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- 1. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin The Accounting Cycle Capturing Economic Events Chapter 3
- 2. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO1 To identify the steps in the accounting cycle and discuss the role of accounting records in an organization.
- 3. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin 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 company’s business activities.
- 4. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO2 To describe a ledger account and a ledger.
- 5. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin The Ledger The entire group of accounts is kept together in an accounting record called a ledger. Cash Accounts Payable Capital Stock Accounts are individual records showing increases and decreases.
- 6. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin The Use of Accounts Increases are recorded on one side of the T- account, and decreases are recorded on the other side. Left or Debit Side Right or Credit Side Title of the Account
- 7. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Let’s see how debits and credits are recorded in the Cash account for JJ’s Lawn Care Service.
- 8. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Cash 5/1 8,000 5/2 2,500 5/25 75 5/8 2,000 5/29 750 5/28 150 5/31 50 5/31 4,125 Bal. Receipts are on the debit side. Payments are on the credit side. The balance is the difference between the debit and credit entries in the account. Debit and Credit Entries
- 9. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO3 To understand how balance sheet accounts are increased and decreased.
- 10. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin A = L + OE ASSETS Debit for Increase Credit for Decrease EQUITIES Debit for Decrease Credit for Increase LIABILITIES Debit for Decrease Credit for Increase Debits and credits affect accounts as follows: Debit and Credit Rules
- 11. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO4 To explain the double- entry system of accounting.
- 12. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin A = L + OE Debit balances Credit balances = In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits. Double Entry AccountingThe Equality of Debits and Credits
- 13. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Let’s record selected transactions for JJ’s Lawn Care Service in the accounts.
- 14. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Will Cash increase or decrease? Will Capital Stock increase or decrease?
- 15. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Capital Stock 5/1 8,000 Cash 5/1 8,000 May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Cash increases $8,000 with a debit. Capital Stock increases $8,000 with a credit.
- 16. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Will Cash increase or decrease? Will Tools & Equipment increase or decrease?
- 17. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Tools & Equipment 5/2 2,500 Cash 5/1 8,000 5/2 2,500 Cash decreases $2,500 with a credit. Tools & Equipment increases $2,500 with a debit.
- 18. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000. Will Truck increase or decrease? Will Cash and Notes Payable increase or decrease?
- 19. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000. Truck 5/8 15,000 Cash 5/1 8,000 5/2 2,500 5/8 2,000 Notes Payable 5/8 13,000 Truck increases $15,000 with a debit. Cash decreases $2,000 with a credit. Notes Payable increases $13,000 with a credit.
- 20. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 11: JJ’s purchased some repair parts for $300 on account. Will Tools & Equipment increase or decrease? Will Accounts Payable increase or decrease?
- 21. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 11: JJ’s purchased some repair parts for $300 on account. Tools & Equipment increases $300 with a debit. Accounts Payable increases $300 with a credit. Tools & Equipment 5/2 2,500 5/11 300 Accounts Payable 5/11 300
- 22. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. Will Tools & Equipment increase or decrease? Will Accounts Receivable increase or decrease?
- 23. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. Tools & Equipment decreases $150 with a credit. Accounts Receivable increases $150 with a debit. Tools & Equipment 5/2 2,500 5/18 150 5/11 300 Accounts Receivable 5/18 150
- 24. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO5 To explain the purpose of a journal and its relationship to the ledger.
