig Pence, 2004, All Rights Reserved The Accounting Process Module 1 Illustration Recording Transactions Correlated to “The Accounting Course Manual,” Craig M. Pence, 2004

2. (c) Craig Pence, 2004, All Rights Reserved The Accounts Since accountants must keep track of assets, liabilities and owner’s equity; every transaction must be recorded in some way. The easiest way to do this is to set up a table with a column for each asset, each liability, and for the owner’s equity. These columns then become the asset, liability and owner’s equity accounts that are maintained for the business.

3. (c) Craig Pence, 2004, All Rights Reserved Transactions that Increase Owner’s Equity: 1. Contributions Contributions of cash or other assets into the business by the owner increase the business assets and, since they belong to the owner, increase the owner's equity. Suppose Fred Tall opens a business, Fred’s Bookkeeping, on December 1, 20XX. D-1. He begins by contributing $10,000 of cash and $500 of supplies to the business. The transaction should be recorded as follows:

4. (c) Craig Pence, 2004, All Rights Reserved Transactions that Increase Owner’s Equity: 2. Cash Revenues Revenue is "recognized" (recorded) when services have been performed or when goods have been delivered, whether the customer has paid or not. This is because the revenue has been earned and the customer is obligated to pay. Recognition of revenue increases assets and increases the owner's equity. D-2-a. Suppose Fred Tall does a job and collects $200 from the customer. This would be recorded as:

5. (c) Craig Pence, 2004, All Rights Reserved Transactions that Increase Owner’s Equity: 3. Revenue on Account When the customer does not pay cash at the time the revenue is earned, the revenue is still recorded. However, instead of a cash asset, Fred gets the customer’s promise to pay. This (Fred’s legal right to collect payment) represents an asset called Accounts Receivable. Eventually the cash will be collected, and then the “account receivable” asset will become a “cash” asset. D-2-b. If Fred finishes another job for a customer and bills her $500 (no payment received yet), the entry would be:

6. (c) Craig Pence, 2004, All Rights Reserved Transactions that Decrease Owner’s Equity: 1. Withdrawals Withdrawals of cash or other assets by the owner from the business for personal (non-business related) use decrease business assets and decrease owner's equity. A withdrawal is the opposite of a contribution. E-1. If Fred takes $1,000 of cash out of the business to use for a vacation trip, the transaction would be recorded as follows:

7. (c) Craig Pence, 2004, All Rights Reserved Transactions that Decrease Owner’s Equity: 2. Cash Expenses Expenses arise when cash is paid by the business for things that do not provide future benefit to the business. E-2-a. Suppose Fred pays the $100 monthly telephone bill. This payment is being made for telephone service during the previous month, so Fred is paying for past usage, not future usage. Therefore, an asset has not been purchased; instead, an expense has been incurred. It will be recorded as follows:

8. (c) Craig Pence, 2004, All Rights Reserved Transactions that Decrease Owner’s Equity: 3. Expenses Incurred but not Paid Expenses are recorded when they have been incurred, whether they have been paid or not. If cash has not yet been paid, it will be necessary to record the obligation to make the payment by increasing liabilities, and decreasing Owner’s Equity. E-2-b. Suppose Fred receives a $200 utility bill that is due next month. An expense has again been incurred and Fred is obligated to pay it at a later date. The account title used to record the liability is “Accounts Payable,” and the expense would be recorded as follows:

9. (c) Craig Pence, 2004, All Rights Reserved Transactions that Decrease Owner’s Equity: 4. Usage of Assets Expenses are also incurred when assets (for example, supplies) have been used up and lose their ability to provide future benefits to the business. E-2-c. Suppose $50 of the supplies are used. What was once an asset has now become an expense, so the Supplies asset account must be decreased along with Owner’s Equity.

