IFF_L3.pptx
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The Double-Entry System
Measurement Issues • Objective 1 – Explain, in simple terms, the generally accepted ways of solving the measurement issues of recognition, valuation, and classification 2– 2
Measuring Business Transactions Once accountants have determined a transaction has occurred, they must decide • When the transaction occurred – The recognition issue • What value to place on the transaction – The valuation issue • How to categorize the components of the transaction – The classification issue 2– 3
Measurement Issues Recognition issue Valuation issue Classification issue • These issues underlie almost every major decision in financial accounting • Controversies exist; solutions are not cut and dried 2– 4
The Recognition Issue • Recognition means the recording of a transaction • Refers to the difficulty of deciding when a business transaction occurred • Point of recognition is important because it affects the financial statements 2– 5
Point of Recognition for Sales and Purchases • Sales and purchases of products – Usually recognized when title of property transfers – Or, may set up a recognition point • Predetermined time at which a transaction should be recorded • Sales and purchases of services – Usually recognized when services have been performed – If services are performed over a long period of time, may set up billing at specific points of time • Transaction recorded at each billing 2– 6
Business Event versus Business Transaction • Business Event – Any occurrence related to the course of running a business • Business Transaction – Economic event that affects the financial position of a business entity 2– 7
Business Events That … Are Not Transactions • Customer inquires about a service • Ordering products from suppliers Are Transactions • Customer buys a service • Receiving products previously ordered • Hiring new employees • Paying employees for work performed 2– 8
The Valuation Issue • Focuses on assigning a monetary value to a transaction • Most controversial issue in accounting • According to GAAP, use original cost – Also called historical cost • Practice of recording transactions at cost follows the cost principle 2– 9
Cost Principle • The principle that a purchased asset should be recorded at its actual cost – Cost • Exchange price associated with a business transaction at the point of recognition – Exchange price • Amount a buyer is willing to pay and a seller is willing to receive • Is objective (not influenced by emotion or personal feelings) • Cost principle is used because cost is verifiable 2– 10
Applying the Cost Principle 1. Company A purchases building for $80, 000 Company A • Records purchase of building at original cost (exchange price) of $80, 000 2. Company A offers same building for sale for $120, 000 3. Company A sells building to Company B for $110, 000 Company A • Records sale of building at sales price (exchange price) of $110, 000 and profit or loss is recognized Company A Company B • Records purchase of building at cost (exchange price) of $110, 000 Company B Only amounts involved in business transactions (exchanges of value) are recorded in the company books
Analyzing Information • Recall - the cost principle requires that a purchased asset is recorded at its actual cost, or the exchange price • Exchange price –The amount a buyer is willing to pay and a seller is willing to receive for an exchange of value –Is objective (not influenced by emotion or personal feelings) 2– 12
The Classification Issue • Classification is the process of assigning transactions to the appropriate accounts • Proper classification depends on – Correctly analyzing the effect of each transaction on the business – Maintaining a system of accounts that reflects that effect • The classification issue refers to the uncertainties associated with assigning transactions to the appropriate accounts 2– 13
Discussion Q. What three issues underlie most accounting decisions? 1. The recognition issue • When a transaction should be recorded 2. The valuation issue • What value should be placed on the transaction 3. The classification issue • How the components should be categorized 2– 14
Accounts and the Chart of Accounts • Objective 2 – Describe the chart of accounts and recognize commonly used accounts 2– 15
Accounts • Used to record transaction data – Record data in a usable form – Data can be quickly retrieved • Separate account used for each – Asset – Liability – Component of owner’s equity (includes revenues and expenses) 2– 16
General Ledger • Group of company accounts • Sometimes simply referred to as the ledger • Two types of systems – Manual system • Each account on separate page or card • Pages or cards placed together in book or file – Computerized system • Accounts maintained on magnetic tapes or disks 2– 17
