Chapter 2 2012

2
The
Accounting
Cycle
© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
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Accounting Methods for Measuring
Performance
CASH BASIS OF ACCOUNTING

VS
ACCRUAL BASIS OF ACCOUNTING
Chapter 2 2
Performance
(a) Cash basis of accounting
– Revenues are recognized when cash is received and
expenses are recognized when cash is paid
(b) Accrual basis of accounting
– Revenues and expenses are recognized on an economic
basis regardless of when cash is paid or received
Chapter 2 3
Success Service Corporation - Dry
Cleaning Company
• TL 3.000 bank loan in January 2014- loan due 30 June 2014-
monthly interest expense of TL 100.
• Paid two months rent on 1 January 2014 – total TL 200
• Paid insurance premium of TL 120 to cover the whole year from
January 1 to December 31
• Purchased supplies of TL 90 to be used for 3 months and paid
TL 75 of it; agreed to pay the rest in February
• In January-provided TL 750 worth of services and collected
cash of TL 500 from customers; the rest would be collected next
month
• Paid salaries of TL 500 at the end of January
Chapter 2 4
Cash Base - Performance
Chapter 2 5
Performance
(a) Cash basis of accounting
– Revenues are recognized when cash is received and
expenses are recognized when cash is paid
(b) Accrual basis of accounting
– Revenues and expenses are recognized on an economic
basis regardless of when cash is paid or received
Chapter 2 6
Accrual Base - Performance
Chapter 2 7
Recognition of Revenues
Shipment
Sales order MILLENIUM
of
3 May
the goods CO.
5 May
Receipt of Receipt Payment

the of the of the bill CUSTOMER
computer bill 2 June
6 May 7 May
Chapter 2 8
Recognition of Service Revenues
Accrual basis of accounting generally requires that

revenues be recognized when both of the following
conditions are met:
• A company has performed all (or the major part of) the
services, or has delivered the goods; i.e., when there is little or
no uncertainty regarding the exchange of goods or services, and
• The price of the services or goods has been accepted by both

seller and buyer, and seller has received either cash or some
other form of asset, enabling reasonable determination of the
time of payment (such as accounts receivable, which is the
buyer’s promise to pay)
Chapter 2 9
Recognition of Expenses
• Expenses are recognized when they are

incurred and helped to produce revenue,
regardless of the cash payment date
Chapter 2 10
Generally Accepted Accounting
Principles
Financial accounting practice is governed by concepts and
rules known as generally accepted accounting principles
(GAAP).
Financial reporting for the world's interconnected financial markets
International financial markets

have become increasingly
interconnected. Financial events in
any part of the world now
influence every part of the world
Hans Hoogervorst
IASB Chairman
In such a globalised financial world, the argument for a single way to describe
financial performance is compelling. So much so, that successive G20
Communiques have called for a rapid move towards a single set of high quality
global accounting standards. http://www.ifrs.org/The-organisation/Pages/financial-reporting.aspx
Chapter 2 11
Principles and Concepts
Principle ???
Entity Every business is a separate economic unit and should be

