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Financial Accounting
Lecture No 2

Basics of Accounting Cycle..

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Financial Accounting
Lectures Outlines Accounting Cycle
Revision of Last lecture

Recording of transactions Source Documents General Journal Posting to Ledgers Trial Balance

Special Thanks

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Accounting Equation
Assets

Liabilities

Equity

Assets

Liabilities & Equity

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Assets
Cash Accounts Receivable Notes Receivable

Vehicles

Resources owned or controlled by a company

Land

Store Supplies

Buildings Equipment

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Liabilities
Accounts Payable Notes Payable

Creditors claims on assets

Taxes Payable Wages Payable

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Equity
Contributed Capital

Owners claim on assets

Retained Earnings

Dividends

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Expanded Accounting Equation

Assets

=
_

Liabilities

+
Revenues

Equity

Common Stock

Dividends

Expenses

Retained Earnings

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The Account and its Analysis

Assets

Liabilities

+
+

Equity

+
Common Stock

Dividends

Expenses

Revenues

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Transaction Analysis Equation

The accounting equation MUST remain in balance after each transaction.

Assets

Liabilities

Equity

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Transaction Analysis
J. Scott invests $20,000 cash to start the business in exchange for stock. The accounts involved are: (1) Cash (asset) (2) Common Stock (equity)

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Transaction Analysis
J. Scott invests $20,000 cash to start the business in return for stock.
Assets Cash Supplies Equipment (1) $ 20,000 = Liabilities Accounts Notes Payable Payable + Equity Common Stock $ 20,000

$ 20,000 $

$ $

20,000

$ 20,000

$ 20,000

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Transaction Analysis
Purchased supplies paying $1,000 cash. The accounts involved are: (1) Cash (asset) (2) Supplies (asset)

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Transaction Analysis
Purchased supplies paying $1,000 cash.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 = Liabilities Accounts Notes Payable Payable + Equity Common Stock $ 20,000

$ 19,000 $ 1,000 $ $ 20,000

$ $

20,000

$ 20,000

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Transaction Analysis
Purchased equipment for $15,000 cash.

The accounts involved are: (1) Cash (asset) (2) Equipment (asset)

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Transaction Analysis
Purchased equipment for $15,000 cash.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 = Liabilities Accounts Notes Payable Payable + Equity Common Stock $ 20,000

4,000 $ 1,000 $ $ 20,000

15,000 =

$ $

20,000

$ 20,000

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Transaction Analysis
Purchased Supplies of $200 and Equipment of $1,000 on account.

The accounts involved are: (1) Supplies (asset) (2) Equipment (asset) (3) Accounts Payable (liability)

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Transaction Analysis
Purchased Supplies of $200 and Equipment of $1,000 on account.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 $ 4,000 $ 1,200 $ $ 21,200 16,000 = = Liabilities Accounts Notes Payable Payable + Equity Common Stock $ 20,000

$ 1,200 $ 1,200 $ $ 21,200 $ 20,000

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Transaction Analysis
Borrowed $4,000 from 1st American Bank.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 (5) 4,000 $ 8,000 $ 1,200 $ 16,000 $ 25,200 = = Liabilities Accounts Notes Payable Payable + Equity Common Stock $ 20,000

$ 1,200 $ $ 1,200 $ $ 4,000 4,000 25,200 $ 20,000

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Transaction Analysis
The balances so far appear below. Note that the Balance Sheet Equation is still in balance.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Common Stock $ 20,000

$ 8,000 $ 1,200 $ $ 25,200

16,000 =

1,200 $

4,000

$ 20,000

$ 25,200

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Transaction Analysis

Now, lets look at transactions involving revenue, expenses and dividends.

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Transaction Analysis
Provided consulting services receiving $3,000 cash. The accounts involved are: (1) Cash (asset) (2) Revenues (equity)

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Transaction Analysis
Provided consulting services receiving $3,000 cash.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Common Stock Revenue $ 20,000 $ 3,000

$ 11,000 $

1,200 $

16,000 =

$ 1,200 $ 4,000 $ 28,200

$ 20,000 $ 3,000

$ 28,200

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Transaction Analysis
Paid salaries of $800 to employees. The accounts involved are: (1) Cash (asset) (2) Salaries expense (equity)
Remember that the balance in the salaries expense account actually increases.

But, equity decreases because expenses reduce equity.

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Transaction Analysis
Paid salaries of $800 to employees.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 (7) (800) $ 10,200 $ 1,200 $ 16,000 = = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Common Stock Revenue Expenses $ 20,000 $ 3,000 $ (800) $ 20,000 $ 3,000 $ (800)

$ 1,200 $

4,000

$ 27,400

$ 27,400

Remember that expenses decrease equity.

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Transaction Analysis
Dividends of $500 are paid to shareholders. The accounts involved are: (1) Cash (asset) (2) Dividends (equity)
Remember that the Dividend account actually increases. But, equity decreases because dividends reduce equity.