Chart of Accounts • List of account numbers with corresponding account names • Helps identify accounts in the ledger First digit in account number refers to major financial statement classification – – – Assets Liabilities Owner's equity Revenues Expenses 2– 18
Example of Account Numbering 1000 - 1999: asset accounts 2000 - 2999: liability accounts 3000 - 3999: equity accounts 4000 - 4999: revenue accounts 5000 - 5999: cost of goods sold 6000 - 6999: expense accounts 7000 - 7999: other revenue (for example, interest income) 8000 - 8999: other expense (for example, income taxes) 2– 19
Owner's Equity Accounts • Revenue and expense accounts separated from other owner's equity accounts • Important for legal and financial reporting purposes – Owner's equity accounts represent how much interest in the assets of a company the owner has – Law requires that Capital and Withdrawal accounts be separate from revenues and expenses for tax and financial reporting – Management needs a detailed breakdown of revenues and expenses for budgeting and operating purposes 2– 20
Account Titles • Should describe what is recorded in the account • An account name can be analyzed to understand its purpose – Identify account’s classification as asset, liability, owner's equity, revenue, or expense – Identify the type of transaction that gave rise to the account • Different companies may use different account names for the same account 2– 21
Discussion Q. What is an account? A. Account • Means by which management accumulates the effects of transactions • Basic storage unit for accounting data Q. How is an account related to the ledger? A. The ledger is a file or book in which the company’s accounts are kept 2– 22
The Double-Entry System: The Basic Method of Accounting • Objective 3 – Define double-entry system and state the rules for double entry 2– 23
Double-Entry System • Based on principle of duality – Every economic event has two aspects that balance, or offset, each other – The two aspects represent • Effort and reward • Sacrifice and benefit • Source and use Example: Pay cash to purchase supplies Cash paid = effort, sacrifice, source Supplies received = reward, benefit, use 2– 24
Principle of Duality • Each transaction recorded with at least one debit and one credit • Total amount of debits = total amount of credits • Whole system always in balance • All accounting systems based on principle of duality 2– 25
The T Account Three parts 1. A title that describes the account 2. A left side, called the debit side 3. A right side, called the credit side Title of Account Debit (left) side Credit (right) side 2– 26
The T Account Illustrated • In Chapter 1, Shannon Realty had several transactions that affected the Cash account • Transactions can be summarized in T accounts – Record cash receipts (increases) on debit (left) side – Record cash payments (decreases) on credit (right) side Title of Account Cash Debit (left) side Cash Receipts (+) Credit (right) side Cash Payments (–) 2– 27
Shannon Realty 1. Deposited $50, 000 in a bank account in the name of Shannon Realty 2. Purchased a lot for $10, 000 and a small building on a lot for $25, 000 3. Purchased office supplies for $500 on credit 4. Paid $200 of the $500 owed for supplies 5. Earned and received a commission of $1, 500 in cash Cash (1) Debit 50, 000 (left) side (5) 1, 500 Credit 35, 000 (right) side (4) 200 (2) Transaction 3 does not affect the Cash account
Shannon Realty (cont’d) 6. A $2, 000 commission is earned, to be received later 7. Received $1, 000 from client for commission earned earlier in the month 8. Paid $1, 000 to rent equipment for office 9. Paid $400 in wages to part-time helper 10. Liability of $300 for utilities expense is recorded 11. Owner withdrew $600 in cash for personal use Cash Credit 35, 000 (right) side (4) 200 (1) Debit 50, 000 (left) side (5) 1, 500 (2) (7) (8) 1, 000 (9) 400 (11) 600 1, 000 Transaction 6 does not affect the Cash account Transaction 10 does not affect the Cash account 2– 29
Footings and the Account Balance • Footings – Working totals of columns – Calculated at end of each month • Account balance – Difference between total debit footing and total credit footing – Also simply called the balance – Debit balance recorded on left side of T account – Credit balance recorded on right side of T account 2– 30
Footings and the Account Balance (cont’d) Total the debit side of the T account (1) (5) (7) Total Debit Footing Cash 50, 000 (2) 1, 500 (4) 1, 000 (8) (9) (11) 52, 500 Bal. Total the credit side of the T account 35, 000 200 1, 000 400 600 37, 200 Total Credit Footing 15, 300 Debit Account Balance ($52, 500 - $37, 200) 2– 31
Analyzing and Processing Transactions • Rules of double-entry bookkeeping 1. Every transaction affects at least two accounts • At least one account is debited and at least one account is credited 2. Total debits must equal total credits • For each transaction • For whole system (all accounts as a group) 2– 32
