FAR Module Chapter 6 Summarries- PDF

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Summary

At the end of the accounting period, some accounts in the general ledger would require updating. The journal entries that bring the accounts up to date are called adjusting entries. One purpose of adjusting entries is for income and expenses to be reported in the correct period.

Adjusti...

Description

Financial Accounting and Reporting

Business Transactions and their Analysis

UNIT 6: Business Transactions and their Analysis Introduction Did you know that millions of times a day, all over the world, transactions occur? Think about it. Any time that a bill is paid, a loan is made, a purchase is made, or a sale is made, a transaction has occurred. An accounting system must record all business transactions to ensure complete and reliable information when the financial statements are prepared. Transaction analysis can be a tricky task. In this unit, you will learn what transaction analysis is, how to analyze a transaction, and how it is related to the accounting equation.

Learning Objectives At the end of the unit, students will be able to:  Record in equation form the financial effects of a business transaction.  Define, identify, and understand the relationship between asset, liability, and owner’s equity accounts.  Analyze the effects of business transactions on a firm’s assets, liabilities, and owner’s equity and record these effects in accounting equation form.

Activating Prior Learning Rollin King and Herb Kelleher had a simple notion when they got into the airline business: “If you get your passengers to their destinations when they want to get there, on time, at the lowest possible fares, and make darn sure they have a good time doing it, people will fly your airline.” Today, Southwest has become one of the most profitable airlines—posting a profit for the 40th consecutive year in a row! However, running an airline is no easy task. Think of all of the financial transactions that take place on a daily basis. The airline has to buy planes, equipment, and supplies—like those peanuts we are so fond of. It also has to pay employees, pay for repairs on their equipment, and buy insurance, just to name a few expenses. Then, it has to sell enough tickets in order to be able to generate money to pay for all of these things. Yikes. That is a lot of cash coming in and going out. With an emphasis on customer service, Southwest has a reputation of being fun, quirky, and having a sense of humor. You never know what might happen when you board a Southwest flight but you know you’ll have a good time. Thinking critically. How does Southwest keep track of all of these transactions so that it can continue to run its airlines profitably?

Financial Accounting and Reporting

Business Transactions and their Analysis

Presentation of Content The Accounting Cycle The accounting cycle represents the steps or procedures used to record transactions and prepare financial statements. The accounting cycle implements the accounting processes of identifying, recording, and communicating economic information. Steps in the Accounting cycle The following are the steps in the accounting cycle: 1. Identifying and analyzing business documents or transactions. - The accountant gathers information from source documents and determines the effect of the transactions on the accounts. 2. Journalizing - the identified accountable events are recorded in the journals. 3. Posting - information from the journal are transferred to the ledger. 4. Preparing the unadjusted trial balance - the balances of the general ledger accounts are proved as to the equality of debits and credits. The unadjusted trial balance serves as basis for adjusting entries. 5. Preparing the adjusting entries - the accounts are updated as of the reporting date on an accrual basis by recording accruals, expiration of deferrals, estimations, and other events often not signaled by new source documents. 6. Preparing the adjusted trial balance (or worksheet preparation) - the equality of debits and credits are rechecked after adjustments are made. The adjusted trial balance serves as basis for the preparation of the financial statements. 7. Preparing the financial statements - these are the means by which the information processed is communicated to users. 8. Closing the books - this involves journalizing and posting closing entries and ruling the ledger. Temporary accounts (or nominal accounts) are closed and the resulting profit or loss is transferred to an equity account. 9. Preparing the post-closing trial balance - the equality of debits and credits are again rechecked after the closing process. 10. Recording of reversing entries - reversing entries are usually made at the beginning of the next accounting period to simplify the recording of certain transactions in that period.

