Module 2 - Accounting for Business Transactions PDF

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Accounting for Business Transactions...

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Chapter 2: Accounting for Business Transactions Starting points of financial statements: business transactions &events Accounting Process: Process to go from transactions & events to financial statements: 1. Identify each transactions & event from source documents 2. Analyze each transaction & event using the account equation 3. Journalizing - Record relevant transactions & events in a journal 4. Post journal information to ledger accounts 5. Prepare & analyze the trial balance & financial statements Account – record of increases & decreases in a specific asset, liability, equity, revenue, or expense. Info from accounts is analyzed, summarized, and presented in reports & financial statements Source documents identify & describe transactions & events entering the accounting system (hard copy or electronic form).  Sales receipts, checks, purchase orders, bills from suppliers, payroll records, & bank statements  Objective & reliable evidence about transactions & events & their amounts Journal – book of original entry that includes a chronological record of all transactions that have occurred within a business during a period occurred  Complete record of each transaction in one place and includes the debit and credit of each transaction General Ledger (Ledger/the books) – record of all accounts with their activity and balances used by a company (often in electronic form) Chart of Accounts – list of all ledger accounts which exist in a business & includes an identification number assigned to each account

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Preassigned numbering scheme: Accounts ordered as in the expanded accounting equation with assets first, then liabilities, equity accounts (common stock, retained earnings, and dividends), revenue accounts, and finally expense accounts Breaks in numbering system  room left to insert additional accounts

Unclassified Balance Sheet – broadly groups accounts into assets, liabilities, and equity

Trial Balance – list of each account from the ledger and its debit & credit balances in separate columns at any given time  Used to verify that debits = credits  Summary of the ledger’s contents, NOT a financial statement  Forms bases of preparing formal financial statement, balance sheet, income statement, and statement of retained earnings  Useful for revealing recordkeeping errors Asset Accounts Cash Accounts Receivable Notes Receivable Inventory Prepaid Accounts Supplies Investment in Land Equipment Buildings Land Patents

Increased by Debit Debit Debit Debit Debit Debit Debit Debit Debit Debit Debit

Liability Accounts Accounts Payable Short-Term Notes Payable Unearned Revenue Accrued Liabilities Long-Term Notes Payable

Increase d by Credit Credit Credit Credit Credit

Equity Accounts Common Stock Dividends Revenues Expenses

Increased by Credit Debit Credit Debit

Debits & Credits A T-account represents a ledger account & is used to show the effects of one or more transactions (plus & minuses are not used in a T-account)

 Left side  debit side (Dr) o Debits increase assets, expenses, & dividends o Debits decrease liabilities, common stock, and revenues 

Right side  credit side (Cr) o Credits decrease assets, expenses, & dividends o Credits increase liabilities, common stock, and revenues

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Difference b/t total debits & total credits for an account (including any beginning balance) is the account balance o Total debits > total credits: debit balance o Total credits > total debits: credit balance o Total debits = total credits: zero balance

Double-Entry Accounting demands the accounting equation remain in balance, which means that for each transaction: 1. At least 2 accounts are involved, w/ at least 1 debit & 1 credit 2. Total amount debited must equal total amount credited   

Net increases or decreases on 1 side have equal net effects on the other side Left side is the normal balance side for assets dividends, and expenses Right side is the normal balance side for liabilities, common stock, and revenues (equity)

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Equity increases from revenues & owner investments (stock issuances), and it decreases from expenses & dividends Increases (credits) to common stock & revenues increase equity; increases (debits) to dividends & expenses decrease equity

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A debit or credit can increase or decrease an account, depending on the account A credit will always decrease an asset account A debit can increase an expense account For an account where a debit is an increase, the credit is a decrease

Step 2 of Accounting Process: Analyzing transactions utilizes 4 steps: Example – on Dec 31, company provides consulting services & bills its customer $3,000 for services 1. Identify: The company has accounts receivable for $3,000 in exchange for consulting revenue 2. Analyze: Assets Accounts receivable + $3,000