Keeping the Accounting Equation in Balance Assets = Liabilities + Owner's Equity Cash Capital +500 Cash – 250 = Accounts Payable – 250 Wages Payable Wages Expense +100 – 100 • For the accounting equation to stay in balance, each transaction must – Increase both sides of equal sign by same amount – Decrease both sides of equal sign by same amount – Increase and decrease one side of equal sign by same amount 2– 33
Accounts and the Accounting Equation Assets Credit Debit for Increases Decreases (–) (+) = Liabilities Debit Credit for Decreases Increases (–) (+) + Owner's Equity Debit Credit for Decreases Increases (–) (+) Assets increase with debits Liabilities and owner's equity increase with credits Assets decrease with credits Liabilities and owner's equity decrease with debits 2– 34
Accounts and the Accounting Equation (cont’d) Assets = 500 1, 000 1, 500 Liabilities + 500 = 500 Owner's Equity 1, 000 + 1, 000 If a debit increases assets a credit must increase liabilities or owner's equity for the accounting equation to remain in balance 2– 35
Accounts and the Accounting Equation (cont’d) Assets = Liabilities 500 1, 000 + 500 250 1, 500 Owner's Equity = 750 250 1, 000 750 + 250 If a credit increases liabilities a debit must decrease liabilities or owner's equity for the accounting equation to remain in balance 2– 36
Components of Owner's Equity • Capital • Withdrawals • Revenues • Expenses 2– 37
Effects of Withdrawals, Revenues, and Expenses on Owner's Equity Capital – Withdrawals + Revenues – Expenses – Withdrawals • Withdrawals and expenses decrease owner's equity – Transactions that increase withdrawals or expenses decrease owner's equity • Revenues increase owner's equity – Transactions that increase revenues increase owner's equity 2– 38
Expanding the Accounting Equation Now that the components of owner's equity have been identified Capital – Withdrawals + Revenues – Expenses And their effects on owner's equity are understood The accounting equation can be expanded to include these components Assets = Liabilities + Owner's Equity 2– 39
Rearranging the Accounting Equation Assets = Liabilities + Capital – Withdrawals + Revenues – Expenses Because Withdrawals and Expenses are deductions from owner's equity, move them to the left side of the equation Assets + Withdrawals + Expenses = Liabilities + Capital + Revenues Accounts increased by debits = Accounts increased by credits 2– 40
Analyzing and Processing Transactions 1. Analyze the transaction – Transactions are supported by source documents – Determine accounts to use and effects of transaction on accounts 2. Apply the rules of double entry – Debits increase assets and decrease liabilities and owner's equity – Credits decrease assets and increase liabilities and owner's equity 2– 41
Analyzing and Processing Transactions (cont’d) 3. Record the entry – Record in chronological order in a journal 4. Post the entry – Transfer dates and amounts from journal to proper accounts in ledger 5. Prepare the trial balance – Confirms that accounts are still in balance 2– 42
Recording a Transaction in Journal Form 1. Date 2. Debit account and debit amount recorded on one line 3. Credit account and credit amount recorded on next line, indented Dr. June 1 Cash Notes Payable Cr. 100, 000 2– 43
Posting Journal Entry to Accounts Journal Dr. June 1 Cash Cr. 100, 000 Notes Payable 100, 000 Ledger Cash June 1 100, 000 Notes Payable June 1 100, 000 2– 44
Discussion Q. Why do debits, which decrease owner's equity, also increase withdrawals and expenses, which are components of owner's equity? A. Withdrawals and expenses are deductions from owner’s equity Owner's equity is decreased by debits Assets = Liabilities + Capital – Withdrawals + Revenues – Expenses + – – + Debit ↓ Cap ↓ OE ↑ Div ↓ OE ↓ Rev ↓ OE ↑ Exp ↓ OE Transactions that increase withdrawals and expenses decrease owner's equity 2– 45
Transaction Analysis Illustrated • Objective 4 – Apply the steps for transaction analysis and processing to simple transactions 2– 46
Investment in Company Business July 1: Joan Miller invests $20, 000 to start her own Transaction advertising agency Step 1 Analyze Increase in assets Increase in owner’s equity Step 2 Apply rules Debits increase assets (Cash) Credits increase owner’s equity (Joan Miller, Capital) Step 3 Record 2– 47
Cash Accts. Receivable Prepaid Insurance Art Supplies Art Equipment Office Supplies Assets Step 4 Post Office Equipment Debit Cash 20, 000 Credit Joan Miller, Capital 20, 000 Accts. Payable Unearned Art Fees Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense Owner's Equity + Liabilities = Prepaid Rent 2– 48
Purchase Assets Business July 2: Rents office and pays two months’ rent in Transaction advance, $1, 600 Step 1 Analyze Increase in assets Decrease in assets Step 2 Apply rules Debits increase assets (Prepaid Rent) Credits decrease assets (Cash) Step 3 Record 2– 49