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Transaction Analysis
Dividends of $500 are paid to shareholders.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 (7) (800) (8) (500) $ 9,700 $ 1,200 $ 16,000 $ 26,900 = = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Common Stock Dividends Revenue Expenses $ 20,000 $ 3,000 $ (800) $ (500) $ 20,000 $ (500) $ 3,000 $ (800)

$ 1,200 $

4,000

$ 26,900

Remember that dividends decrease equity.

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Analyzing and Recording Process

Exchanges of economic consideration between two parties.

External Transactions occur between the organization and an outside party.

Internal Transactions occur within the organization.

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Analyzing and Recording Process

Analyze each transaction and event from source documents

Record relevant transactions and events in a journal

Prepare and analyze the trial balance

Post journal information to ledger accounts

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Source Documents
Checks Employee Earnings Records Bills from Suppliers Purchase Orders

Bank Statements Sales Tickets

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The Account and its Analysis

An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item.

The general ledger is a record containing all accounts used by the company.

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Ledger and Chart of Accounts

The ledger is a collection of all accounts for an information system. A companys size and diversity of operations affect the number of accounts needed. The chart of accounts is a list of all accounts and includes an identifying number for each account.
101 106 126 128 167 201 236 307 Cash Accounts receivable Supplies Prepaid insurance Equipment Accounts payable Unearned revenue Common stock 319 403 406 622 637 640 652 690 Dividends Revenues Rental revenue Salaries expense Insurance expense Rent expense Supplies expense Utilities expense

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Debits and Credits

A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions.
T- Account (Left side) (Right side) Debit Credit

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Double-Entry Accounting
Assets
ASSETS

Liabilities
LIABILITIES

Equity
EQUITIES

Debit

Credit

Debit

Credit

Debit

Credit

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Double-Entry Accounting Equity

Common Stock
Stock

Dividends

Revenues
Revenues

Expenses

Dividends

Expenses

Debit Credit

Debit Credit

Debit Credit

Debit Credit

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Double-Entry Accounting
An account balance is the difference between the increases and decreases in an account. Notice the T-Account

Cash
Investment by owner for stock Consulting services revenues earned Collection of accounts receivable 30,000 Purchase of supplies 4,200 Purchase of equipment 1,900 Payment of rent Payment of salary Payment of account payable Payment of cash dividend 36,100 Total decreases 4,800 2,500 26,000 1,000 700 900 200 31,300

Total increases Balance

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Journalizing & Posting Transactions

Assets

Liabilities

Equity

T- Account (Left side) (Right side) Debit Credit

Step 1: Analyze transactions and source documents.

ACCOUNT NAME:
Date Description PR

Step 2: Apply doubleentry accounting

ACCOUNT No.
GENERAL JOURNAL
Debit Credit Balance
Date Description Post. Ref.

Page
Debit

123
Credit

Step 4: Post entry to ledger

Step 3: Record journal entry

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Journalizing Transactions
Transaction Date Titles of Affected Accounts

GENERAL JOURNAL
Date Account Titles and Explanations PR 2007 Dec. 1 Cash Common stock Investment by shareholders
Transaction Dec. 2 Supplies explanation

Page 1
Debit 30,000 30,000 Credit

Cash

Dollar amount of debits 2,500 and credits

2,500

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Balance Column Account

T-accounts are useful illustrations, but balance column ledger accounts are used in practice.
CASH
Date 2007 Dec. 1 Dec. 2 Dec. 3 Dec. 10 Explanation PR

ACCOUNT No. 101

Debit Credit Balance

Initial investment Purchased supplies Purchased equipment Collection from customer

30,000 2,500 26,000 4,200

30,000 27,500 1,500 5,700

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Posting Journal Entries

GENERAL JOURNAL
Date Account Titles and Explanation 2007 Dec. 1 Cash Common stock Investment by shareholders Dec. 2 Supplies Cash 1 Identify the debit account Purchased store supplies for cash PR Debit 30,000 30,000

Page 1
Credit

2,500

in ledger.
ACCOUNT No.
PR Debit Credit

2,500

CASH

101
Balance

Date 2007

Explanation

Dec. 3

Purchased equipment

G1

20,000.00

########

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Posting Journal Entries

GENERAL JOURNAL
Date Account Titles and Explanation 2007 Dec. 1 Cash Common stock Investment by shareholders Dec. 2 Supplies 2 Enter the date. Cash Purchased store supplies CASH for cash PR Debit 30,000 30,000

Page 1
Credit

2,500 2,500

ACCOUNT No.
PR Debit Credit

101
Balance

Date 2007 Dec. 1 Dec. 3

Explanation

Purchased equipment

G1

20,000.00

########

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Posting Journal Entries

GENERAL JOURNAL
Date Account Titles & Elxplanations PR 2007 Dec. 1 Cash Common stock Investment by shareholders Dec. 2 Supplies 3 Enter the amount and description. Cash Purchased store supplies CASH for cash
Date 2007 Dec. 1 Dec. 3 Explanation PR Debit