Financial Accounting and Reporting

Business Transactions and their Analysis

The preparation of trial balances and reversing entries represented in steps (4), (6), (9), and (10) are optional, meaning they are not required in the preparation of financial Statements However, for best internal control purposes, trial balances should be prepared. Step 1 and 2 are discussed in this unit. The other steps are discussed in the succeeding units. IDENTIFYING AND ANALYZING TRANSACTIONS AND EVENTS This is the first step in the accounting cycle. It involves identifying a business transaction and analyzing whether or not that transaction affects the assets, liability, equity, income or expenses of the business. A transaction that has an effect on the accounts is an "accountable event," which needs to be recorded in the books of accounts. On the other hand, a transaction that has no effect on the accounts is a "non-accountable event," which is not recorded in the books of accounts. Transactions are normally identified from "source documents." Source documents are written evidences containing information about transactions. Source documents come in various forms which include, but not limited to, the following: a. Sales invoices, e. Bank deposit slips, b. Official receipts, f. Bank statements, c. Purchase orders, g. Checks, d. Delivery receipts, h. Statements of account, and the like Illustration: Source Documents Sales invoice vs. Official receipt Sales invoices (SI) are used for the sale of goods while Official receipts (OR), are used for the rendering of services. For example, if you buy groceries, the grocery store will issue you a sale invoice; if you pay your tuition fee in school, the school will issue you an official receipt.

Financial Accounting and Reporting

Business Transactions and their Analysis

Purchase order A purchase order is a document issued by a buyer to a seller indicating the types, quantities and agreed prices for products or services that the buyer intends to purchase. Purchase orders are prepared as internal control over purchases. For example, to prevent unnecessary purchases, you should require your personnel to prepare purchase orders for all the purchases of your business.

Delivery receipt A delivery receipt is a document signed by the receiver of a shipment acknowledging receipt of the goods. Bank A deposit evidences a bank shows the deposit, the name and the amount

deposit slip slip deposit to a account. It date of bank account number, and deposited.

Financial Accounting and Reporting

Business Transactions and their Analysis

Bank statement A bank statement is a report issued by a bank (on a monthly basis) that shows the deposits and withdrawals during the period and the cumulative balance of a depositor's bank account.

Check A check is an instrument that orders a bank (drawee) to pay the person named on the check or the bearer thereof (payee) a definite amount of money from the drawer's bank account. Drawer

Drawer 0994994303

Drawee Bank

Statement of account

John Doe

Financial Accounting and Reporting

Business Transactions and their Analysis

A of account is a report a business sends to its customer listing the transactions with the customer during a period, the payments made by the customer and any remaining balance due from the customer. A statement of account also serves as a notice of billing. For example, a school periodically issues statements of accounts to its students reminding them to settle any unpaid tuition fee.

Types of events 1. External events are transactions that involve the business and another external party. Examples include sale, purchase, borrowing of money, payment of liabilities, and the like. 2. Internal events are events that do not involve an external party. Examples include production (cooking of barbecue) and casualty losses (e.g., destruction of properties due to storm, earthquake, and the like). JOURNALIZING After an accountable event is identified and analyzed, the second step is to record it in the journal by means of a journal entry. This recording process is called journalizing. Journal entry A journal entry has the following format: Date Account title to be debited Account title to be credited

Pxxx Pxxx

Short description of the transaction

The following are the parts of a journal entry: 1. Date - journal entries are recorded in the journal chronologically, i.e., arranged according to the dates they are recorded. 2. Account titles and Amounts to be debited and credited - under the double-entry system, each transaction is recorded in the journal in two parts — debit and credit.

Financial Accounting and Reporting

Business Transactions and their Analysis

3. Short description of the transaction - a short description of the transaction is provided for future reference. Simple and Compound journal entries A journal entry may have one of the following a. Simple journal entry – one that contains a single debit and a single credit element. The illustrated journal entry above is an example of a simple journal entry. b. Compound journal entry - one that contains two or more debits or credits. Illustration 1: Journal entries — Start-up In this illustration, we will discuss how to set up the accounting records of a start-up business. You opened a barbecue stand on January 1, 20x1. The following were the business transactions on this date: Transaction #1: Initial investment You provided P800 cash as initial investment to your business. Step #1: Transaction analysis Accounts affected: Effects on accounts: Debit / Credit:

