COMM1140 2021T1 Week 3 Lecture Slides PDF

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COMM1140 Financial Management

Week 3 Recording Business Transactions – Part one: Transaction Analysis & Double Entry Dr Conor Clune Senior Lecturer, UNSW Business School General housekeeping: • Please switch your microphone to mute to avoid disruption to the class • Use the chat channel to ask questions or make a comment, or raise your 'virtual' hand • If you have poor internet, turn off your video • Wait for your lecturer to start

Learning Objectives 1. Carry out transaction analysis and determine the impact of transactions on elements of balance sheets and income statements transaction 1-7.

o LRM ltd (transaction 8-14). 2. Describe how debits and credits work in the double entry accounting system.

o Describe the normal balances for assets, liabilities, equity, revenues and expenses

o Record transactions using debits and credits (prepare journal entries) 3. Understand debits and credits in the context of transaction analysis

LO1. What are transactions? Transactions are events that affect the operations or finances of an organisation.  Analyze each transaction from the perspective of a company!

Accounting systems record transactions. To be considered a transaction, it must impact on the accounting equation: Assets = Liability + Equity

Transaction analysis Transaction analysis involves an examination of each business transaction with the aim of understanding its effect on the accounting equation (i.e. A=L+SE). Example: Borrow $10 000 from the bank.

After this transaction, the accounting equation is in balance.

Transaction analysis: The accounting equation extended The equation you were introduced to earlier is as follows: Assets = Liabilities + Equity This is extended to: A = L + SE CA + NCA = CL + NCL + SE What is SE made up of?

Extending the Accounting Equation • A = L + SE • CA + NCA = CL + NCL + SE • Where SE:       

SC + Op. RP + profit – dividends SC = Capital contributions by equity holders (share capital) Op. RP = Opening retained profits Profit = R – E R = Revenue E = Expenses D = Dividends to equity holders

CA + NCA = CL + NCL + SC + Op. RP + R – E – D

Link between the balance sheet and the income statement

Balance sheet CA + NCA = CL + NCL + SE CA + NCA = CL + NCL +

SC + Op. RP +

R – E

Income statement

– D

Let’s consider seven transactions.

Transactions 1. Issued shares for $300 000 cash. 2. Borrowed $50 000 cash from the bank. 3. Purchase equipment for $100 000 cash. 4. Signed six-month agreement to provide catering service for a monthly fee of $2500 starting next month. 5. Catering services provided for an office function; billed customer for $2500. 6. Customer paid $2500 they owed on their account. 7. Paid the bank $5000 as part repayment of the loan.

Transaction 1 Issued shares for $300 000 cash.

A

=

L

+ SE

Does the accounting equation balance?  YES! It must balance!

Transaction 2 Borrowed $50 000 cash from the bank.

A

=

L

+ SE

Does the accounting equation balance?  YES! It must balance!

Transaction 3 Purchase equipment for $100 000 cash.

A

=

L

+ SE

Does the accounting equation balance?  YES! It must balance!

Transaction 4 Signed six-month agreement to provide catering service for a monthly fee of $2500 starting next month.

A

=

L

+ SE

Transaction 5 Catering services provided for an office function; billed customer for $2500.

A

=

L

+ SE

Does the accounting equation balance?  YES! It must balance!

Transaction 6 Customer paid $2500 they owed on their account.

A

=

L

+ SE

Does the accounting equation balance?  YES! It must balance!

Transaction 7 Paid the bank $5000 as part repayment of the loan.

A =

L

+ SE

Does the accounting equation balance?  YES! It must balance!

An illustrative example: Prepare transaction analysis LRM Ltd: Balances as at 1 April 2019 Cash Inventory Land and buildings Equipment Accounts payable Notes payable Loans Share capital

140 000 55 000 300 000 90 000 15 000 70 000 300 000 200 000

Transactions for April 2019 8

Cash sales of $30 000; Cost of goods sold = $12 000.

9 10

Credit sales of $40 000; Cost of goods sold = $16 000. $8000 payments to suppliers on the account.

11 12

$20 000 wages paid for first 2 weeks of April. Received invoice for $2000 for an advertisement on April 5.

13

Received $25 000 from accounts receivable.

14

At end of month: $18 000 wages is owing for last 2 weeks of the month. Due to be paid on May 1.

Double entry accounting

A = L + SE The Golden Rule: The accounting equation must always balance It means Debits = Credits.

In accounting we use debit (Dr) nd credit (Cr) to describe changes in accounts

Debit–credit convention • Remember the equation: Assets = Liabilities + Equity • We define increases in Assets to be debits (DR) – decreases in Assets therefore must be credits (CR). • DR = CR, therefore increases in Liabilities and Equity must be credits, decreases must be debits.

Debit–credit convention With this in mind: How do we record increases in assets? Dr. Assets How do we record increases in liabilities? Cr Liabilities How do we record increases in equity? Cr Equity

Debit–credit convention Let’s think about equity in more detail… Retained earnings is part of shareholder equity How do we record increases in revenue? Cr. Revenue How do we recorded increases in expenses? Dr Expense

Double entry system: Debit and Credit Debit Credit How to increase account balances: +Asset

+Liability +Shareholder equity

+Expense

+Revenue

To reduce these account balances: -Liability

-Asset

- S. Equity - Revenue

-Expense

Remembering debits/credits Type Assets Liabilities Shareholder’s equity Revenues Expenses

Normal

Incr.

Decr.

Journal entries • Journal entries are, essentially, a shorthand version on transaction analysis. • They are prepared using the rules of debit and credit. • Debits must always equal credits.

Journal entries Example Machinery is purchased for $10 000 cash. Journal entry:

Depreciation  Allocation of the cost of a noncurrent asset to expense over the life of an asset  To recognise the consumption of the asset’s economic value. Dr Depreciation expense xxx (+E) Cr Accumulated depreciation xxx (-A) • Accumulated depreciation (a contra asset account, B/S) shows all depreciation charged against an asset to date. • Depreciation expense (I/S) shows only this year’s depreciation allocation.

Depreciation - example  Asset costs $10 000 with a life of 4 years and no estimated salvage value. Straight line depreciation each year:

After 3 years, book value is:

Dividends The dividends recommended by directors are authorised by shareholders at an annual meeting: (Declaration)

When the final dividends are paid: (Payment)

Link transaction analysis and journal entries  Back to the previous transactions.  Prepare journal entries for transaction 1-7.  Prepare journal entries for LRM ltd.

Transaction 1-7 1: Issued shares for $300 000 cash. 2: Borrowed $50 000 cash from the bank. 3: Purchase equipment for $100 000 cash. 4: Signed six-month agreement to provide catering service for a monthly fee of $2500 starting next month.  5: Catering services provided for an office function; billed customer for $2500.  6: Customer paid $2500 they owed on their account.  7: Paid the bank $5000 as part repayment of the loan.    

Transactions for April 2019 8

Cash sales of $30 000; Cost of goods sold = $12 000.

9 10

Credit sales of $40 000; Cost of goods sold = $16 000. $8000 payments to suppliers on the account.

11 12

$20 000 wages paid for first 2 weeks of April. Received invoice for $2000 for an advertisement on April 5.

13

Received $25 000 from accounts receivable.

14

At end of month: $18 000 wages is owing for last 2 weeks of the month. Due to be paid on May 1....