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Debit Prepaid Rent 1, 600 Credit Cash 1, 600 + Liabilities = Prepaid Rent Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 50
Purchases Business July 3: Purchases art equipment for cash, $4, 200 Transaction Step 1 Analyze Increase in assets Decrease in assets Step 2 Apply rules Debits increase assets (Art Equipment) Credits decrease assets (Cash) Step 3 Record 2– 51
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Debit Art Equipment 4, 200 Credit Cash 4, 200 + Liabilities = Prepaid Rent Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 52
Purchases Business July 4: Orders art supplies, $1, 800, and office Transaction supplies, $800 Step 1 Analyze No entry because transaction has not occurred Step 2 Apply rules Step 3 Record 2– 53
Purchases Business July 5: Purchases office equipment, $3, 000. Pays Transaction $1, 500 in cash and the remaining amount on credit Step 1 Analyze Increase in assets Decrease in assets Increase in liabilities Step 2 Apply rules Debits increase assets (Office Equipment) Credits decrease assets (Cash) Credits increase liabilities (Accounts Payable) Step 3 Record 2– 54
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment = Prepaid Rent Debit Office Equipment 3, 000 Credit Cash 1, 500 Accts. Payable 1, 500 Unearned Art Fees Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense Owner's Equity + Liabilities Accts. Payable 2– 55
Purchases July 6: Purchases art supplies, $1, 800, and office Business Transaction supplies, $800, on credit Step 1 Analyze Increase in assets Increase in liabilities Step 2 Apply rules Debits increase assets (Art Supplies and Office Supplies) Credits increase liabilities (Accounts Payable) Step 3 Record 2– 56
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment = Prepaid Rent Debit Art Supplies 1, 800 Office Supplies 800 Credit Accts. Payable 2, 600 Unearned Art Fees Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense Owner's Equity + Liabilities Accts. Payable 2– 57
Purchase Assets July 8: Pays for one-year life insurance policy, Business Transaction effective July 1, $960 Step 1 Analyze Increase in assets Decrease in assets Step 2 Apply rules Debits increase assets (Prepaid Insurance) Credits decrease assets (Cash) Step 3 Record 2– 58
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Liabilities = Prepaid Rent Debit Prepaid Insurance 960 + Credit Cash 960 Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 59
Partial Payment of Liability Business July 9: Pays Taylor Supply Company $1, 000 of Transaction amount owed Step 1 Analyze Decrease in liabilities Decrease in assets Step 2 Apply rules Debits decrease liabilities (Accts. Payable) Credits decrease assets (Cash) Step 3 Record 2– 60
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Liabilities = Prepaid Rent Debit Accts. Payable 1, 000 + Credit Cash 1, 000 Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 61
Revenues Business July 10: Performs service by placing Transaction advertisements and collects fee of $1, 400 Step 1 Analyze Increase in assets Increase in owner’s equity Step 2 Apply rules Debits increase assets (Cash) Credits increase owner’s equity (Advertising Fees Earned) Step 3 Record 2– 62
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Liabilities = Prepaid Rent Debit Cash 1, 400 + Credit Ad. Fees Earned 1, 400 Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 63
Expenses Business July 12: Pays secretary two weeks’ wages, $1, 200 Transaction Step 1 Analyze Decrease in owner’s equity (increase in expenses) Decrease in assets Step 2 Apply rules Debits decrease owner’s equity (increase Wages Expense) Credits decrease assets (Cash) Step 3 Record 2– 64
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Liabilities = Prepaid Rent Debit Wages Expense 1, 200 + Credit Cash 1, 200 Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 65
Revenue July 15: Accepts advance fee for artwork to be Business done for another agency, $1, 000 Transaction (Payment received for future services) Step 1 Analyze Increase in assets Increase in liabilities Step 2 Apply rules Debits increase assets (Cash) Credits increase liabilities (Unearned Art Fees) Step 3 Record 2– 66
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Liabilities = Prepaid Rent Debit Cash 1, 000 + Credit Unearned Art Fees 1, 000 Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 67
Revenue July 19: Performs advertising service for which Business payment will be collected at later date, $4, 800 Transaction (Revenue earned, to be received later) Step 1 Analyze Increase in assets Increase in owner's equity (revenues) Step 2 Apply rules Debits increase assets (Accounts Receivable) Credits increase owner's equity (Advertising Fees Earned) Step 3 Record 2– 68
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Liabilities = Prepaid Rent Debit Accts. Receivable 4, 800 + Credit Ad. Fees Earned 4, 800 Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 69