=

Liabilities

=

+

Equity Consulting Revenue + $3,000

3. Record: Cash is debited, and common stock credited by $15,000 each (recorded in journal) No. Date General Journal Debit Credit 1 Dec 31 Accounts receivable 3,000 Consulting revenue 3,000 4. Post: entry posted to general ledger Accounts receivable (1) 3,000

using T-accounts Consulting revenue (1) 3,000

The owner invests $15,000 cash in the business in exchange for common stock 1. Identify: The company exchanges $15,000 cash for common stock 2. Analyze: infusion of cash increases cash by $15,000 and equity by $15,000. Equation is still balanced Assets = Liabilities + Equity Cash Common Stock + $15,000 = + $15,000 3. Record: Cash is debited, and common stock credited by $15,000 each (recorded in journal) Dr. Cr. Cash 15,000 Common Stock 15,000 4. Post: entry posted to from journal to accounts Cash (2) 15,000

general ledger using TCommon Stock (1)

15000

Step 3 of Accounting Process: Journalizing (recording transactions in a journal)

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Journal entries - Individual entries in journal Compound journal entry – there is more than 1 debit or credit Companies can use various journals, but every company uses a general journal and can be used to record any transaction that is not accounted for in another journal Steps of journalizing: 1. Date transaction  Enter year at the top of the first column and enter the month & day on the first line of each journal entry 2. Enter titles of accounts debited, and then enter amounts in the Debit column on the same line  Debited account titles are taken from the chart of accounts & are aligned with the left margin of the Account Titles and Explanation column 3. Enter titles of accounts credited and the enter amounts  Credited account titles are taken from the chart of accounts & are indented with the left margin of the Account Titles and Explanation column to distinguish them from debited accounts 4. Enter brief explanation of the transaction on the line below the entry

 Indented about half as far as the credited account titles Step 4 of Accounting Process: Posting from Journal to Ledger Accounts

Balance column accounts: different formatting of T-accounts used in a ledger for actual accounting systems that need more structure  An abnormal balance is identified by writing it in red or setting it in brackets  A zero balance for an account is usually shown by writing zeros or a dash in the balance column  Immediately after posting a transaction, the balance of the account is written in the Balance column  Heading of the Balance column - does not show if it is debit or credit balance.  Account is assumed to have a normal balance. o An abnormal balance is a balance on the side where decreases are recorded  When a transaction is 1st recorded, the posting reference (PR) column is left blank. Later, when posting entries to the ledger, the identification numbers of the individual ledger accounts are entered in the PR column  Posting process does NOT require detailed explanations in the ledger  Entries are posted as soon as possible and must be posted to the ledger before financial statements are prepared  Posting process creates a link b/t the ledger and the journal

Step 5 of Accounting Process: Trial Balance

1. Each account from the general ledger is listed along with the balance in each account 2. Order of accounts presented in the general ledger and trial balance: assets, liabilities, equity, revenue, and then expenses  same order accounts appear in formal financial statement 3. Debit & credit columns are totaled to ensure the books are in balance  equality does not guarantee errors will not be made  Ex  column totals are still equal when a debit or credit of a correct amount is made to the wrong account  Another error  when equal debits & credits of an incorrect amount are entered Balance Sheet, Statement of Retained Earnings, Income Statement, and Statement of Cash Flows: use data from the trial balance (and other financial statements) for their preparation

1. Income Statement – first financial statement prepared because the “bottom line” aka the net income or net loss for the period is then used to prepare the statement of retained earnings  Calculates the results of operations for the specific time-period (year, month, quarter) for which it is prepared

2. Statement of Retained Earnings – reports information about how equity changes over the reporting period

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The net income from the income statement is now brought forward; any dividends are subtracted to arrive at the end-of-period retained earnings balance End-of-period balance is carried forward to the balance sheet (mechanics of how the net income or net loss is “absorbed” into the balance sheet)

3. Balance Sheet – reports the financial position of a company at a given point in time (at the close of business on a specified date), usually at the end of a month, quarter, or year.