10. (c) Craig Pence, 2004, All Rights Reserved Transactions that Change Only Assets: 1. Purchase of Assets The purchase of one type of asset in exchange for some other business asset affects only asset accounts. F-4-a. This usually results from the cash purchase of a new asset. If Fred purchases equipment, paying $2,000 of business cash to obtain it, the transaction would be recorded as follows:

11. (c) Craig Pence, 2004, All Rights Reserved Transactions that Change Only Assets: 2. Sale of Assets The sale of one type of asset in exchange for some other business asset affects only asset accounts. F-4-b. This usually results from the cash sale of an asset. If Fred sells some supplies that had originally cost $100, receiving $100 from the buyer, the transaction would be recorded as follows:

12. (c) Craig Pence, 2004, All Rights Reserved Transactions that Change Only Assets: 3. Collection of a Receivable The collection of an account receivable also results in a change in asset balances. The balance in Accounts Receivable falls when the account is collected, and Cash is increased. F-4-c. If Fred collects $200 of the account receivable balance, the transactions would be recorded as follows:

13. (c) Craig Pence, 2004, All Rights Reserved Transactions that Increase Liabilities: 1. Purchases on Account The business may obtain assets by agreeing to pay at a later date. For example, supplies may be purchased “on account” from a supplier. Since legal title to the asset passes to the buyer upon delivery even if payment has not been made, these transactions increase assets and increase liabilities. The obligation is recorded in the Accounts Payable account. G-1-a. Suppose Fred buys a $5,000 computer on account. The entry to record the transaction is as follows:

14. (c) Craig Pence, 2004, All Rights Reserved Transactions that Increase Liabilities: 2. Borrowing Cash Cash assets may also be obtained from creditors. When cash is borrowed from a bank, the business owner signs a legal document called a “promissory note.” G-1-b. Since promissory notes are different from open account balances, a different liability account, Notes Payable, is used for them. If Fred were to borrow $3,000 from his bank, signing a note, the transaction would be recorded as follows:

15. (c) Craig Pence, 2004, All Rights Reserved A Transaction that Decreases Liabilities: Paying the Creditor Payment of the amount owed the creditor (examples: payment of account balances that had been recorded in Accounts Payable, or payment of a bank loan) will decrease liabilities and decrease assets. H-1. If Fred pays the $200 utility bill that was recorded previously in E-2-b, the transaction would be recorded as follows:

16. (c) Craig Pence, 2004, All Rights Reserved Events That Are Not Transactions Recall that a business transaction is an event that causes a change in assets, liabilities, or owner’s equity. Each of the following is an event that would NOT be recorded in the accounting records. Can you explain why they are not transactions? (See the next slide for answers). 1)Fred meets with a new client and agrees to do the client’s tax return. The client will bring all her records to the office next week so Fred can begin the return. 2)Fred hires a new bookkeeper, agreeing to pay $15 per hour. The new bookkeeper will report for work next Monday. 3)Fred “builds” a new computer system he wants to buy for the business through the manufacturer’s online order page and places the order for it. The price is $2,950. It will take 2 weeks for the manufacturer to put the machine together and ship it to Fred.

17. (c) Craig Pence, 2004, All Rights Reserved Solutions 1)Fred meets with a new client and agrees to do the client’s tax return. The client will bring all her records to the office next week so Fred can begin the return. Since no work has yet been done, no revenue has been earned. Revenue is only recorded when it has been earned. 2)Fred hires a new bookkeeper, agreeing to pay $15 per hour. The new bookkeeper will report for work next Monday. Since the bookkeeper has not yet done any work, no expense has been incurred. Expenses are only recorded when they have been incurred. This will not begin to happen until Monday, when the bookkeeper begins work. 3)Fred “builds” a new computer system he wants to buy for the business through the manufacturer’s online order page and places the order. The price is $2,950. It will take 2 weeks for the manufacturer to put the machine together and ship it to Fred. Since legal title to the computer has not yet passed to Fred, the asset cannot yet be recorded. Assets are owned by the business, and Fred will not “own” the computer until it is delivered and he takes possession of it.

18. (c) Craig Pence, 2004, All Rights Reserved Summary This concludes our presentation of the process of recording business transactions in the accounting records. It is important that you become confident about your ability to analyze business events, and understand how they affect the assets, liabilities and owner’s equity of the business. It is the basis for everything that is done in the remainder of this course! I hope this presentation has been helpful to you in achieving this goal, but remember that review and practice are very important. Refer to your course manual, the online resources, and your text book for additional explanation and illustrations.