Expenses Business July 26: Pays secretary two more weeks’ wages, Transaction $1, 200 Step 1 Analyze Decrease in owner's equity (increase in expenses) Decrease in assets Step 2 Apply rules Debits decrease owner's equity (increase Wages Expense) Credits decrease assets (Cash) Step 3 Record 2– 70
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Liabilities = Prepaid Rent Debit Wages Expense 1, 200 + Credit Cash 1, 200 Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 71
Expenses Business July 29: Receives and pays utility bill, $200 Transaction Step 1 Analyze Decrease in owner's equity (increase in expenses) Decrease in assets Step 2 Apply rules Debits decrease owner's equity (increase Utilities Expense) Credits decrease assets (Cash) Step 3 Record 2– 72
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Accts. Payable Unearned Art Fees Liabilities = Prepaid Rent Debit Utilities Expense 200 + Credit Cash 200 Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 73
Expenses July 30: Receives (but does not pay) telephone bill, Business $140 Transaction (Expense incurred, to be paid later) Step 1 Analyze Decrease in owner's equity (increase in expenses) Increase in liabilities Step 2 Apply rules Debits decrease owner's equity (increase Telephone Expense) Credits increase liabilities (Accts. Payable) Step 3 Record 2– 74
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment Unearned Art Fees 140 + Debit Telephone Exp. Credit Accts. Payable Liabilities = Prepaid Rent Owner's Equity Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense 2– 75
Withdrawals July 31: Joan Miller withdraws $1, 400 from the Business Transaction business for personal living expenses Step 1 Analyze Decrease in owner's equity Decrease in assets Step 2 Apply rules Debits decrease owner's equity (increase Joan Miller, Withdrawals) Credits decrease assets (Cash) Step 3 Record 2– 76
Cash Prepaid Insurance Art Equipment Office Supplies Assets Accts. Receivable Art Supplies Step 4 Post Office Equipment = Prepaid Rent Debit Joan Miller, Withdrawals 1, 400 Credit Cash 1, 400 Unearned Art Fees Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense Owner's Equity + Liabilities Accts. Payable 2– 77
Discussion Q. Why does Joan Miller record the expense for the telephone bill even though she hasn’t paid it yet? – An expense has been incurred for telephone services used – An obligation to pay exists – Joan Miller records the expense and the liability for the telephone service 2– 78
The Trial Balance • Objective 5 – Prepare a trial balance and describe its value and limitations 2– 79
The Trial Balance • For every amount debited, an equal amount must be credited – Result: The total of debits and credits for all the T accounts must be equal • Trial balance is prepared to test this – Usually prepared at the end of a month or an accounting period – Can be prepared anytime 2– 80
Normal Account Balances • Normal balance means usual balance • Refers to whether increases in the accounts are made with debits or credits – Accounts that are increased with debits have a normal debit balance – Accounts that are increased with credits have a normal credit balance • An account may have an “abnormal” balance – Copy into the trial balance as it stands 2– 81
Normal Account Balances and the Accounting Equation Recall the basic accounting equation: Assets = Liabilities + Owner's Equity Debit Credit (+) (–) Debit Credit (–) (+) • Assets are increased by debits • Liabilities and owner's equity are increased by credits 2– 82
Normal Account Balances and the Accounting Equation (cont’d) However, when the basic accounting equation is expanded to include all the components of owner's equity, Assets = Liabilities + Capital – Withdrawals + Revenues – Expenses + – – + + – We see that Withdrawals and expense accounts reduce owner's equity 2– 83
Normal Account Balances and the Accounting Equation (cont’d) Withdrawals and expenses can be moved to the left side of the equation so that Assets + Withdrawals + Expenses + – + – = Liabilities + Capital + Revenues – + – + Accounts increased by debits Accounts increased by credits Accounts with a normal debit balance Accounts with a normal credit balance 2– 84
Steps in Preparing a Trial Balance 1. List each T account that has a balance – Record debit balances in the left column – Record credit balances in the right column – List accounts in the order that they appear in the ledger 2. Add each column 3. Compare the column totals – Total debits should equal total credits 2– 85
Joan Miller Advertising Agency 1. Determine the T account balances for Joan Miller Advertising Agency – Use footings 2. Transfer account balances to the trial balance 3. Total each column 4. Compare column totals 2– 86
Cash Art Equipment Office Supplies Assets Prepaid Insurance Art Supplies Office Equipment = Prepaid Rent 1. Determine account balances Unearned Art Fees Joan Miller, Capital Advertising Fees Earned Wages Expense Joan Miller, Withdrawals Utilities Expense Telephone Expense + Liabilities Accts. Payable Owner's Equity Joan Miller Advertising Agency Accts. Receivable 2– 87