- 25. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin In an actual accounting system, transactions are initially recorded in the journal. GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2007 May 1 Cash 8,000 Capital Stock 8,000 Owners invest cash in the business. The Journal
- 26. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Posting involves copying information from the journal to the ledger accounts. Posting Journal Entries to the Ledger Accounts
- 27. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2007 May 1 Cash 8,000 Capital Stock 8,000 Owners invest cash in the business. General Ledger Cash Date Debit Credit Balance 2007 May 1 8,000 8,000 Posting Journal Entries to the Ledger Accounts
- 28. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2007 May 1 Cash 8,000 Capital Stock 8,000 Owners invest cash in the business. General Ledger Capital Stock Date Debit Credit Balance 2007 May 1 8,000 8,000 Posting Journal Entries to the Ledger Accounts
- 29. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2007 May 2 Tools & Equipment 2,500 Cash 2,500 Purchased lawn mower. Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service. Posting Journal Entries to the Ledger Accounts
- 30. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin General Ledger Cash Date Debit Credit Balance 2007 May 1 8,000 8,000 2 2,500 5,500 This ledger format is referred to as a running balance. Ledger Accounts After Posting
- 31. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin General Ledger Cash Date Debit Credit Balance 2007 May 1 8,000 8,000 2 2,500 5,500 T accounts are simplified versions of the ledger account that only show the debit and credit columns. Ledger Accounts After Posting
- 32. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO6 To explain nature of net income, revenue, and expenses.
- 33. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Net income is not an asset it’s an increase in owners’ equity from profits of the business. A = L + OE Increase Decrease Either (or both) of these effects occur as net income is earned . . . Increase . . . but this is what “net income” really means. What is Net Income?
- 34. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin A = L + OE Retained Earnings 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.
- 35. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin JJ's Lawn Care Service Income Statement For the Month Ended May 31, 2007 Sales Revenue 750 $ Operating Expense: Gasoline Expense 50 Net Income 700 $ The income statement summarizes the profitability of a business for a specified period of time. The Income Statement: A Preview
- 36. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin 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.
- 37. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin 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 owner’s equity.
- 38. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO7 To apply the realization and matching principles in recording revenue and expenses.
- 39. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin The Realization Principle: When To Record Revenue Realization Principle Revenue should be recognized at the time goods are sold and services are rendered.
- 40. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up.
- 41. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Debits and Credits for Revenue and Expense EQUITIES Debit for Decrease Credit for Increase Expenses decrease owners’ equity. Revenues increase owners’ equity. EXPENSES Credit for Decrease Debit for Increase REVENUES Debit for Decrease Credit for Increase
- 42. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin EQUITIES Debit for Decrease Credit for Increase Payments to owners decrease owners’ equity. Owners’ investments increase owners’ equity. DIVIDENDS Credit for Decrease Debit for Increase Investments by and Payments to Owners CAPITAL STOCK Debit for Decrease Credit for Increase
- 43. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO8 To understand how revenue and expense transactions are recorded in an accounting system.
- 44. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Let’s analyze the revenue and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction.
- 45. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 29: JJ’s provided lawn care services for a client and received $750 in cash. Will Cash increase or decrease? Will Sales Revenue increase or decrease?
- 46. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Sales Revenue 5/29 750 May 29: JJ’s 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
- 47. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Will Cash increase or decrease? Will Gasoline Expense increase or decrease?
- 48. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Gasoline Expense 5/31 50 May 31: JJ’s 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. Cash 5/1 8,000 5/2 2,500 5/29 750 5/8 2,000 5/31 50
- 49. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Will Cash increase or decrease? Will Dividends increase or decrease?
- 50. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Dividends 5/31 200 May 31: JJ’s 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
- 51. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO9 To prepare a trial balance and explain its uses and limitations.
- 52. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May.
- 53. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin JJ's Lawn Care Service Unadjusted Trial Balance May 31, 2007 Cash 3,925 $ Accounts receivable 75 Tools & equipment 2,650 Truck 15,000 Notes payable 13,000 $ Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Total 21,900 $ 21,900 $ All balances are taken from the ledger accounts on May 31. You may notice from the balances presented that JJ’s Lawn Care Service had transactions in May other than those presented on the preceding slides. Proves equality of debits and credits.
- 54. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO10 To distinguish between accounting cycle procedures and the knowledge of accounting.
