The Accounting Cycle: Capturing Economic Events

1. The Accounting Cycle: Capturing Economic Events

Chapter 3
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2.

The Accounting Cycle
Journalize
transactions.
Post entries to
the ledger
accounts.
Prepare trial
balance.
Prepare after-closing Journalize and
post closing
trial balance.
entries.
Prepare
financial
statements.
Make end-ofyear
adjustments.
Prepare adjusted
trial balance.
3-2

3. 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.
3-3

4. The Ledger

Cash
Accounts
Payable
Capital
Stock
Accounts are
individual records
showing increases
and decreases.
The entire group of
accounts is kept
together in an
accounting record
called a ledger.
3-4

5. The Use of Accounts

Increases are
recorded on one side
of the T account, and
decreases are
recorded on the
other side.
Title of Account
Left
or
Debit
Side
Right
or
Credit
Side
3-5

6. Debit and Credit Entries

Receipts are
on the debit
side.
5/1
5/25
5/29
5/31
Bal.
Cash
8,000
5/2 2,500 Payments are
credit
75
5/8 2,000 on the
side.
750 5/28
150
5/31
50
4,125
The balance is the
difference between the
debit and credit entries
in the account.
3-6

7. Debit and Credit Entries

Debits and credits affect accounts as follows:
A = L + OE
ASSETS
LIABILITIES
EQUITIES
Debit
Credit
for
for
Increase Decrease
Debit
Credit
for
for
Decrease Increase
Debit
Credit
for
for
Decrease Increase
3-7

8. Double Entry AccountingThe Equality of Debits and Credits

Double Entry Accounting The Equality of
Debits and Credits
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.
3-8

9.

Let’s record
selected
transactions
for JJ’s Lawn
Care Service in
the accounts.
3-9

10.

May 1: Jill Jones and her family invested $8,000
in JJ’s Lawn Care Service and received 800 shares
of stock.
Will
Cash
Cash
increases
increase
$8,000
or decrease?
with a debit.
Cash
5/1 8,000
Will
Capital
Capital
Stock
Stock
increases
increase$8,000
or
with
decrease?
a credit.
Capital Stock
5/1 8,000
3-10

11.

May 2: JJ’s purchased a riding lawn mower
for $2,500 cash.
Will
Cash
Cash
decreases
increase
$2,500
or decrease?
with a credit.
Cash
5/1 8,000
5/2 2,500
Tools
Will
& Tools
Equipment
&
Equipment
increases increase
$2,500
or
with
decrease?
a debit.
Tools & Equipment
5/2 2,500
3-11

12.

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
increases
Will
Truck
increase
$15,000
with a debit.
or decrease?
Truck
5/8 15,000
Cash decreases
Will Cash and
$2,000 with a credit.
Notes Payable
Notes Payable
increase or
increases $13,000
decrease?
with a credit.
Cash
5/1 8,000
5/2 2,500
5/8 2,000
Notes Payable
5/8 13,000
3-12

13.

May 11: JJ’s purchased some repair parts
for $300 on account.
Tools
Will
& Tools
Equipment
&
Equipment
increases $300
increase
with
or decrease?
a debit.
Accounts
Will Accounts
Payable
increases
Payable increase
$300 with
or
decrease?
a credit.
Tools & Equipment
5/2 2,500
5/11
300
Accounts Payable
5/11
300
3-13

14.

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
Will
& Tools
Equipment
&
decreases
Equipment$150
increase
with
or adecrease?
credit.
Tools & Equipment
5/2 2,500 5/18
150
5/11
300
Accounts
Will Accounts
Receivable
Receivable
increases $150
increase
with
or decrease?
a debit.
Accounts Receivable
5/18
150
3-14

15. The Journal

In an actual accounting system,
transactions are initially recorded in the
journal.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2009
May 1 Cash
Capital Stock
8,000
8,000
Owners invest cash in the business.
3-15

16. Posting Journal Entries to the Ledger Accounts

Posting simply
means updating the
ledger accounts for
the effects of the
transactions
recorded in the
journal.
3-16

17. Posting Journal Entries to the Ledger Accounts

GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2009
May 1 Cash
8,000
Capital Stock
8,000
Owners invest
cash in the
business.
General
Ledger
Date
2009
May 1
Cash
Debit
Credit
8,000
Balance
8,000
3-17

18. Posting Journal Entries to the Ledger Accounts

GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2009
May 1 Cash
8,000
Capital Stock
8,000
Owners invest
cash in the
business.
General
Ledger
Date
2009
May 1
Capital Stock
Debit
Credit
8,000
Balance
8,000
3-18