kept distinct from the activities of its owners and other
companies
Monetary Only economic events that have monetary transactions will
Unit be reported in the financial statements
Cost assets are presented at their original (historical) cost
Principle
Going companies are established with the goal that they will
Concern operate for an indefinitely long period of time
Periodicity economic activities of any firm can be divided into discrete
time periods for reporting purposes
Matching all revenues must be recorded in the accounting period in
Principle which the goods are sold or services are rendered and all
expenses must be recorded in the accounting period in
which they are incurred to produce such revenues
Chapter 2 12
Accounting Cycle
Chapter 2 13
Analysis and Recording Business
Transactions
• Business transaction is an economic event
that causes a change in the financial
position
• Financial Position:
– What we own
– How we own
Chapter 2 14
Fundamental Accounting Equation
ASSETS = EQUITIES
ASSETS = LIABILITIES + OWNERS' EQUITY
Chapter 2 15
How do we use the fundamental
equation?
Assets = Liabilities + Shareholders’
Equity
Implications:
– If assets increase : either Liabilities and/or Shareholders’
should also increase and vice versa
• For example: borrow cash, cash (asset) will increase and
Liabilities will increase
• when it is paid back: cash (asset) will decrease and liabilities will
decrease
– What will happen when Shareholders’ Equity
increase?
– Which financial statement shows this equation?
Chapter 2 16
How do we record?
• an ACCOUNT: accounting report of a specific
asset, liability or owners’ equity item
• Has 3 elements: title, debit side and credit side
(also called the “T-Account”)
• Changes in the accounts are entered manually
into a book called a ledger
• computerized
• Basic forms of book ledgers: the two-column
account format, and the four-column account
format
• Chart of accounts
Chapter 2 17
Forms of Ledgers
Two-Column Account
T-Account form that depicts the two-column account:
Chapter 2 18
How do accounts behave?
Assets = Liabilities + Shareholders’ Equity
+ + +
So Assets increase on the left hand or debit
side then they decrease on the credit side
Chapter 2 19
Behavior of Accounts
Liabilities and Owners’ Equity accounts
increase on the credit side, decrease on the
debit side
Chapter 2 20
Transaction Analysis and The
Duality Concept
• if an asset account increases, because of
duality concept there must be a
corresponding
1. increase in a specific liability account
2. or a decrease in a another asset account
3. or an increase in owners' equity account.
Chapter 2 21
Illustration of Transaction Analysis and
Recording: Express Travel Agency
1. Ms. Fodor invested TL100.000 at the inception
Chapter 2 22
Express Travel Agency
2. On 1 January employed a full time secretary and a sales
representative.
Chapter 2 23
3. On 1 January rented an office building and paid 3 months
rent of TL 600.
Chapter 2 24
4. On 2 January office furniture and equipment is purchased for TL
15.000 , for which TL 5.000 is paid in cash and the rest would be paid
later in January and February 2014.
Chapter 2 25
5. On 3 January insured the office building and the equipment
effective from 1 January to 31 December 2014 and paid TL
120 for the whole period.
Chapter 2 26
6. On 5 January the company agreed with Turkish Airlines to
sell airline tickets of THY and receive commissions in
return.
Chapter 2 27
7. On 10 January Express Travel Agency borrowed TL 15.000 from the
bank at an annual interest rate of 24% for six months. The principal
and the interest of the loan will be paid together on 10 July 2014.
Chapter 2 28
7. On 10 January Express Travel Agency borrowed TL 15.000 from
the bank at an annual interest rate of 24% for six months. The
principal and the interest of the loan will be paid together on 10
July 2014.
Chapter 2 29
8. On 10 January purchased office supplies for TL 2.500 in
cash.
Chapter 2 30
8. On 10 January purchased office supplies for TL 2.500 in
cash.
Chapter 2 31
9. During the first half of January the agency sold tickets to various
customers and on 16 January issued a commission invoice to THY
amounting to TL 5.000 that will be collected later in January 2014.
Chapter 2 32
9. During the first half of January the agency sold tickets to
various customers and on 16 January issued a
commission invoice to THY amounting to TL 5.000 that
will be collected later in January 2014.
Chapter 2 33
10. On 20 January the company paid TL 5.000 for the
furniture and equipment that were purchased on 2
January.
Chapter 2 34
10. On 20 January the company paid TL 5.000 for the
furniture and equipment that were purchased on 2
January.
Chapter 2 35
11. On 22 January received TL 7.500 from a customer for
organizing the accounting conference that will be held on
February 2, 2014.
Chapter 2 36
11. On 22 January received TL 7.500 from a customer for
organizing the accounting conference that will be held on
February 2, 2014.
Chapter 2 37
12. The company received the full payment of commission
charged to THY of TL 5.000 on 23 January.
Chapter 2 38
12. The company received the full payment of commission
charged to THY of TL 5.000 on 23 January.
Chapter 2 39
13. On 24 January paid salaries of TL 9.000 employees in
cash.
Chapter 2 40
13. On 24 January paid salaries of TL 9.000 employees in
cash.
Chapter 2 41
14. During the second half of January the agency sold tickets to various
amounting to TL 7.500 which will be collected in February 2014.
Chapter 2 42
14. During the second half of January the agency sold tickets to various
amounting to TL 7.500 which will be collected in February 2014.
Chapter 2 43
15. Ms. Fodor withdrew TL 3.000 on 31 January for personal use.
Chapter 2 44
15. Ms. Fodor withdrew TL 3.000 on 31 January for personal
use.
Chapter 2 45
Summary
1. determine the effects of transactions on three
components of the accounting equation,
2. determine which specific accounts are
affected, and
3. assure that total of the increases should be
equal to either increases on the other side of
the equation or to decreases on the same
side, or a combination there of.
Chapter 2 46
Behavior Summary
Chapter 2 47
Accounting Cycle
Chapter 2 48
Posting to the Ledger
Chapter 2 49
Ledger-Cash Example- Express Travel Agency
Chapter 2 50
Trial Balance
Chapter 2 51
Normal Balances of Accounts
Chapter 2 52
Chapter 2 53

Chapter 2 2012

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2

CASH BASIS OF ACCOUNTING

ACCRUAL BASIS OF ACCOUNTING

Receipt of Receipt Payment

Accrual basis of accounting generally requires that

• The price of the services or goods has been accepted by both

• Expenses are recognized when they are

International financial markets

Entity Every business is a separate economic unit and should be

ASSETS = LIABILITIES + OWNERS' EQUITY

T-Account form that depicts the two-column account:

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