- 55. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Make end-of- year adjustments. Prepare adjusted trial balance. Prepare financial statements. Prepare after-closing trial balance. Journalize and post closing entries. The Accounting Cycle
- 56. © The McGraw-HillCompanies, Inc., 2008 McGraw-Hill/Irwin End of Chapter 3
Editor's Notes
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- #3 Learning objective number 1 is to identify the steps in the accounting cycle and discuss the role of accounting records in an organization.
- #4 All accountants play a pivotal roll in establishing and maintaining economic information about a company. Much of Chapter Three will illustrate how an accounting system works. Most information is stored on computers -- and accounting information is no exception. Accountants must be proficient in establishing and maintaining databases of financial information for a company. This information is used to prepare financial statements and other reports of interest to management and others.
- #5 Learning objective number 2 is to describe a ledger account and a ledger.
- #6 An account is an individual record showing increases and decreases in the balance. Think of a checkbook as an account. In it, cash receipts and disbursements are maintained, in chronological order, as well as the current account balance. The entire group of accounts for a particular business is called the ledger.
- #7 Accountants often use a T-account to represent a general ledger account. It is a quick way to analyze transactions before entering information in the journal. The left side of a T-account is always called the debit side, and the right side is always called the credit side. This terminology comes from the time when the double-entry system was first developed. These terms are still used as a matter of convention. The words do not have any significant meaning other than they stand for the left and right side of a ledger account. Increases and decreases in an account balance are handled differently, depending upon the nature of the account.
- #8 Let’s go back to JJ’s Lawn Care Service and look at how to record transactions in the cash account.
- #9 Part I Here are the dates and amounts of transactions that impacted the cash account of JJ’s Lawn Service for the month of May. Part II Because cash is an asset, all receipts, or increases, should be placed on the debit, or left, side of the ledger account. Part III If increases are placed on the left side of the account, all payments, or decreases, should be placed on the right, or credit, side of the account, according to the basic accounting rules for assets. Part IV The balance in any account is the difference between total debits and credits. The balance is placed on the side with the greater dollar amount.
- #10 Learning objective number 3 is to understand how balance sheet accounts are increased and decreased.
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- #12 Learning objective number 4 is to explain the double-entry system of accounting.
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- #25 Learning objective number 5 is to explain the purpose of a journal and its relationship to the ledger.
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- #33 Learning objective number 6 is to explain nature of net income, revenue, and expenses.
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- #38 Part I Revenues represent the price of goods sold or services rendered to customers during any given accounting period. Revenues increase owners’ equity. Part II Expenses are the cost of goods or services used up in the process of earning revenue. Accountants try to match expenses incurred with the revenues generated in an accounting period. Expenses decrease owners’ equity.
- #39 Learning objective number 7 is to apply the realization and matching principles in recording revenue and expenses.
- #40 One of the basic concepts of accounting is that revenue should be recognized when the goods or services are sold to customers. This concept may take some time to understand, as most people are cash-based. That is, they recognize revenue when cash is received rather than when it is earned and recognize expenses when paid rather than when incurred.
- #41 The matching principle states that we must match expenses with the period in which they are used.
- #42 Part I Let’s look more closely at the recording of revenues and expenses. To review, revenues increase owners’ equity and expenses decrease owners’ equity. Part II A decrease is shown in owners’ equity with a debit. Increases in expenses must be recorded as debits in a separate ledger account. Part III An increase in owners’ equity is shown with a credit. Increases in revenues must be recorded as credits in a separate ledger account.
- #43 Part I To review, payments to owners decrease owners’ equity and investments by owners increase owners’ equity. Part II Dividends represent payments to owners of a corporation. An increase in the dividend account must be shown with a debit. Part II Capital stock represents investments by owners of a corporation. An increase in the capital stock account must be shown with a credit.
- #44 Learning objective number 8 is to understand how revenue and expense transactions are recorded in an accounting system.
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- #52 Learning objective number 9 is to prepare a trial balance and explain its uses and limitations.
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- #55 Learning objective number 10 is to distinguish between accounting cycle procedures and the knowledge of accounting.
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