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Recording Transactions
Chapter 3 Recording Transactions
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Use Double-Entry Accounting
Learning Objective 1 Use Double-Entry Accounting
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The Double-Entry Accounting System
LO-1 The Double-Entry Accounting System Method followed for recording transactions, whereby every transaction affects at least two accounts Accountants analyze each transaction to determine: Which accounts it affects Whether to increase or decrease the balances How much each balance will change
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The Double-Entry Accounting System
LO-1 The Double-Entry Accounting System Transactions are recorded in: General Journal: Chronological record of an organization’s transactions and how each transaction affects the balances in particular accounts General Ledger: Collection of all ledger accounts that supports an organization’s financial statements Ledger account: Listing of all the increases and decreases in a particular account
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General Ledger: T-Account
LO-1 General Ledger: T-Account Device used to portray individual ledger accounts in the general ledger Each T-account takes the form of the capital letter T and represents an individual ledger account Transactions affecting a particular ledger account are accumulated here
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General Ledger: T-Account
LO-1 General Ledger: T-Account Assets increase on the left side of the T-account and decrease on the right side Liabilities and owners’ equity accounts increase on the right side of the T-account and decrease on the left side
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General Ledger: T-Account
LO-1 General Ledger: T-Account Balance: Net result of all activity that has been recorded in an account as of a particular point in time In a T-account, it is the difference between the total left-side and right-side amounts The balance in a ledger account at the end of the period is computed as: Beginning balance + Amount of increases – Amount of decreases
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Assets = Liabilities + Stockholders’ Equity
LO-1 General Ledger In the double-entry system, every transaction affects at least two accounts After each transaction, the balance sheet equation must always remain in balance The process of creating a new T-account in preparation for recording a transaction is called opening the account Assets = Liabilities + Stockholders’ Equity
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Recording Transactions in T-Accounts
LO-1 Recording Transactions in T-Accounts 1. Initial investment by owners, $400,000 cash Analysis The asset Cash increases The stockholders’ equity Paid-in Capital increases
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Recording Transactions in T-Accounts
LO-1 Recording Transactions in T-Accounts 2. Loan from bank, $100,000 Analysis The asset Cash increases The liability Note Payable increases
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Recording Transactions in T-Accounts
LO-1 Recording Transactions in T-Accounts 3. Acquired store equipment for cash, $15,000 Analysis The asset Cash decreases The asset Store Equipment increases
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Debits and Credits Accountants use the terms
LO-1 Debits and Credits Accountants use the terms Debit (abbreviated Dr.): An entry or balance on the left side of any account Credit (abbreviated Cr.): An entry or balance on the right side of any account Some accountants use the word “charge” instead of debit
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Describe the Five Steps in the Recording Process
Learning Objective 2 Describe the Five Steps in the Recording Process
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LO-2 The Recording Process Sequence of five steps in recording and reporting transactions
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Five Steps in Recording Process
LO-2 Five Steps in Recording Process Step 1- Transaction documentation Source documents: Original records supporting any transaction Generated as a result of transactions Filed to verify details and accuracy of subsequent records Step 2- General journal or book of original entry Contains analysis of the transaction, based on the source documents
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Five Steps in Recording Process
LO-2 Five Steps in Recording Process Step 3- Ledger Enter transactions into ledger accounts Step 4- Trial balance List of accounts in general ledger together with their balances Aids in verifying clerical accuracy and in preparing financial statements
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Five Steps in Recording Process
LO-2 Five Steps in Recording Process Step 5- Preparing financial statements Occurs at least once a quarter, every three months, for publicly traded companies in the United States Occurs at least annually for companies reporting under IFRS
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Chart of Accounts A numbered or coded list of all account titles
LO-2 Chart of Accounts A numbered or coded list of all account titles Typically arranged in order in which accounts appear in the financial statements Varies across companies as a function of the size, nature, and complexity of the firm May be used instead of account names
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Learning Objective 3 Analyze and Journalize Transactions and Post Journal Entries to the Ledgers
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Journalizing Transactions
LO-3 Journalizing Transactions This is Step 2 of the recording process Journalizing: The process of entering transactions into the general journal Journal entry An analysis of effects of a single transaction on various accounts, usually accompanied by an explanation Identifies accounts to be debited and credited
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Recording Journal Entries
LO-3 Recording Journal Entries Conventions for recording journal entries in the general journal Date and identification number comprise the first two columns Accounts and Explanation in the third column Names of accounts affected Debit account titles on the left margin Credit account titles indented Narrative explanation of the transaction
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Recording Journal Entries
LO-3 Recording Journal Entries Fourth column is posting reference (Post Ref. ) Contains identifying number from chart of accounts, which is used for cross-referencing to ledger accounts Debit and credit columns are the fifth and sixth columns Show the amounts debited (left-entry) or credited (right-entry) to each account Currency symbols not used Negative numbers do not appear
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Posting Transactions to the General Ledger
LO-3 Posting Transactions to the General Ledger This is Step 3 of the recording process Posting: The transferring of amounts from general journal to the appropriate accounts in the general ledger Cross-referencing Helps identify each general ledger posting to appropriate journal entry Allows users to find all the components of the transaction in the general ledger
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Posting Transactions to the General Ledger
LO-3 Posting Transactions to the General Ledger The following example shows How the $15,000 credit to Cash from the purchase of store equipment in transaction 3 is posted from the general journal to the general ledger Columns for dates, explanations, journal references, and amounts in the ledger
