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THE UNIVERSITY OF NEW SOUTH WALES

Australian School of Business School of Accounting ACCT 1501: Accounting and Financial Management 1A
Week 3

The Double Entry System

Student Handout

Lecturer: Dr. Youngdeok Lim School of Accounting UNSW QUAD 3069 youngdeok.lim@unsw.edu.au

Blackboard: http://telt.unsw.edu.au.

WEEK 3: The Double Entry System


1. Introduction

Last week we discussed the importance of the balance sheet and income statement to managers. It is therefore critical that every manager understand the impact of transactions on these financial reports. This week covers those skills by extending transaction analysis, which considers the impact of specific transactions on the accounting equation. The double entry system involving debits and credits, which forms the basis of modern accounting, is then addressed.

Learning objectives
At the end of this topic you should be able to:

Carry out transaction analysis and determine the impact of transactions on elements of balance sheets and income statements Describe how debits and credits work in the double entry accounting system. Understand debits and credits in the context of transaction analysis

Required reading
Trotman, Gibbins & Carson Chapter 3 AASB: Framework for Presentation of Financial Statements (downloadable from your course website or http://www.aasb.gov.au )

2.

Tutorial Questions Week 4

Students should attempt these questions before the tutorial. Preparation Questions: DQ 3.2 3.4; P3.16, P3.18

Tutorial Questions: DQ 3.3, 3.5, 3.7 P3.12, P3.19

Accounting and Financial Management 1A

Week 3, Session 1, 2013 The Double Entry System

Dr. Youngdeok Lim Quad 3069

Todays lecture objectives:


Carry out transaction analysis and determine the impact of
transactions on elements of balance sheets and income statements

Hot: Describe how debits and credits work in the double entry
accounting system.

Understand debits and credits in the context of transaction analysis

Revisit balance sheet and income statement

Beginning period (t-1) L t-1 A t-1 SE t-1

Ending Period (t) At Lt SE t

Incorporated into B/S

A t-1 = L t-1 + SE t-1 E R

A t = L t + SE t

R E = Profit for the period

Capture of income

Retained profits: the sum of net profits earned over the life of a company less dividends declared to shareholders

Consolidated B/S Woolworths Limited


As at 24 June 2012
Current Assets Noncurrent Assets $5,802 M Current Liabilities $15,779 M Noncurrent Liabilities Total Liabilities Equities Total Assets $21,581 M Total Liabilities and Equities $6,766 M $6,369 M $13,135 M $8,446 M $21,581 M

Consolidated I/S Woolworths Limited


For the 52 weeks ended on 24 June 2012
Revenue - Cost of sales (Cost of goods sold) Gross profit +/- other revenue/expense Net profit $55,268 M ($40,792 M) $14,476 M ($12,659 M) $1,817 M

Transactions
Transactions are events that affect
the operations or finances of an organisation.

Analyze each transaction from the perspective of a company!

Accounting systems record transactions.

Business Model

Investors (e.g. banks, shareholders)


Financing

Purchase

Sale

Suppliers (e.g. farmers)


Payment (Cash/Accounts Payable)

Company (e.g. Woolworths)


Payment (Cash/Accounts Investing Receivable)

Customers (e.g. You)

Property Plant and Equipment, financial securities etc

Transaction analysis
Transaction analysis involves an examination of each business transaction with the aim of understanding its effect on the accounting equation.
Example: Borrow $10 000 from the bank.
A liability (source) has increased An asset (resource) has increased

Loan Cash

After this transaction the accounting equation is in balance.

Lets consider seven transactions.

Transaction 1

Issued shares for $300 000 cash.


Cash Share capital

+ SE

Does the accounting equation balance?

YES! It must balance!

Transaction 1

Issued shares for $300 000 cash.

Cash 1 +300,000

Assets Accounts Receivable/ Debtors Equipment

Liabilities

Shareholders equity Share Capital +300,000 Retained Profits

Bank Loan

Transaction 2
Borrowed $50 000 cash from the bank.
Cash Bank Loan

+ SE

Does the accounting equation balance?

YES! It must balance!

Transaction 2

Borrowed $50 000 cash from the bank.

1 2

Cash +300,000 +50,000

Assets Accounts Receivable/ Debtors

Liabilities

Shareholders equity Share Capital +300,000 Retained Profits

Equipment

Bank Loan +50,000

Transaction 3

Purchase equipment for $100 000 cash.


Equipment

=
Cash

+ SE

Does the accounting equation balance?

YES! It must balance!

Transaction 3

Purchase equipment for $100 000 cash.


Assets Accounts Receivable/ Debtors = Liabilities + Shareholders equity Share Capital +300,000 Retained Profits

1 2 3

Cash +300,000 +50,000 -100,000

Equipment

Bank Loan +50,000

+100,000

Transaction 4

Signed six-month agreement to provide catering service for a monthly fee of $2500 starting next month.

