Chapter 2 PPT PDF

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Chapter 2 PPT...

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Chapter 2 Recording Business Transactions

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Learning Objectives After completing this tutorial, students are able to:  Objective 1 - Define and understand the concepts of accounting transactions and accounts;  Objective 2 - Analyze accounting transactions;  Objective 3 - Understand how accounting works;  Objective 4 - Record accounting transactions in journals; and  Objective 5 - Construct a Trial Balance and look for errors. 2

Learning Objective 1

Define and understand the concepts of accounting transactions and accounts i.e. What is an accounting transaction?

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Accounting Transactions • Each accounting transaction is a two-sided event, which has financial impact on the business and the amount of the transaction can be measured reliably. • A two-sided event involves the action of (1) giving and (2) receiving something. • Accounting refers to the record of information of these two sides of the event.

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Accounting Transactions – Example On 14 February 2018, ABC Jewelry Shop sold one diamond ring, which costs $100,000 to a customer. The customer settled the $100,000 bill in cash. • To ABC Jewelry Shop, the above is an accounting transaction, specifically, a sales transaction because:  It is a two-sided event that involves giving and receiving – ABC Jewelry Shop gave out the ring and received $100,000 cash.  It has financial impact to ABC Jewelry Shop because there is an increase in ABC Jewelry Shop’s cash after this sales transaction.  The information in this sales transaction can be measured reliably. Both the diamond ring sold (1 ring) and the cash received ($100,000) can be reliably counted. 5

The Account What is an account?  An account is a record of all the changes in a particular asset, liability and shareholders’ equity element.  An account is a basic summary device of accounting.  Accounts are to be maintained in a book called Ledger. The Accounting Equation: Assets = Liabilities + Shareholders’ Equity 6

The Layout of An Account An account (ledger account) can be illustrated in a T-Account form. Account Name Left hand side  Debit side (Dr.)

Debit entry

(account code)

Right hand side  Credit side (Cr.)

Credit entry 7

The Layout of An Account in Columnar Format Cash Date

Explanation

Debit

Credit

101 Balance

Credit

201 Balance

Credit

301 Balance

2018 1 Sept Accounts payable Date Explanation

Debit

2018 1 Sept Share capital Date Explanation

Debit

2018 1 Sept 8

Examples of Assets • Assets are economic resources that provide a future benefit for a business. • Some common examples of Assets: Cash, Inventory, Accounts receivable, Notes receivable, Prepaid rent, Land, Building, Equipment, Furniture and fixtures, etc

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Examples of Liabilities • Liability is an obligation to pay an individual or organization. • Some common examples of liabilities: Accounts payable, Notes payable, Salary payable, Utility payable, etc.

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Elements in Shareholders’ Equity • Shareholders’ Equity is the shareholders’ residual claim to the entity’s assets. • Elements in Shareholders’ Equity:  Share Capital  Retained Earnings • Net income = Total revenues – total expenses is one element of retained earnings. • Dividends are declared by board of directors. It is paid to shareholders based on earnings. It indicates a decrease in retained earnings. 11

Learning Objective 2

Analyze accounting transactions

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Double Entry Accounting • All business transactions include, at least, two effects on an entity’s financial statement elements. • At all times, the accounting equation must remain in balance. • Each transaction affects at least two accounts. • Every business transaction involves both a debit and a credit. • The total debits and credits for every business transaction must be equal.

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Debits and Credits Rules – Basic Accounting Equation Assets

Debit

Credit

Liabilities

Debit

Credit

Shareholders’ Equity

Debit

Credit

• Increases in assets are recorded on the left (debit) side. Decreases in assets are recorded on the right (credit) side. • Increases in liabilities and shareholders’ equity are recorded on the right (credit) side. Decreases in liabilities and shareholders’ equity are recorded on the left (debit) side.