Page 1
Debit 30,000 30,000 Credit

2,500 2,500
ACCOUNT No.
Credit

101
Balance

30,000 Purchased equipment

G1

20,000

(20,000)

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Posting Journal Entries

GENERAL JOURNAL
Date Account Titles and Explanation PR 2007 Dec. 1 Cash Common stock Investment by shareholders Dec. Enter the journal reference. 2 Supplies 4 Cash Purchased store supplies CASH for cash Debit 30,000 30,000

Page 1
Credit

2,500 2,500

ACCOUNT No.
Debit Credit

101
Balance

Date 2007 Dec. 1

Explanation

PR G1

30,000

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Posting Journal Entries

GENERAL JOURNAL
Date Account Titles & Elxplanations 2007 Dec. 1 Cash Common stock Investment by shareholders Dec. 5 2 Supplies Compute the balance. Cash Purchased store supplies CASH for cash PR Debit 30,000 30,000

Page 1
Credit

2,500 2,500

ACCOUNT No.
PR G1 Debit Credit

101
Balance

Date 2007 Dec. 1 Dec. 3

Explanation

30,000 20,000

30,000 (20,000)

Purchased equipment

G1

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Posting Journal Entries

GENERAL JOURNAL
Date Account Titles and Explanation 2007 Dec. 1 Cash Common stock Investment by shareholders Dec. 6 2 Enter the ledger reference. Supplies Cash Purchased store supplies CASH for cash PR 101 Debit 30,000 30,000

Page 1
Credit

2,500 2,500

ACCOUNT No.
Debit Credit

101
Balance

Date 2007 Dec. 1 Dec. 3

Explanation

PR G1

30,000 20,000

30,000 (20,000)

Purchased equipment

G1

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Analyzing Transactions
Transaction:
Cash 30,000

Shareholders invested $30,000 in FastForward on Dec. 1.

Analysis:
Assets = Liabilities + Equity Common Stock 30,000

Double entry:
(1) Cash Common stock 101 301
101

30,000 30,000
Common Stock (1)
301

Posting:
(1) Cash 30,000
30,000

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Analyzing Transactions
Transaction: FastForward purchases supplies by paying $2,500 cash.

Analysis:
Cash (2,500) Assets Supplies 2,500 = Liabilities + Equity Common Stock

Double entry:
(2) Supplies Cash 126 101 2,500 2,500
Cash 30,000
101

Posting:
(2) Supplies 2,500
126

(1)

(2)

2,500

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Analyzing Transactions
Transaction: FastForward purchases equipment by paying $26,000 cash.

Analysis:
Assets Cash Equipment (26,000) 26,000 = Liabilities + Equity Common Stock

Double entry:
(3) Equipment Cash 167 101 26,000 26,000
Cash 30,000
101

Posting:
(3) Equipment 26,000
167

(1)

(2) (3)

2,500 26,000

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Analyzing Transactions
Transaction: FastForward purchases $7,100 of supplies on credit.

Analysis:
Assets Supplies 7,100 = Liabilities Accounts Payable 7,100 + Equity Common Stock

Double entry:
(4) Supplies Accounts payable 126 201 7,100 7,100

Posting:
(2) (4) Supplies 26,000 7,100
126

Accounts Payable (4)

201

7,100

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Analyzing Transactions
Transaction: FastForward provides consulting services and immediately collects $4,200 cash.

Analysis:
Assets Cash 4,200 = Liabilities + Equity Revenue 4,200

Double entry:
(5) Cash Consulting Revenue 101 403 4,200 4,200

Posting:
403 Consulting Revenue (5) 4,200

(1) (5)

Cash 30,000 4,200

101

(2) (3)

2,500 26,000

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After processing its remaining transactions for December, FastForwards Trial Balance is prepared.
FastForwar d Trial Balance December 31, 2007 Cash Accounts receivable Supplies Prepaid Insurance Equipment Accounts payable Unearned consulting revenue Common stock Dividends Consulting revenue Rental revenue Salaries expense Rent expense Utilities expense Total Debits $ 4,350 9,720 2,400 26,000 Credits

6,200 3,000 30,000 5,800 300

200

The trial balance lists all account balances in the general ledger. If the books are in balance, the total debits will equal the total credits.

1,400 1,000 230 $ 45,300 $ 45,300

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Six Steps for Searching for and Correcting Errors

If the trial balance does not balance, the error(s) must be found and corrected. Make sure the trial balance columns are correctly added. Recompute each account balance in the ledger.

Make sure account balances are correctly entered from the ledger. See if debit or credit accounts are mistakenly placed on the trial balance.

Verify that each journal entry is posted correctly. Verify that each original journal entry has equal debits and credits.

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Using a Trial Balance to Prepare Financial Statements

Point in Time Period of Time

Point in Time

Income Statement
Statement of Retained Earnings

Beginning Balance Sheet

Statement of Cash Flows

Ending Balance Sheet

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End of Lecture 02
Special Thanks

To MBA- I (90E) Students