A = L + SE
What if the company received $2500 in advance for the service to be provided in this month?

Transaction 4
Not a transaction:

no service provided. no current right to receive. no cash movement that needs to be recorded.

Transaction 5

Catering services provided for an office function; billed customer for $2500.
Accounts receivable Revenue

A =
YES! It must balance!

+ SE

Does the accounting equation balance?

Transaction 5

Catering services provided for an office function; billed customer for $2500.
Assets Accounts Receivable/ Debtors = Liabilities + Shareholders' equity Share Capital +300,000 Retained Profits

1 2 3 4 5

Cash +300,000 +50,000 -100,000

Equipment

Bank Loan +50,000

+100,000 +2,500 +2,500


Revenue

Transaction 6

Customer paid $2500 they owed on their account.


Cash

=
Accounts receivable

+ SE

Does the accounting equation balance?

YES! It must balance!

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Transaction 6

Customer paid $2500 they owed on their account.


Assets Cash Accs rec. Equipment = Liabilities Bank loan + Shareholders equity Share capital +300,000 +50,000 +100,000 Retained profits

1 2 3 4 5 6

+300,000 +50,000 -100,000

+2,500 +2,500 -2,500

+2,500 Revenue

Transaction 7

Paid the bank $5000 as part repayment of the loan.

A=
Cash

+ SE
Bank loan

Does the accounting equation balance?

YES! It must balance!

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Transaction 7

Paid the bank $5000 as part repayment of the loan.


Assets Cash Accs rec. Equipment = Liabilities Bank loan + Shareholders equity Share capital +300,000 +50,000 +100,000 Retained profits

1 2 3 4 5 6 7

+300,000 +50,000 -100,000

+2,500 +2,500 -5,000 -2,500 -5,000

+2,500 Revenue

Transaction analysis complete


Assets Cash Accs rec. Equipment = Liabilities Bank loan + Shareholders equity Share capital +300,000 +50,000 +100,000 Retained profits

1 2 3 4 5 6 7

+300,000 +50,000 -100,000

+2,500 +2,500 -5,000 247,500 347,500 A 0 100,000 = = = -2,500 -5,000 45,000 45,000 L + + + 300,000

+2,500 Revenue

2,500

302,500 SE

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Balance sheet

ASSETS Cash Equipment 247 500 100 000

LIABILITIES Bank loan 45 000

SHAREHOLDERS EQUITY Share capital Retained profits 347 500 300 000 2 500 347 500

Assets = Liabilities + Shareholders equity

Income statement

Revenue Expense Net profits

2 500 0 2 500

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MCQ: Inventory was purchased for cash, when:

1. 2. 3. 4.

an asset increased and another asset decreased an asset decreased and an expense increased an asset decreased and a liability decreased a liability increased and an expense increased

Transaction analysis: The accounting equation extended

The equation you were introduced to earlier is as follows: Assets = Liabilities + Equity This is extended to: A = L + SE CA + NCA = CL + NCL + SE What is SE made up of?

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Accounting equation, cont.

Shareholders equity

contributions by shareholders Profit


revenues expenses

Distribution to shareholders (dividends)

Expanding the accounting equation


A = L + SE CA + NCA = CL + NCL + SE Where SE:

SC + opening RP at the start of the period + RP for the period SC + opening RP + profit dividends SC = Capital contributions by equity holders (share capital) RP = Retained profits Op RP = Opening retained profits Profit = R E R = Revenue E = Expenses Dividends = Distributions to equity holders

CA + NCA = CL + NCL + SC + Op. RP + R E D

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Link between the balance sheet and the income statement

Balance sheet
CA + NCA = CL + NCL + SE

CA + NCA = CL + NCL +

SC + Op. RP +

R E

Income statement

An illustrative example: Prepare transaction analysis

LRM Ltd: Balances as at 1 April 2012


Cash Inventory Land and buildings Equipment Accounts payable Notes payable Loans Share capital 140 000 55 000 300 000 90 000 15 000 70 000 300 000 200 000

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Transactions for April 2012

8 9 10 11 12 13 14

Cash sales of $30 000; Cost of goods sold = $12 000. Credit sales of $40 000; Cost of goods sold = $16 000. $8000 payments to suppliers. $20 000 wages paid for first 2 weeks of April. Received invoice for $2000 for an advertisement on April 5. Received $25 000 from accounts receivable. At end of month: $18 000 wages is owing for last 2 weeks of the month. Due to be paid on May 1.