 Must be prepared after the statement of retained earnings  w/out having prepared the income statement, which feeds into the statement of retained earnings, the balance sheet would NOT balance  Left side of balance sheet – lists assets, supplies, prepaid insurance, and equipment o Assets = liabilities + equity

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Upper ride side – shows that it owes $6,200 to creditors & $3,000 in services to customers who paid in advance Equity section – revenues & expenses will change the equity account o Shows an ending balance of $33,270 (notice link b/t the ending balance of the statement of retained earnings & the retained earning balance on balance sheet)

4. Statement of Cash Flows Asset Accounts: 1. Cash accounts show a company’s cash balance  All increases & decreases in cash are recorded in this account  Includes money & any funds that a bank accepts for deposit (coins, checks, money orders, & checking account balances) 2. Accounts receivable are held by a seller and are promises of payment from customers to sellers  Increased by credit sales or sales on account (or on credit)  Decreased by customer payments  All increases & decreases in receivables recorded in this account  Multiple customers  separate records are kept for each & are titled Accounts Receivable – “Customer Name” 3. Note receivable (promissory note) is a written promise of another entity to pay a specific sum of money on a specified future date to the holder of the note  Holder has an asset recorded in a Note (or Notes) Receivable account 4. Prepaid accounts (or prepaid expenses) are assets from prepayments of future expenses (expenses expected to be incurred in future accounting periods)  When expenses are later incurred, amounts in prepaid accounts are transferred to expense accounts  Prepaid insurance, prepaid rent, and prepaid services  Expire w/ passage of time (rent) or through use (prepaid meal plans)  When financial statements prepared  expired & used prepaid accounts recorded as expenses & unexpired and unused recorded as assets (reflecting future benefits) 5. Supplies (assets until they are used) accounts – where unused supplies are recorded  When supplies used up  theirs costs reported as expenses  Supplies grouped by purposes (office supplies & store supplies) 6. Equipment (asset) accounts  When equipment is used/wears down  cost gradually reported as an expense (depreciation)  Grouped by purpose (office equipment & store equipment) 7. Business accounts  Buildings are assets because they provide expected future benefits  When used/wear down  cost reported as expense (depreciation)  Several buildings owned  separate accounts sometimes kept for each of them

 Cost of buildings located on land is separately recorded in building accounts NOT land accounts 8. Land accounts record the cost of land Equity Accounts (equity of business is based on what the shareholders invent into the business less what is paid to them as dividends + revenue earned – expenses made) 1. Common Stock 2. Dividends 3. Revenues 4. Expenses Revenue Recognition Principle: revenue should always be recorded in the period in which the service is performed, or product is sold. The actual cash payment may be received before (unearned revenue) or after the period (accounts receivable) in which the revenue is earned

Chapter 3: Adjusting Accounts for Financial Statements Timing & Reporting Time Period Assumption: presumes that an organization’s activities can be divided into specific time periods such as a month, a three-month quarter, a six-month interval, or a year. Accrual Basis Accounting: records revenues when services and products are delivered and records expenses when incurred (matched with revenues)  An accounting system that uses the matching principle to determine when to recognize revenues & expenses  Consistent with GAAP  Uses the adjusting process to recognize revenues when earned and expenses when incurred Revenue Recognition Principle: revenue should always be recorded in the period in which the service is performed, or product is sold. The actual cash payment may be received before (unearned revenue) or after the period (accounts receivable) in which the revenue is earned Expense Recognition Principle: expenses be recorded in the same accounting period as the revenues that are recognized as a result of those expenses Three-Step Process for Adjusting Entries: 1. Determine what the current account balance equals 2. Determine what the current account balance should equal 3. Record an adjusting entry to get from step 1 to step 2 Unadjusted Trial Balance: list of accounts and balances before adjusting entries have been recorded and posted to the ledger

Adjusted Trial Balance: list of accounts and balances after adjusting entries have been recorded and posted to the ledger  We can prepare financial statements directly from the information in the adjusted trial balance  Revenue and expense balances are transferred from the adjusted trial balance to the income statement  Generally, has more accounts listed than the unadjusted trial balance Steps involved in adjusting entries: 1. Prepare an unadjusted trial balance 2. Journalize and post adjusting entries 3. Prepare an adjusted trial balance 4. Prepare financial statements Preparing Financial Statements Closing process (occurs at the end of an accounting period after financial statements are completed) 1. Identify accounts for closing 2. Record and post the closing entries 3. Prepare a post-closing trial balance 