Trial Balance Record debit balances in the left column Record credit balances in the right column Add each column The trial balance proves the ledger is in balance Total debits = Total credits 2– 88
Trial Balance (cont’d. ) • The trial balance proves whether or not the ledger is in balance – Total of all debits recorded = Total of all credits recorded • What it does not do – Prove that all transactions were analyzed correctly – Prove that amounts were recorded in the proper accounts – Detect whether transactions have been omitted – Detect errors of the same amount made in both a debit and a credit 2– 89
Detecting Errors in the Trial Balance • If the debit and credit columns are not equal, look for the following errors – A debit entered as a credit, or visa versa – An incorrectly computed account balance – Error in carrying the account balance to the trial balance – Trial balance summed incorrectly 2– 90
Detecting Errors in the Trial Balance (cont’d) • If trial balance is out of balance by an amount divisible by 2 – Caused by recording an account with a debit balance as a credit, or visa versa • If trial balance is out of balance by an amount divisible by 9 – Caused by transposing two numbers when transferring an amount to the trial balance 2– 91
Discussion Q. Does the trial balance detect whether transactions have been omitted? A. No. The trial balance proves whether or not the ledger is in balance (total debits = total credits). It does not 1) Prove that all transactions were analyzed correctly 2) Prove that amounts were recorded in the proper accounts 3) Detect whether transactions have been omitted 4) Detect errors of the same amount made in both a debit and a credit 2– 92
Recording and Posting Transactions • Objective 6 – Record transactions in the general journal and post transactions from the general journal to the ledger 2– 93
The General Journal • Why aren’t transactions entered directly into the accounts? – Since the debit is recorded in one account and the credit in another, it would be very difficult to • Identify individual transactions • Find errors • Solution – Record all transactions chronologically in a journal 2– 94
Journalizing … is the process of recording transactions • General journal is the simplest and most flexible – Also called book of original entry • Separate journal entry records each transaction 2– 95
Journalizing Transactions Business July 6: Purchase art supplies, $1, 800, and office Transaction supplies, $800, on credit Record in Journal 1. The date 2. Names of accounts debited and dollar amounts on same lines in debit column 3. Names of accounts credited (indented) and dollar amounts on same lines in credit column 4. Explanation of transaction 5. Account identification numbers, if appropriate 15– 96
Journalizing Transactions (cont. ) Business July 8: Pays for one-year life insurance policy, Transaction effective July 1, $960 Skip a line between each entry • A compound entry has more than one debit or credit entry • The July 6 entry is a compound entry because it has two debit entries 2– 97
General Ledger • Used to record the details of each transaction • Used to update each account • T account is a simple, direct form • In practice, the ledger account form is used • Advantage of ledger account form over T account is that current balance of account is always available 2– 98
Ledger Account Form • Account title and number appear at top of account form • The date appears in the first two columns (as in the journal) • Item column is rarely used because explanations already appear in the journal • Post. Ref. column used to note journal page where the original entry for the transaction can be found • Dollar amount of entry is entered in appropriate debit or credit column • New account balance computed in final two columns after each entry 2– 99
Posting to the Ledger 1. Locate debit account in the ledger 2. Enter date of transaction Enter journal page number in Post. Ref. column 3. Enter in Debit column amount of debit from journal 4. Calculate account balance and enter in appropriate Balance column 5. In journal Post. Ref. column enter account number to which amount was posted 6. Repeat for credit entry 2– 100
Posting to the Ledger (cont. ) 1. Locate credit account in the ledger 2. Enter date of transaction Enter journal page number in Post. Ref. column 3. Enter in Credit column amount of credit from journal 4. Calculate account balance and enter in appropriate Balance column 5. In journal Post. Ref. column enter account number to which amount was posted 2– 101
Some Notes on Presentation Dollar signs are required and are placed before the first amount in each column A ruled line appears before each subtotal or total A double line appears under a final total that has been verified 2– 102
IFF_L3.pptx