LRM Ltd: Exhibit 3.3, page 100


Accounts Transaction Cash receivable Inventory Balance 140,000 0 55,000 8 30,000 -12,000 9 40,000 -16,000 10 -8,000 -8,000 -20,000 Expenses 2,000 25,000 -25,000 18,000 15,000 27,000 Assets 300,000 599,000 90,000 9,000 70,000 18,000 300,000 Liabilities 397,000 -18,000 Expenses 200,000 2,000 Stockholder's equity 202,000 -2,000 Expenses Land and Accounts Notes Wages building Equipment payable payable payable Loans 300,000 90,000 15,000 70,000 0 300,000 Share Retained Capital profits 200,000 0 30,000 Revenues -12,000 Expenses 40,000 Revenues -16,000 Expenses

11 -20,000 12 13 14 Total 167,000

A=L+SE

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LRM Ltd: Exhibit 3.4, page 101


LRM Ltd Income statement for the month ended 30 April 2012 $ Sales Cost of goods sold Gross profit Operating expenses Wages Advertising Net profit $ 70 000 28 000 42 000 40 000 2 000

38 000 2 000

LRM Ltd: Exhibit 3.5, page 101


LRM Ltd Balance sheet as at 30 April 2012 Assets $ Current assets Cash Accounts receivable Inventory Non-current assets Land and building at cost Office equipment at cost 167 15 27 209 000 000 000 000 Liabilities and shareholders equity $ Current liabilities Accounts payable 9 000 Notes payable 70 000 Wages payable 18 000 97 000 Non-current liabilities Loans Total liabilities Shareholders equity Share capital Retained profit * Total shareholders equity Total liabilities and shareholders equity 300 000 397 000

300 000 90 000 390 000

200 000 2 000 202 000 599 000

Total assets

599 000

* Retained profit = opening retained profits (0) + profit (2000) dividends declared (0) = 2000

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Double entry accounting

A = L + SE
The Golden Rule:

The accounting equation must always balance It means Debits = Credits.


In accounting we use debit (Dr) and credit (Cr) to describe changes in accounts

Debitcredit convention
Remember the equation:
Assets = Liabilities + Equity

We define increases in Assets to be debits (DR)


decreases in Assets therefore must be credits (CR) DR = CR, therefore increases in Liabilities (and Equity) must be credits, decreases must be debits.

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Basic orientation of the double-entry bookkeeping system


Always record on the left-hand side Uses of Capital Sources of Capital Always record on the right-hand side

Assets (A)

Liabilities (L)

Capital (SE)

Simultaneous recording of the use of capital and the source of capital

Expenses (+E)

Revenues (+R)

Double entry system: Debit and Credit Debit +A +E -L -SE -R -E Credit +L +SE +R -A

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Remembering debits/credits

Type Assets Liabilities Shareholders equity Revenues Expenses

Normal Debit Credit Credit Credit Debit

Incr. Debit Credit Credit Credit Debit

Decr. Credit Debit Debit Debit Credit

Debit and credit


Company record v.s. Bank statement

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Journal entries
Journal entries are, essentially, a shorthand version on
transaction analysis. They are prepared using the rules of debit and credit. Debits must always equal credits.

Journal entries
Example Machinery is purchased for $10 000 cash. Journal entry: Dr Machinery Cr Cash 10 000 10 000

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MCQ. Identify the journal entry required to correctly record each of the following transactions.

Cash received from accounts receivable

1. 2. 3. 4.

Dr Accounts Receivable Dr Cash Dr Cash none of the above

Cr Cash Cr Accounts Payable Cr Accounts Receivable

Link transaction analysis and journal entries Back to the previous transactions. Prepare journal entries for transaction 1-7. Prepare journal entries for LRM ltd.

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Transaction 1-7
1: Issued shares for $300 000 cash. 2: Borrowed $50 000 cash from the bank. 3: Purchase equipment for $100 000 cash. 4: Signed six-month agreement to provide catering service for a monthly fee of $2500 starting next month. 5: Catering services provided for an office function; billed customer for $2500. 6: Customer paid $2500 they owed on their account. 7: Paid the bank $5000 as part repayment of the loan.

Solution: Transaction 1-7


1. 2. 3. 4. 5. 6. 7.

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LRM ltd transactions for April 2012

8 9 10 11 12 13 14

Cash sales of $30 000; Cost of goods sold = $12 000. Credit sales of $40 000; Cost of goods sold = $16 000. $8000 payments to suppliers. $20 000 wages paid for first 2 weeks of April. Received invoice for $2000 for an advertisement on April 5. Received $25 000 from accounts receivable. At end of month: $18 000 wages is owing for last 2 weeks of the month. Due to be paid on May 1.

Solution: LRM ltd case


8. 9. 10. 11. 12. 13. 14.

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Wrap-Up
Double entry system: Debit and Credit
Debit +A +E -L -SE -R -E Credit +L +SE +R -A

Relationship between transaction analysis and


journal entries A negative figure in transaction analysis implies the
abnormal side in journal entries.

Next Lecture

Record-Keeping Please bring comprehensive class example from


the black board.

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