You are on page 1of 37

The Accounting Cycle

Capturing Economic Events


Chapter 3

PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin Copyright 2012 The McGraw-Hill Companies, Inc.3-1

The Role of Accounting Records


Establishes accountability for assets and transactions. Keeps track of routine business activities.
Obtains detailed information about a particular transaction. Evaluates efficiency and performance within company. Maintains evidence of a companys business activities.
3-2

The Ledger
Cash

Accounts Payable

Accounts are individual records showing increases and decreases. The entire group of accounts is kept together in an accounting record called a ledger.
3-3

Capital Stock

The Use of Accounts


Increases are recorded on one side of the T account, and decreases are recorded on the other side.

Title of Account

Left or Debit Side

Right or Credit Side

3-4

Debit and Credit Entries


5/1 5/25 5/29 5/31 Bal. Cash 8,000 5/2 2,500 Payments are credit 75 5/8 2,000 on the side. 750 5/28 150 5/31 50 4,125 The balance is the
difference between the debit and credit entries in the account.

Receipts are on the debit side.

3-5

Debit and Credit Entries


Debits and credits affect accounts as follows:

A = L + OE
ASSETS Debit Credit for for Increase Decrease LIABILITIES Debit Credit for for Decrease Increase EQUITIES Debit Credit for for Decrease Increase
3-6

Double Entry AccountingThe Equality of Debits and Credits

Debit balances

A = L + OE =
Credit balances
3-7

In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.

Lets record selected transactions for JJs Lawn Care Service in the accounts.

3-8

May 1: Jill Jones and her family invested $8,000 in JJs Lawn Care Service and received 800 shares of stock.

Cash increases $8,000 with a debit.

Capital Stock increases $8,000 with a credit.

Cash 5/1 8,000

Capital Stock 5/1 8,000

3-9

May 2: JJs purchased a riding lawn mower for $2,500 cash.

Cash decreases $2,500 with a credit.

Tools & Equipment increases $2,500 with a debit.

Cash 5/1 8,000 5/2 2,500

Tools & Equipment 5/2 2,500

3-10

May 8: JJs purchased a $15,000 truck. JJs paid $2,000 in cash and issued a note payable for the remaining $13,000.
Cash decreases $2,000 with a credit. Notes Payable increases $13,000 with a credit.
Cash 5/1 8,000 5/2 2,500 5/8 2,000
Notes Payable 5/8 13,000
3-11

Truck increases $15,000 with a debit.

Truck 5/8 15,000

May 18: JJs sold half of the repair parts to ABC Lawns for $150, a price equal to JJs cost. ABC Lawns agrees to pay JJs within 30 days.

Tools & Equipment decreases $150 with a credit.


Tools & Equipment 5/2 2,500 5/18 150 5/11 300

Accounts Receivable increases $150 with a debit.


Accounts Receivable 5/18 150

3-12

The Journal
In an actual accounting system, transactions are initially recorded in the journal.
GENERAL JOURNAL
Date 2011 May 1 Cash Capital Stock Owners invest cash in the business.
3-13

Account Titles and Explanation

Debit 8,000

Credit

8,000

Posting Journal Entries to the Ledger Accounts


Posting simply means updating the ledger accounts for the effects of the transactions recorded in the journal.
3-14

Posting Journal Entries to the Ledger Accounts


GENERAL JOURNAL
Date 2011 May 1 Cash Capital Stock Owners invest cash in the business. General Ledger 8,000 8,000 Account Titles and Explanation Debit Credit

Date 2011 May 1

Cash Debit Credit 8,000

Balance 8,000
3-15

Posting Journal Entries to the Ledger Accounts


GENERAL JOURNAL
Date 2011 May 1 Cash Capital Stock Owners invest cash in the business. General Ledger 8,000 8,000 Account Titles and Explanation Debit Credit

Date 2011 May 1

Capital Stock Debit Credit 8,000

Balance 8,000
3-16

Posting Journal Entries to the Ledger Accounts


GENERAL JOURNAL
Date 2011 May 2 Tools & Equipment Cash Purchased lawn mower. 2,500 2,500 Account Titles and Explanation Debit Credit

Lets see what the cash account looks like after posting the cash portion of this transaction for JJs Lawn Care Service.
3-17

Ledger Accounts After Posting


General Ledger Cash Debit Credit 8,000 2,500

Date 2011 May 1 2

Balance 8,000 5,500

This ledger format is referred to as a running balance.