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Debits and Credits Rules – Shareholders’ Equity Accounts Expanded Accounting Equation Assets = Liabilities + Share capital + Retained earnings (Shareholders’ Equity) • Revenues are increases in retained earnings (equity) that result from delivering goods or services to customers. • Expenses are decreases in retained earnings (equity) due to cost of operating the business. • Dividends are paid to shareholders as a return on their investment and are recorded as direct reductions of retained earnings (equity). 15

Debits and Credits Rules – Shareholders’ Equity Accounts Expanded Accounting Equation Assets = Liabilities +

share capital + retained earnings

Assets = L + share capital + revenue – expenses - dividend (Retained Earnings)

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Debits and Credits Rules Shareholders’ Equity Assets

Debit

Liabilities

Credit

-

Debit

-

Credit

Share Capital

Debit

-

Credit

Retained earnings

Debit

-

Credit

Increase in Retained Earnings Revenue

Debit

-

Credit

Decrease in Retained Earnings Dividends

Debit

Credit

-

Expenses

Debit

Credit

-

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Learning Objective 3 Understand how accounting works

Learning Objective 4 Record accounting transactions in journals

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The Journal • The journal (day book) is a chronological record of accounting transactions. • Preparation of journals include the following three steps:  Specify each account affected by the transaction and classify each account by type (i.e. Assets, Liabilities, Shareholders’ Equity, Incomes and Expenses)*.  Determine whether each account should be increased or decreased based on the debit and credit rule.  Record the accounting transaction in the journal, which is called “making the journal entry,” or “journalizing the transaction.”

• Posting – copying information from the journal to the ledger accounts. 19

Layout of General Journal (The Journal ) Journal Date 2018 1 June

Accounts and Explanation Account to be debited (

Account to be credited Narrations )

Debit

Credit

$

$

xx xx

indent

A description and explanation of the transaction recorded The process to record the transactions in the journal is called journalization. 20

Example • RedLotus Travel, Inc. is a travel agency. It has 11 transactions. Your task is to prepare journal entries for all these 11 transactions. • What you will learn include:  Classify whether a transaction is an accounting transaction  if yes, is it related to the company business?;  Analyze an accounting transaction;  Preparation of journal entries; and  Posting to ledger accounts. 21

Transaction 1 (1) Received $50,000 cash and issued shares to the owners.

Steps 1, 2

Step 3

20x8 Apr

Cash Share capital Issued ordinary shares.

$ 50,000

$ 50,000

Step 4 Steps: 1. Classify whether a transaction is an accounting transaction  if yes, is it related to the company’s business?; 2. Analyse an accounting transaction (i.e. how many accounts are affected and how are they affected?) 3. Prepare the journal entry for the accounting transaction; and 4. Post to the ledger accounts.

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Transaction 2 (2) Paid $40,000 cash for land.

20x8 Apr

Land Cash Paid cash for land.

$ 40,000

$ 40,000

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Transaction 3 (3) Purchased supplies for $3,700 on account.

20x8 Apr

Supplies Accounts payable Purchased office supplies on account.

3,700 3,700

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Transaction 4 (4) Performed services and received cash of $7,000.

20x8 Apr

Cash Service revenue Performed services for cash.

7,000 7,000

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Transaction 5 (5) Performed services for UPS on account, $3,000.

20x8 Apr

Accounts receivable Service revenue Performed services on account.

3,000 3,000

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Transaction 6 (6) Paid expenses in cash : rent $1,100; employee salary $1,200; utilities $400.

20x8 Apr

Rent expense Salary expense Utilities expense Cash Paid expenses.

1,100 1,200 400 2,700

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Transaction 7 (7) Paid $1,900 on the account payable created in transaction 3.

20x8 Apr

Accounts payable Cash

1,900 1,900

Paid cash on account.

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Transaction 8 Starr Williams, the major shareholder of RedLotus Travel, paid $30,000 out of his personal bank account to remodel his home.

Analysis: 1. This transaction involves the action of receiving and giving, it is an accounting transaction. 2. However, this accounting transaction is related to the personal matter of Starr Williams and it is not related to RedLotus Travel’s business. Therefore, NO JOURNAL ENTRY IS REQUIRED for this transaction.

