Lecture Accounting: What the numbers mean (5/e) - Chapter 4: The bookkeeping process and transaction analysis

After reading this chapter, you should be able to answer the following questions: How can the basic accounting equation be expanded to include revenues and expenses? How does the expanded accounting equation stay in balance after every transaction? How is the income statement linked to the balance sheet through owners’ equity?...

CHAPTER THE BOOKKEEPING PROCESS AND TRANSACTION ANALYSIS McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives How can the basic accounting equation be expanded to include revenues and expenses? How does the expanded accounting equation stay in balance after every transaction? How is the income statement linked to the balance sheet through owners’ equity? What are the meanings of the terms journal, ledger, T-account, account balance, debit, credit, and closing the books? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives How is the bookkeeping system a mechanical adaptation of the expanded accounting equation? How is a transaction analyzed, how is a journal entry prepared, and how is the effect of a transaction on working capital determined? What are the five questions of transaction analysis? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã How can the basic accounting equation be expanded to include revenues and expenses? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Bookkeeping/Accounting Process ã The process begins with transactions • The transactions are reflected in the financial statements • One must know the mechanical process to understand the effects of transactions on the financial statements McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 The Balance Sheet Equations • The basic equation is: Assets = Liabilities + Owners’ Equity • Since Owners’ Equity consists of PaidIn Capital and Retained Earnings, the equation can be restated as: • Assets = Liabilities + (Paid-In Capital + Retained Earnings) McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 The Balance Sheet Equations ã Since Retained Earnings is computed as Beginning Retained Earnings plus Revenues and less Expenses, the basic equation can be restated as: Assets = Liabilities + (Paid-In Capital + Beginning Retained Earnings + Revenues Expenses) McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã How does the expanded accounting equation stay in balance after every transaction? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 EXHIBIT 4-1 Transaction Summary ASSETS LIABILITIES Accounts Merchandise Notes Accounts Paid-In Transaction Cash Receivable Inventory Equipment Payable Payable Capital +30 +30 -25 +25 +15 +15 -10 +20 +10 +2 +5 -7 +5 -5 Total 17 20 18 15 10 30 Revenues +20 Expenses 20 -12 +3 Total 17 20 18 15 13 30 OWNERS' EQUITY Retained Earnings Revenue Expenses +20 +20 -12 -3 -15 +5 McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã How is the income statement linked to the balance sheet through owners’ equity? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Journal Entries • • The journal is the book of original entry The format for a journal entry is as follows: Date • • • Dr Account name Amount Cr Account name Amount Note the date is entered for reference Dr and Cr are used for debit and credit A journal entry may have more than one debit and more than one credit McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã How is a transaction analyzed, how is a journal entry prepared, and how is the effect of a transaction on the financial statements determined? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Transaction Effects - Balance Sheet • The horizontal model is an alternative to using Taccounts and journal entries • The model is as follows: Balance Sheet Income Statement Assets = Liabilities + Owners’ Equity Net Income = Revenues – Expenses (Accounts and amounts affected by transactions are entered under the appropriate categories) McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Adjusting Entries • Made to reflect accrual accounting in the financial statements • Results in revenues and expenses being reported in the appropriate fiscal period • Two types of adjusting entries ã Accruals ã Reclassifications McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Accruals and Reclassifications • Accruals- transactions for which cash has not yet been received or paid, but revenues and expenses need to be matched • Reclassifications – the initial recording of a transaction must be reclassified to reflect when revenues were earned or when expenses were incurred McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Accruals ã Example: Work performed by employees in March, but paid in April • At the end of March debit Wages Expense and credit Wages Payable • Example: Interest earned in March, but not received • At the end of March debit Interest Receivable and credit Interest Revenue McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Reclassifications ã Example: Supplies are purchased in February and are recorded as an asset Then the supplies are used • The expense Supplies Expense should be debited and the asset Supplies should be credited for the amount of supplies used • If the purchased supplies were debited to Supplies Expense when purchased, the unused supplies should be debited to the asset account and the Supplies Expense account should be credited McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Adjusting Entries Revisited • Generally, every adjusting entry affects both the Balance Sheet and the Income Statement • After the adjusting entries have been made, the account balances are determined, and the financial statements are prepared McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã What are the five questions of transaction analysis? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Five Transaction Analysis Questions • • • • • What’s going on? What accounts are affected? How are they affected? Does the Balance Sheet balance? (Do the debits equal the credits?) Does my analysis make sense? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 What’s Going On? • To analyze a transaction, the transaction must be understood • It is necessary to understand the entity for which accounting is being done and standard business practices McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 What Accounts Are Affected? • Often the accounts affected are explained by understanding what is going on • Can also be answered by the process of elimination McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 How Are They Affected? • Answer this by using “increasing” or “decreasing” • Then relate the increases and decreases to debits and credits to the appropriate accounts • If using the horizontal model, debits and credits are avoided McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Does the Balance Sheet Balance? • If using the horizontal model, the answer is found easily • Remember that debits must equal credits and assets must equal liabilities plus owners’ equity McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Does My Analysis Make Sense? ã Think about the effect of the transaction on the financial statements • Do the effects that you have recorded reflect what happened? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 ... revenues and expenses? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Bookkeeping/ Accounting Process ã The process begins with transactions • The transactions are reflected in the financial... What are the meanings of the terms journal, ledger, T-account, account balance, debit, credit, and closing the books? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Bookkeeping Jargon and. .. know the mechanical process to understand the effects of transactions on the financial statements McGraw­Hill/Irwin ? ?The? ?McGraw­Hill Companies, Inc., 2002 The Balance Sheet Equations • The basic