Financial A ccounting CHAPTER 3 Accounting Cycle: Capturing Economic Events

1. Financial Accounting CHAPTER 3 Accounting Cycle: Capturing Economic Events

2. The Accounting Cycle Make end-of-year adjustments. Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Journalize and post closing entries. Prepare financial statements. Prepare adjusted trial balance. Prepare after-closing trial balance.

3. Title of Account Left or debit side Right or credit side Debit balance Credit balance BASIC FORM OF ACCOUNT • In its simplest form, an account consists of 1 the title of the account, 2 a left or debit side, and 3 a right or credit side. • The alignment of these parts resembles the letter T, and therefore the account form is called a T account.

4. DR CR DEBITS AND CREDITS • The term debit means left and credit means right respectively. • The act of entering an amount on the left side of an account is called debiting the account and making an entry on the right side is crediting the account. • When the debit amounts exceed the credits, an account has a debit balance; when the reverse is true, the account has a credit balance.

5. Tabular Summary Account Form Cash Cash Debit Credit $15,000 - 7,000 15,000 7,000 1,200 1,200 1,700 1,500 1,500 250 - 1,700 600 1,300 - 250 Balance 600 - 1,300 TABULAR SUMMARY COMPARED TO ACCOUNT FORM $ 8,050 $8,050 (Debit)

6. Cash Debits Credits 15,000 DEBITING AN ACCOUNT Example: The owner makes an initial investment of $15,000 to start the business. Cash is debited as the owner’s Capital is credited.

7. Cash Debits Credits 7,000 CREDITING AN ACCOUNT Example: Monthly rent of $7,000 is paid. Cash is credited as Rent Expense is debited.

8. Cash Debits Credits 15,000 7,000 8,000 DEBITING AND CREDITING AN ACCOUNT Example: Cash is debited for $15,000 and credited for $7,000, leaving a debit balance of $8,000.

9. Assets Liabilities Equity DOUBLE-ENTRY SYSTEM • In a double-entry system, equal debits and credits are made in the accounts for each transaction. • Thus, the total debits will always equal the total credits and the accounting equation will always stay in balance.

10. DEBIT AND CREDIT EFFECTS — ASSETS AND LIABILITIES Increase assets Decrease assets Decrease liabilities Increase liabilities Debits Credits

11. NORMAL BALANCE • Every account classification has a normal balance, whether it is a debit or credit. • For that particular account, the opposite side entries should never exceed the normal balance.

12. ASSETS LIABILITIES EQUITIES Debit for Increase Credit for Decrease Debit for Decrease Credit for Increase Debit for Decrease Credit for Increase Debit and Credit Rules Debits and credits affect accounts as follows: A=L+OE

13. GENERAL LEDGER THE LEDGER • The entire group of accounts maintained by a company is called the ledger. • A general ledger contains all the assets, liabilities, and owner’s equity accounts.

14. Posting Journal Entries to the Ledger Accounts Postinginvolves copying information from the journal to the ledger accounts.

15. The Ledger Accounts are individual records showing increases and decreases. Cash Accounts Payable The entire group of accounts is kept together in an accounting record called a ledger. Capital Stock

16. Individual Owner’s Equity Individual Assets Individual Liabilities Equipment Interest Payable Salaries Expense Land Salaries Payable Fees Earned Supplies Accounts Payable J. Lind, Drawing Cash Notes Payable J. Lind, Capital THE GENERAL LEDGER

17. Posting Journal Entries to the Ledger Accounts

18. Posting Journal Entries to the Ledger Accounts

19. Posting Journal Entries to the Ledger Accounts Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service.

20. Ledger Accounts After Posting This ledger format is referred to as a running balance.

21. Ledger Accounts After Posting T accounts are simplified versions of the ledger account that only show the debit and credit columns.

22. POSTING A JOURNAL ENTRY In the ledger, enter in the appropriate columns of the account(s) debited the date, journal page, and debit amount shown in the journal.

23. POSTING A JOURNAL ENTRY In the reference column of the journal, write the account number to which the debit amount was posted.

24. POSTING A JOURNAL ENTRY In the ledger, enter in the appropriate columns of the account(s) credited the date, journal page, and credit amount shown in the journal.

25. POSTING A JOURNAL ENTRY In the reference column of the journal, write the account number to which the credit amount was posted.

26. CHART OF ACCOUNTS Most companies have a chart of accounts that lists the accounts and the account numbers which identify their location in the ledger.