"Cash" (asset) and "Owner's capital" (equity) Cash is increased; Owner's capital is increased. Asset is increased through debit. Equity is increased through credit

Step #2: Journal entry Your initial investment is recorded in the journal as follows: Date Jan. 1, 20x1

JOURNAL Account titles

Debit

Cash Owner’s capital To record the owner’s investment to the business

Credit 800 800

Note the parts of a journal entry: (l) Date, (2) Accounts and amounts debited and credited, and (3) Short description of the transaction.  1)

The effects of the entry above on the basic accounting equation are analyzed below: ASSETS Cash 800

= =

LIABILITIES 0

+ +

EQUITY Owner’s capital

800

Financial Accounting and Reporting

Business Transactions and their Analysis

Transaction #2: Loan The business obtained a loan of P1,200. Step#1: Transaction analysis Accounts affected: Effects on accounts: Debit / Credit:

"Cash" (asset) and ""Notes payable" (liability) Cash is increased; Notes payable is increased. Asset is increased through debit. Liability is increased through credit

Step #2: Journal entry The business loan is recorded as follows: Date Jan. 1, 20x1

JOURNAL Account titles Cash Notes payable To record loan obtained

Debit 1,200

Credit 1,200

Both the journal entries above are examples of "simple journal entries" because they have single debits and credits.  1) 2)

The effects of the entries above on the basic accounting equation are analyzed below: ASSETS Cash 800 Cash 1,200 Totals 2,000

= = =

+ 0 + Note payable 1,200 + 1,200 + LIABILITIES

EQUITY Owner’s capital

800 0 800

Observe that the equality of the basic accounting equation is maintained as each transaction is recorded. This is in accordance with the concepts of duality and equilibrium.

Transaction #3: Capital expenditures The business acquired the following for cash: Item description Cost Barbecue grill P1,000 Cooking accessories 120 Beach umbrella 400 The items acquired are considered "capital expenditures" (or "capital assets ") because they will be used for a period longer than one year. Capital expenditures are recorded as assets rather than expenses. Step#1: Transaction analysis Accounts affected:

"Equipment" (asset) and ""Cash" (asset)

Financial Accounting and Reporting

Effects on accounts: Debit / Credit:

Business Transactions and their Analysis

Equipment is increased; Cash is decreased. Asset is increased through debit and decreased through credit

Step #2: Journal entry The acquisition of equipment is recorded as follows: Date Jan. 1, 20x1

JOURNAL Account titles Equipment – barbeque grill Equipment – cooking accessories Equipment – beach umbrella Cash (1,000+120+400) To record the acquisition of equipment

Debit 1,000 120 400

Credit

1,520

Additional analyses:  Equipment (i.e., barbecue grill, cooking accessories and beach umbrella) is debited because these are the assets that the business has obtained, i.e., "value received."  Cash is credited because this is the asset given up in order to obtain the equipment, i.e., "value parted with." The journal entry above is an example of a "compound journal entry" because it has more than one debit. The effects of the entries above on the basic accounting are analyzed below: ASSETS = LIABILITIES + EQUITY 1) Cash 800 = 0 + Owner’s capital 1,200 = Note payable 1,200 + 2) Cash Equipment 3) -BBQ grill 1,000 -Cooking Accessories 120 -Beach Umbrella 400 Cash (1,520) 0 + Totals 2,000 1,200 +

800 0

0 800

Notice that the acquisition of equipment through payment of cash did not affect the total assets. This is because the transaction is recorded as an increase in one asset (i.e., increase in equipment) and simultaneously a decrease in another asset, (i.e., decrease in cash) Transaction #4: Acquisition of inventory The business purchased inventory for P480 cash. Step#1: Transaction analysis Accounts affected: Effects on accounts:

"Inventory" (asset) and ""Cash" (asset) Inventory is increased; Cash is decreased.