3-18

Ledger Accounts After Posting


General Ledger Cash Debit Credit 8,000 2,500

Date 2011 May 1 2

Balance 8,000 5,500

T accounts are simplified versions of the ledger account that only show the debit and credit columns.
3-19

What is Net Income?


Net income is not an asset its an increase in owners equity from profits of the business.

A = L + OE
Increase Decrease Increase As income is earned, either an asset is increased or a liability is decreased. Net income always results in the increase of Owners Equity
3-20

Retained Earnings

A = L + OE
Capital Stock Retained Earnings

The balance in the Retained Earnings account represents the total net income of the corporation over the entire lifetime of the business, less all amounts which have been distributed to the stockholders as dividends.
3-21

The Income Statement: A Preview


JJ's Lawn Care Service Income Statement For the Month Ended May 31, 2011 Sales Revenue Operating Expense: Gasoline Expense Net Income $ 750 50 700

The income statement summarizes the profitability of a business for a specified period of time.
3-22

Accounting Periods
Time Period Principle To provide users of financial statements with timely information, net income is measured for relatively short accounting periods of equal length.

3-23

Revenue and Expenses


The price for goods sold and services rendered during a given accounting period. Increases owners equity.

The costs of goods and services used up in the process of earning revenue.

Decreases owners equity.

3-24

The Matching Principle: When To Record Revenue


Matching Principle Revenue should be recognized at the time goods are sold and services are rendered.

3-25

The Matching Principle: When To Record Expenses


Matching Principle Expenses should be recorded in the period in which they are used up.

3-26

The Accrual Basis of Accounting


Current Accounting Period
Jan. 1, 2011 Dec. 1, 2011

Future Accounting Period


Jan. 1, 2012 Dec. 1, 2012

Cash is received or paid here OR The income statement reports revenue or expenses here

But . . .

The income statement reports revenue or expense here

But . . .

Cash is received or paid here


3-27

Debit and Credit Rules for Revenue and Expenses


Expenses decrease owners equity.
EQUITIES Debit Credit for for Decrease Increase

Revenues increase owners equity.

EXPENSES Debit Credit for for Increase Decrease

REVENUES Debit Credit for for Decrease Increase

3-28

Dividends
Payments to owners decrease owners equity.
DIVIDENDS
Debit Credit for for Increase Decrease

EQUITIES
Debit Credit for for Decrease Increase

Owners investments increase owners equity.


CAPITAL STOCK

Debit Credit for for Decrease Increase

3-29

Lets analyze the revenue and expense transactions for JJs Lawn Care Service for the month of May. We will also analyze a dividend transaction.
3-30

May 29: JJs provided lawn care services for a client and received $750 in cash.

Cash increases $750 with a debit.

Sales Revenue increases $750 with a credit.

Cash 5/1 8,000 5/2 2,500 5/29 750 5/8 2,000

Sales Revenue 5/29 750

3-31

May 31: JJs purchased gasoline for the lawn mower and the truck for $50 cash.

Cash decreases $50 with a credit.

Gasoline Expense increases $50 with a debit.


Gasoline Expense 5/31 50

Cash 5/1 8,000 5/2 2,500 5/29 750 5/8 2,000 5/31 50

3-32

May 31: JJs Lawn Care paid Jill Jones and her family a $200 dividend.

Cash decreases $200 with a credit.

Dividends increase $200 with a debit.

Cash 5/1 8,000 5/2 2,500 5/29 750 5/8 2,000 5/31 50 5/31 200

5/31

Dividends 200

3-33

Now, lets look at the Trial Balance for JJs Lawn Care Service for the month of May.

3-34

JJ's Lawn Care Service Unadjusted Trial Balance May 31, 2011 Cash $ 3,925 Accounts receivable 75 Tools & equipment 2,650 Truck 15,000 Notes payable $ Accounts payable Capital stock Dividends 200 Sales revenue Gasoline expense 50 Total $ 21,900 $

13,000 150 8,000 750 21,900

All balances are taken from the ledger accounts on May 31 after considering all of JJs transactions for the month.
3-35

The Accounting Cycle in Perspective


Accountants spend much of their time focusing on the more analytical aspects of their discipline.

3-36

End of Chapter 3

3-37