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Two purposes: (1) Resets revenue, expense, and dividends account balances to zero at the end of each period (updates the Retained Earnings account for inclusion on the balance sheet) so these accounts can properly measure income & dividends for the next period. (2) Helps summarize a period’s revenues & expenses Applies only to temporary accounts

Temporary accounts relate to one accounting period.  Include all income statement accounts, the dividends account, and the Income Summary account.  Opened at the beginning of a period, used to record transactions & events for that period, and then closed at the end of the period Permanent accounts report on activities related to 1 or more future accounting periods.  Include asset, liability, and equity accounts (all balance sheet accounts).  Not closed each period & carry their ending balance into future periods Closing entries transfer the end-of-period balances in revenue, expense, and dividends accounts to the permanent Retained Earnings account.  Necessary at the end of each period after financial statements are prepared Post-closing trial balance is a list of permanent accounts and their balances from the ledger after all closing entries have been journalized & posted (lists balances for all accounts not closed)  Verifies that (1) total debits = total credits for permanent accounts & (2) all temporary accounts have zero balances

Accounting Cycle: steps (for adjusting and closing accounts) in preparing financial statements where the steps are repeated each reporting period.  Steps 1-3 occur regularly as a company enters into transactions.  Steps 4-9 are done at the end of a period

Unclassified Balance Sheet: broadly groups accounts into assets, liabilities, and equity (FastForward’s balance sheet) Classified Balance Sheet: organizes assets and liabilities into subgroups  Important classification - separation between current (expected to come due, either collected or owed, within 1 year or the company’s cycle, whichever is longer) & noncurrent for both assets & liabilities  Operating cycle - time span from when cash is used to acquire goods & services until cash is received from the sale of goods and services. Most are < 1 year (most companies use a one-year period to classify current ad noncurrent items) o Assume an operating cycle of one year unless otherwise stated Assets Current Assets (accounts receivable, cash)

Liabilities & Equity Current Liabilities (taxes payable, unearned rent, notes payable due in 3 months, accounts payable) Noncurrent Liabilities Long-Term Liabilities

Noncurrent Assets Long-Term Investments (bonds, land held, notes rec. due in 2 years) Plant Assets (equipment) Equity Intangible Assets (Franchise) *Current assets & current liabilities listed before noncurrent & in order of how quickly they will be converted to, or paid in, cash *Long-term investments (noncurrent investments) examples are notes receivables & stock and bond investments that are expected to be held for more than 1 year Profit Margin (Return on Sales): ratio of net income to net sales and is a useful measure of a company’s operating results. Shows the percent of profit in each dollar of sales.

Asset that is NOT depreciated  Land The difference between the cost of an asset and the accumulated depreciation for that asset  Book Value Order that financial statements are typically prepared in: 1. Income Statement 2. Statement of Retained Earnings 3. Balance Sheet Supplies: Count supplies at period-end and make an adjusting entry Example: Company purchased $9,720 of supplies in December, some of which were used during that same month. When financial statements are prepared at December 31, the cost of supplies used during December is expensed. Supplies Dec. 2, 6, 26 Purchase supplies & record asset Dec. 31 Physical count remaining unused After counting  found that $8,670 of supplies remaining of the $9,720 total supplies supplies Dec. 31 Record expense Supply expense = 9,720 – 8,670 = $1,050 Adjusting entry to record this expense and reduce the Supplies asset account, along with T-account postings: Adjustment Dec. 31 Supplies Expense…… ………………….1,05 0 Supplies…… ………………………. ………………… … 1,050 Record supplies used

Dec. 2 6 26 Balance

Supplies 2,500 Dec. 31 7,100 120 8,670

1,050

Dec.3 1

Supplies Expense 1,050

Depreciation: Depreciation expense is recorded wit...