Ch.2 Notes - Financial Accounting PDF

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Financial Accounting - Chapter 2 - Lecture Notes - Sheridan College...

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The Recording Process Learning Outcomes: ● Define debits and credits and explain how they are used to record transactions ○ The account ■ Debits and credits ■ Double-entry accounting ● How a journal is used in the recording process and journalize transactions on the accounting equation ○ Analyzing and recording transactions ■ The accounting cycle and steps in the recording process ■ The journal ● How a ledger helps in the recording process and post transactions ○ The ledger ■ Posting ■ The recording process illustrated ■ Summary of illustration of journalizing and posting ● Prepare a trial balance ○ The trial balance ■ Limitations of a trial balance ■ Locating errors ■ Some process explanations RECAP ● Asset ○ Something that you own that has future value ● Liability ○ Obligation to be discharged in the future, something that you owe (services or goods) ● Equity ○ Your net assets (what is left over, to be enjoyed by you, after you pay all your assets/debt) ● Assets = Liability + Owners Equity ● Revenue ○ The income from a business’ product or service ● Expenses ○ Expenses are the costs of assets that are consumed and services that are used in a company's business activities to earn revenue ● Assets vs Expenses ○ Assets have future value (because we haven't consumed) expenses do not have future value (because they already are consumed) The Account An account is an individual accounting record of increases and decreases in a specific asset, liability, or owner's equity item. For example, Softbyte has separate accounts called Cash, Accounts Receivable, Accounts Payable, Service Revenue, Salaries Expense, and so on.

Three Parts (called T-Account) ● Title of the Account ● Left side or Debit side ● Right side or Credit side Debit/Credit ● Debit normal balance ○ If Debit amounts exceed the credits ● Credit normal balance ○ If Credit amounts exceed the debits Debit/Credit Procedure ● Debit does not mean increase or decrease ○ Can be either depending on the type of account ○ It is the money flowing into the account ○ Assets are on the debit side of the equation ■ Increase in assets are on debit side (you are gaining an asset) but decreases on the credit side (you are losing an asset, credit it) ● Credit does not mean increase or decrease ○ Also depends on account type ○ It is the money flowing out of the account ○ Liabilities are on the credit side of the equation ■ Increases in liabilities are on credit side (you are liable to pay this) but decreases are on the debit side Assets = Liabilities + Owners Equity(Owners Capital-Drawings+Profit (revenues-expenses)) Assets Debit Increase

Credit Decrease

Normal Balance

Liabilities Debit Decrease

Credit Increase Normal Balance

Owners Capital Debit Decrease

Credit Increase Normal Balance

Drawings

Debit Increase

Credit Decrease

Normal Balance

Revenues Debit Decrease

Credit Increase Normal Balance

Expenses Debit Increase

Credit Decrease

Normal Balance Double-Entry Accounting System ● Each transaction is recorded with equal debits and credits ○ Total debits always equals total credits ● Accounting equation will always stay in balance ○ Assets = Liabilities + Owners Equity ● Every account has a normal balance ○ Either debit or credit The Accounting Cycle (Steps 1-3) The Recording Process 1. Analyze Business Transactions ● Determine effect on accounts 2. Journalize the Transactions ● The book of original entry 3. Post to Ledger Accounts The Journal ● Where transactions are first recorded ● Every company has a general journal ● Contributes to recording process: ○ Discloses complete effect of a transaction in one place ○ Provides a chronological record ○ Helps prevent and locate errors Journalizing ● Entering transaction data in the journal ● Separate journal entry for each transaction ● A complete entry consists of ○ Transaction date

○ Accounts & amounts to be debited and credited ○ Brief explanation of transaction Journalizing Technique 1. The date of the transaction is entered in the date column 2. The debit account title (that is, the account to be debited) is entered first at the extreme left margin of the column headed “Account Titles and Explanation,” and the amount of the debit is recorded in the debit column. 3. The credit account title (that is, the account to be credited) is indented and entered on the next line in the column headed “Account Titles and Explanation,” and the amount of the credit is recorded in the credit column. 4. A brief explanation of the transaction appears on the line below the credit account title. A space is left between journal entries. The blank space separates individual journal entries and makes the entire journal easier to read. 5. The column titled Ref (which stands for Reference) is left blank when the journal entry is made. This column is used later when the journal entries are transferred to the ledger accounts. ● Debit amounts are recorded in the Debit (left) column ● Credit amounts are recorded in the Credit (right) column ● Separate entries with a blank line ● Ref column is used later when transferred to ledger ● List all debits in each entry before listing credits ● Simple Entry: involved two accounts ● Compound Entry: involves three or more accounts The Ledger ● Ledger: Entire group of accounts maintained by a company ● General Ledger: contains all the assets, liabilities, and owner’s equity accounts ○ Arranged in financial statement order ○ Assets, liabilities, owner’s capital, drawings, revenues and expenses ● Posting: procedure of transferring journal entries to the ledger accounts Posting 1. Post to debit account: date, journal page number, amount 2. Enter debit account number in journal reference column 3. Post to credit account: journal page number, amount 4. Enter credit account number in journal reference column Charts of Accounts ● List of accounts and their account numbers ○ Indicates where accounts are found in the ledger ○ Usually starts with balance sheet accounts, followed by income statement accounts ● Varies by company ○ Number of accounts

○ ○

Types of accounts Numbering system The Accounting Cycle (Steps 1-4)

1. 2. 3. 4.

Analyze Journalize Post Trial Balance

The Trial Balance ● List of accounts and their balances at a specific time ● Proves that debits equal credits after posting ● Uncovers errors in journalizing and posting ● To prepare a trial balance: ○ List accounts and their balances ○ Total the debit and credit columns ○ Ensure the two column totals are equal Limitations of a Trial Balance ● Does not prove: ○ That all transactions have been recorded ○ That the ledger is correct ● Numerous errors may exist even though the trial balance columns (Dr. & Cr.) equal ○ Total debits and total credits may be equal, but may still be posted to the wrong account or in the wrong amount Locating Errors ● If trial balance does not balance, then: ○ If error is amount of $1, $100, or $1000, re-add and recalculate account balances ○ If evenly divisible by 2, look for a balance (=½ of the error) in the wrong column ○ If evenly divisible by 9, look for transposition errors (reversing order of numbers) ○ Otherwise, scan to see if an account balance has been omitted...