Financial Accounting and Reporting

Debit / Credit:

Business Transactions and their Analysis

Asset is increased through debit and decreased through credit

Step #2: Journal entry The purchase of inventory is recorded as follows: Date Jan. 1, 20x1

JOURNAL Account titles

Debit

Inventory Cash To record the acquisition of inventory

Credit 480 480

Additional analyses: Inventory is debited because this is the asset obtained, while cash is credited because this is the asset given up in order to obtain the inventory. You may also want to think of it this way:  When you purchased inventory, your inventory increased. Inventory is an asset account and recall that an asset is increased by debiting it. Therefore, to record an increase in inventory, you need to debit the inventory account.  When you paid for the inventory purchased, your cash decreased. Cash is an asset account and recall again that an asset is decreased by crediting it. Therefore, to record a decrease in cash, you need to credit the cash account.  1) 2) 3)

The effects of the entries above on the basic accounting equation are analyzed below: ASSETS Cash Cash Equipment -BBQ grill

800 1,200 1,000 120 400 (1,520) 480 (480) 2,000

= = =

LIABILITIES 0 Note payable 1,200

+ + +

EQUITY Owner’s capital

800 0

-Cooking Accessories -Beach Umbrella 4)

Cash Inventory Cash Totals

0 + 1,200 +

0 800

Remember the following:  The initial investment by an owner to the business is recorded as debit to the asset contributed (e.g., "Cash") and credit to an equity account called "Owner's capital."  Receipts of cash are debited to the "Cash" account, while payments of cash are credited to the "Cash" account. Illustration 2: Journal entries — Operation

Financial Accounting and Reporting

Business Transactions and their Analysis

Your barbecue operations started on January 2, 20x1. The following were the business transactions on this date: You opened a barbecue stand on January 1, 20x1. The following were the business transactions on this date: Transaction #5: Sale Total cash sales of the barbeque amounted to P700. The total cost of the barbecues sold is P280.. Step #1: Transaction analysis Accounts affected: Effects on accounts: Debit / Credit:

    

"Cash" (asset) and "Sales" (income); “Cost of sales” (expense) and “Inventory” (asset) Cash is increased; Sales is increased. Cost of sales is increased; Inventory is decreased. Asset is increased through debit and decreased through credit  Income is increased through credit.  Expenses is increased through debit.

Step #2: Journal entry Your sales are recorded as follows: Date Jan. 2, 20x1

JOURNAL Account titles

Debit

Cash Sales

Credit 700 700

To record total sales of barbecue.

The cost of sales is recorded as follows: Date Jan. 2, 20x1

JOURNAL Account titles Cost of goods sold Inventory To record the cost of the barbecues sold as expense.

Debit

Credit 280

Additional analyses:  "Cash" is debited to record the cash you received from the customers.

280

Financial Accounting and Reporting

  

Business Transactions and their Analysis

"Sales" is credited to record the income you earned from the sale of inventory. "Cost of goods sold" is debited to record the cost of the barbecues sold as expense. "Inventory" is credited to record the decrease in inventory due to sale.

The entry above to record the cost of goods sold is an application of the "matching concept" discussed in Unit 2. Recall that under this concept, costs that are directly associated with the earning of revenue are recognized as expenses in the same period in which the related revenue is recognized. Thus, in the transactions above, the cost of the inventory purchased is initially recorded as asset (i.e., inventory) and recognized as expense (i.e., cost of goods sold) when the inventory is sold. This way, expense is "matched" or recognized in the same period where sales revenue is recognized.  The effects of the entries above on the basic accounting equation are analyzed as follows: ASSETS Cash Cash Equipment -BBQ grill

1) 2) 3)

= = =

800 1,200

0 Note payable 1,200

+ + +

0

+

0

+

LIABILITIES

1,000 120 400 (1,520) = 480 (480) = 700 (280) = 2,420

EQUITY Owner’s capital

800 0

-Cooking Accessories -Beach Umbrella

Cash Inventory Cash Cash Inventory Totals

4) 5)

0 1,200 +

0

Sales Cost of sales

0 700 (280) 1,220

Observe that the “sales” (income) increases equity, while “cost of sales” (expense) decreases equity.



We can also use the expanded accounting equation to analyze the effects of the entries: ASSETS 2,420

= =

LIABILITIES + 1,200 +

Sal...