27. October 1, C.R. Byrd invests $10,000 cash in an advertising venture to be known as the Pioneer Advertising Agency. Transaction Basic Analysis The asset Cash is increased $10,000, and owner’s equity C. R. Byrd, Capital is increased $10,000. Debits increase assets: debit Cash $10,000. Credits increase owner’s equity: credit C.R. Byrd, Capital $10,000. Debit-Credit Analysis INVESTMENT OF CASH BY OWNER

28. INVESTMENT OF CASH BY OWNER JOURNAL ENTRY POSTING

29. October 1, office equipment costing $5,000 is purchased by signing a 3-month, 12%, $5,000 note payable. Transaction Basic Analysis The asset Office Equipment is increased $5,000, and the liability Notes Payable is increased $5,000. Debits increase assets: debit Office Equipment $5,000. Credits increase liabilities: credit Notes Payable $5,000. Debit-Credit Analysis PURCHASE OF OFFICE EQUIPMENT

30. PURCHASE OF OFFICE EQUIPMENT JOURNAL ENTRY POSTING

31. October 2, a $1,200 cash advance is received from R. Knox, a client, for advertising services that are expected to be completed by December 31. Transaction The asset Cash is increased $1,200; the liability Unearned Fees is increased $1,200 because the service has not been rendered yet. Note that although many liabilities have the word “payable” in their title, unearned fees are considered a liability even though the word payable is not used. Basic Analysis Debits increase assets: debit Cash $1,200. Credits increase liabilities: credit Unearned Fees $1,200. Debit-Credit Analysis RECEIPT OF CASH FOR FUTURE SERVICE

32. RECEIPT OF CASH FOR FUTURE SERVICE JOURNAL ENTRY POSTING

33. October 3, office rent for October is paid in cash, $900. Transaction Basic Analysis The expense Rent is increased $900 because the payment pertains only to the current month; the asset Cash is decreased $900. Debit-Credit Analysis Debits increase expenses: debit Rent Expense $900. Credits decrease assets: credit Cash $900. PAYMENT OF MONTHLY RENT

34. PAYMENT OF MONTHLY RENT JOURNAL ENTRY POSTING

35. October 4, $600 is paid for a one-year insurance policy that will expire next year on September 30. Transaction The asset Prepaid Insurance is increased $600 because the payment extends to more than the current month; the asset Cash is decreased $600. Note that payments of expenses that will benefit more than one accounting period are identified as prepaid expenses or prepayments. When a payment is made, an asset account is debited in order to show the service or benefit that will be received in the future. Basic Analysis Debit-Credit Analysis Debits increase assets: debit Prepaid Insurance $600. Credits decrease assets: credit Cash $600. PAYMENT FOR INSURANCE

36. PAYMENT FOR INSURANCE JOURNAL ENTRY POSTING

37. October 5, an estimated 3-month supply of advertising materials is purchased on account from Aero Supply for $2,500. Transaction Basic Analysis The asset Advertising Supplies is increased $2,500; the liability Accounts Payable is increased $2,500. Debits increase assets: debit Advertising Supplies $2,500. Credits increase liabilities: credit Accounts Payable $2,500. Debit-Credit Analysis PURCHASE OF SUPPLIES ON CREDIT

38. PURCHASE OF SUPPLIES ON CREDIT JOURNAL ENTRY POSTING

39. October 9, hire four employees to begin work on October 15. Each employee is to receive a weekly salary of $500 for a 5-day work week, payable every 2 weeks -- first payment made on October 26. Transaction A business transaction has not occurred. There is only an agreement between the employer and the employees to enter into a business transaction beginning on October 15. Basic Analysis Debit-Credit Analysis A debit-credit analysis is not needed because there is no accounting entry. HIRING OF EMPLOYEES

40. October 20, C. R. Byrd withdraws $500 cash for personal use. Transaction Basic Analysis The owner’s equity account C. R. Byrd, Drawing is increased $500; the asset Cash is decreased $500. Debits increase drawings: debit C. R. Byrd, Drawing $500. Credits decrease assets: credit Cash $500. Debit-Credit Analysis WITHDRAWAL OF CASH BY OWNER

41. WITHDRAWAL OF CASH BY OWNER JOURNAL ENTRY POSTING

42. October 26, employee salaries of $4,000 are owed and paid in cash. (See October 9 transaction.) Transaction Basic Analysis The expense account Salaries Expense is increased $4,000; the asset Cash is decreased $4,000. Debit-Credit Analysis Debits increase expenses: debit Salaries Expense $4,000. Credits decrease assets: credit Cash $4,000. ILLUSTRATION 2-27 PAYMENT OF SALARIES

43. PAYMENT OF SALARIES JOURNAL ENTRY POSTING

44. October 31, received $10,000 in cash from Copa Company for advertising services rendered in October. Transaction Basic Analysis The asset Cash is increased $10,000; the revenue Fees Earned is increased $10,000. Debit-Credit Analysis Debits increase assets: debit Cash $10,000. Credits increase revenues: credit Fees Earned $10,000. RECEIPT OF CASH FOR FEES EARNED

45. RECEIPT OF CASH FOR FEES EARNED JOURNAL ENTRY POSTING

46. Ledger Accounts After Posting This ledger format is referred to as a running balance.

47. Ledger Accounts After Posting T accounts are simplified versions of the ledger account that only show the debit and credit columns.

48. The Accounting Cycle Make end-of-year adjustments. Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Journalize and post closing entries. Prepare financial statements. Prepare adjusted trial balance. Prepare after-closing trial balance.