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Transaction 9 (9) Received $1,000 on account.

20x8 Apr

Cash Accounts receivable Collected cash on account.

1,000 1,000

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Transaction 10

(10) Sold half of the land for $22,000 cash and a gain of $2,000 is recognized.

20x8 Apr

Cash Land Gain on sale of land

22,000 20,000 2,000

Sold land costing $20,000 for $22,000.

20,000

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Transaction 11 (11) Declared and paid a dividend of $2,100 to shareholders.

20x8 Apr

Dividends Cash Dividends declared and paid.

2,100 2,100

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Summary - Flow of Accounting Data Transactions Occur Determine whether the transaction is an accounting transaction (receiving and giving concept) Analyze of Accounting Transactions (including analyzing whether the accounting transaction is related to the company’s business) Preparing Journal Entries for Accounting Transactions Posting the Accounting Information to the Ledger 33

Learning Objective 5 Construct a Trial Balance and look for errors

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Balancing Off • The balance is the difference between the account’s total debits and its total credits. • If an account’s total debits exceeds its total credits, that account has a debit balance. • If an account’s total credits exceeds its total debits, that account has a credit balance.

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Balancing off Land

Cash (1) (4) (9) (10)

$50,000 7,000 1,000 22,000

(2) (6) (7) (11)

$40,000 2,700 1,900 2,100

(2)

$40,000 (10)

$20,000

Balance 20,000 Supplies

Balance 33,300

(3)

Accounts Receivable (5)

$3,000

(9)

$3,700

Balance 3,700

1,000 Accounts Payable

Balance 2,000 (7)

$1,900

(3)

$3,700

Balance 1,800 36

Shareholders’ Equity Rent Expense (6)

Service Revenue

1,100

(4) (5)

Balance 1,100

Balance 10,000

Utilities Expense (6)

$400

Balance

400

(6)

$7,000 3,000

Gain on sale of land

Salary Expense

(10)

$2,000

$1,200

Balance 2,000

Balance 1,200 Dividends

Share Capital (1)

$50,000

Balance 50,000

(11)

$2,100

Balance 2,100 37

Example of Balancing Off the Accounts – RedLotus Travel, Inc.

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The Normal Balance of an Account

An account’s normal balance falls on the side of the account where increases are recorded. Normal Balance (Debit) Assets Debit (Dr.) Credit (Cr.)





Normal Balance (Credit) Liabilities Debit (Dr.) Credit (Cr.)





Normal Balance

Normal Balance

Expenses Debit (Dr.) Credit (Cr.)





Revenue Debit ( Dr.) Credit (Cr.)





Normal Balance

Normal Balance

Dividends Debit (Dr.) Credit (Cr.)

 Normal Balance



Share Capital Debit (Dr.)

Credit (Cr.)



 Normal Balance 39

The Trial Balance • The trial balance lists all accounts with their ending balances. • In the trial balance, the ending balances of assets accounts are recorded first, then come with the ending balances of liabilities and shareholders’ equity. • The final debit balance MUST EQUAL to the final credit balance. • The trial balance is usually prepared at the end of the financial period.

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Example of a Trial Balance (RedLotus Travel, Inc.)

Total Debit = Total Credit 41

Accounting Errors • In the trial balance, total debit = total credit. If it is NOT the case, there must be errors. • What are the common three types of errors?  Missing account  A debit treated as a credit, or vice versa  Transposition – example: reporting $3,200 as $2,300.

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End-of-Chapter Summary Problem

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End-of-Chapter Summary Problem (continued)

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End-of-Chapter Summary Problem (continued)

; Utilities Payable, no balance

Please refer to the format in Chapter 1 Slide 41.

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Homework Assignment Homework assignment:  S2-6  S2-12  E2-15A  E2-18A  E2-19A  End-of-Chapter Summary problem

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