19. Posting Journal Entries to the Ledger Accounts

GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2009
May 2 Tools & Equipment
Cash
2,500
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.
3-19

20. Ledger Accounts After Posting

Date
2009
May 1
2
General Ledger
Cash
Debit
Credit
8,000
2,500
Balance
8,000
5,500
This ledger format is referred to as a
running balance.
3-20

21. Ledger Accounts After Posting

Date
2009
May 1
2
General Ledger
Cash
Debit
Credit
8,000
2,500
Balance
8,000
5,500
T accounts are simplified versions of
the ledger account that only show the
debit and credit columns.
3-21

22. What is Net Income?

Net income is not an asset it’s an increase
in owners’ equity from profits of the
business.
A = L + OE
Increase
Decrease
As income is earned,
either an asset is
increased or a liability is
decreased.
Increase
Net income
always results in
the increase of
Owners’ Equity
3-22

23. Retained Earnings

A = L + OE
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.
3-23

24. The Income Statement: A Preview

JJ's Lawn Care Service
Income Statement
For the Month Ended May 31, 2009
Sales Revenue
Operating Expense:
Gasoline Expense
Net Income
$
750
$
50
700
The income statement summarizes the
profitability of a business for a specified period
of time.
3-24

25. 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.
3-25

26. 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.
3-26

27. The Revenue Principle: When To Record Revenue

Revenue Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.
3-27

28. The Matching Principle: When To Record Expenses

Matching Principle
Expenses should be
recorded in the
period in which they
are used up.
3-28

29. The Accrual Basis of Accounting

Current
Accounting Period
Jan. 1, 2009
Future
Accounting Period
Dec. 1, 2009
Cash is received or paid
here
Jan. 1, 2010
But . . .
Dec. 1, 2010
The income statement
reports revenue or
expense here
OR
The income statement
reports revenue or
expenses here
But . . .
Cash is received or paid
here
3-29

30. Debit and Credit Rules for Revenue and Expenses

Expenses
decrease
owners’
equity.
EQUITIES
Debit
Credit
for
for
Decrease Increase
Revenues
increase
owners’
equity.
EXPENSES
REVENUES
Debit
Credit
for
for
Increase Decrease
Debit
Credit
for
for
Decrease Increase
3-30

31. Dividends

Payments to
owners
decrease
owners’
equity.
EQUITIES
Debit
Credit
for
for
Decrease Increase
DIVIDENDS
Debit
Credit
for
for
Increase Decrease
Owners’
investments
increase
owners’
equity.
CAPITAL STOCK
Debit
Credit
for
for
Decrease Increase
3-31

32.

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.
3-32

33.

May 29: JJ’s provided lawn care services for
a client and received $750 in cash.
Will
Cash
Cash
increases
increase
$750
or decrease?
with a debit.
Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
Will
Sales
Sales
Revenue
Revenue
increases
increase
$750
orwith
decrease?
a credit.
Sales Revenue
5/29
750
3-33

34.

May 31: JJ’s purchased gasoline for the lawn
mower and the truck for $50 cash.
Cash
Will Cash
decreases
increase
$50
or
with
decrease?
a credit.
Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
5/31
50
Gasoline
Will Gasoline
Expense
Expense
increasesincrease
$50 withor
a
decrease?
debit.
Gasoline Expense
5/31
50
3-34

35.

May 31: JJ’s Lawn Care paid Jill Jones and
her family a $200 dividend.
Will
Cash
Cash
decreases
increase
$200
or decrease?
with a credit.
Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
5/31
50
5/31
200
Will Dividends
Dividends increase
increase or
$200 with a debit.
decrease?
5/31
Dividends
200
3-35

36.

Now, let’s look at
the Trial Balance
for JJ’s Lawn
Care Service for
the month of May.
3-36

37.

JJ's Lawn Care Service
Unadjusted Trial Balance
May 31, 2009
Cash
$
3,925
Accounts receivable
75
Tools & equipment
2,650
Truck
15,000
Notes payable
$
Accounts payable
Capital stock
Dividends
200
Sales revenue
Gasoline expense
50
Total
$
21,900 $
13,000
150
8,000
750
21,900
All balances are taken from the ledger accounts on May
31 after considering all of JJ’s transactions for the
month.
3-37

38. The Accounting Cycle in Perspective

Accountants spend
much of their time
focusing on the
more analytical
aspects of their
discipline.
3-38

39. End of Chapter 3

3-39