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Posting Transactions to the General Ledger
LO-3 Posting Transactions to the General Ledger
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Posting Transactions to the General Ledger
LO-3 Posting Transactions to the General Ledger Another format for the general ledger Shows a running balance of the account holdings in the far right column Provides status report for account at a glance
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Simple and Compound Entry
LO-3 Simple and Compound Entry Simple entry: A journal entry for a transaction that affects only two accounts Compound entry: A journal entry for a transaction that affects more than two accounts
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Revenue and Expense Transactions
LO-3 Revenue and Expense Transactions Assets = Liabilities + Stockholder’s Equity Assets = Liabilities + ( Paid-in Capital + Retained Earnings) The T-accounts can be grouped in the following way: = + +
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Revenue and Expense Transactions
LO-3 Revenue and Expense Transactions Revenue and expense information is accumulated separately to simplify the preparation of the income statement However, revenue and expense accounts are part of retained earnings on the balance sheet
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Revenue and Expense Transactions
LO-3 Revenue and Expense Transactions Revenue account accumulates items that increase retained earnings Credit to revenue is effectively a credit to retained earnings Expense account accumulates items that decrease retained earnings Debit to expense is effectively a debit to retained earnings Debit entry increases expense, but decreases retained earnings =
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Recording Revenue and Expense Transactions
LO-3 Recording Revenue and Expense Transactions 10a. Sales on credit, $160,000 Analysis The asset Accounts Receivable increases Stockholders’ equity, specifically Retained Earnings, increases because a revenue account, Sales Revenue, increases Journal Entry
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Recording Revenue and Expense Transactions
LO-3 Recording Revenue and Expense Transactions
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Recording Revenue and Expense Transactions
LO-3 Recording Revenue and Expense Transactions 10b. Cost of merchandise inventory sold, $100,000 Analysis The asset Merchandise Inventory decreases Stockholders’ equity, specifically Retained Earnings, decreases because an expense account, Cost of Goods Sold, increases Journal Entry
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Recording Revenue and Expense Transactions
LO-3 Recording Revenue and Expense Transactions
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Prepaid Expenses and Depreciation Transactions
LO-3 Prepaid Expenses and Depreciation Transactions 12. Paid rent for 3 months in advance, $6,000 Analysis The asset Cash decreases The asset Prepaid Rent increases Journal Entry
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Prepaid Expenses and Depreciation Transactions
LO-3 Prepaid Expenses and Depreciation Transactions
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Prepaid Expenses and Depreciation Transactions
LO-3 Prepaid Expenses and Depreciation Transactions 13. Recognized expiration of rental services, $2,000 Analysis The asset Prepaid Rent decreases Stockholders’ Equity, specifically Retained Earnings decreases because an expense account, Rent Expense , increases Journal Entry
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Prepaid Expenses and Depreciation Transactions
LO-3 Prepaid Expenses and Depreciation Transactions
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Prepaid Expenses and Depreciation Transactions
LO-3 Prepaid Expenses and Depreciation Transactions 14. Recognized depreciation, $100 Analysis The asset-reduction account Accumulated Depreciation, Store Equipment increases Stockholders’ Equity, specifically Retained Earnings, decreases because an expense account, Depreciation Expense, increases Journal Entry
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Prepaid Expenses and Depreciation Transactions
LO-3 Prepaid Expenses and Depreciation Transactions
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Accumulated Depreciation
LO-3 Accumulated Depreciation Accumulated Depreciation: Cumulative sum of all depreciation recognized since the date of acquisition of an asset Also called Allowance for Depreciation Contra account A separate but related account that offsets or is a deduction from a companion account
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Accumulated Depreciation
LO-3 Accumulated Depreciation Balance is on opposite side as that of the related companion account Contra asset: A contra account whose companion account is an asset Contra asset has a credit balance Balance in contra asset is deducted from the related asset account, which has a debit balance
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LO-3 Book Value Book Value: Balance of an account shown on the books, minus the value of any associated contra accounts Called net book value, carrying amount, carrying value
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Prepare and Use a Trial Balance
Learning Objective 4 Prepare and Use a Trial Balance
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Preparing the Trial Balance
LO-4 Preparing the Trial Balance Purpose Help check accuracy of postings Establish a summary of balances in all accounts Total debits should equal total credits
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Preparing the Trial Balance
LO-4 Preparing the Trial Balance List assets, liabilities, and stockholders’ equity followed by the income statement accounts, revenues and expenses All accounts except retained earnings show their balances as of the date the trial balance is prepared
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Preparing the Trial Balance
LO-4 Preparing the Trial Balance *If a Retained Earnings balance existed at the start of the accounting period, it would appear here.
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Close Revenue and Expense Accounts and Update Retained Earnings
Learning Objective 5 Close Revenue and Expense Accounts and Update Retained Earnings
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LO-5 Closing the Books and Deriving Financial Statements from the Trial Balance Close the books: To transfer the balances in all revenue and expense accounts to retained earnings Resets the revenue and expense accounts to zero so that they are ready to record the next period’s transactions
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LO-5 Closing the Books and Deriving Financial Statements from the Trial Balance Closing entries: Journal entries that transfer balances in the “temporary” stockholders’ equity accounts (revenue and expense accounts) to the “permanent” stockholders’ equity account, Retained Earnings
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Two approaches to closing entries
Closing the Books and Deriving Financial Statements from the Trial Balance Two approaches to closing entries Two step process Transfer revenue and expense accounts to an Income Summary account Transfer Income Summary account to Retained Earnings account One step process Transfer the revenue and expense accounts directly into Retained Earnings account, bypassing the Income Summary account
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Closing the Accounts LO-5 There are three closing entries:
C1: Close all revenue accounts C2: Close all expense accounts C3: Close the Income Summary account
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