Presentation on theme: "Accounting for Transactions and the Financial Statements"— Presentation transcript:
1Accounting for Transactions and the Financial Statements Chapter 2Accounting for Transactions and the Financial StatementsQ: How does a bank determine is a business is qualified to receive a loan? How does a bonding company determine if a construction company is stable enough for bonding? How does an educated investor analyze a company to determine if it’s under valued?A: All of the above questions have the same answer…..to evaluate the financial stability of a business, one would look at the financial statements of the company which are prepared or certified by Financial Accountants.There are four (book defines 3) primary types of financial statements that get prepared together as a package for evaluation by interested outside parties:
2Financial StatementsP1Let’s prepare the Financial Statements reflecting the transactions we have recorded.Income StatementStatement of Retained EarningsBalance SheetStatement of Cash FlowsThere are four fundamental financial statements used in accounting.1. The income statement shows our revenues and expenses.2. The statement of owner’s equity shows the change in the owners’ equity during the current period.3. The balance sheet is a listing of all asset, liability, and equity account balances.4. The statement of cash flows shows where the company got its cash and how it spent its cash.The first financial statement that we prepare is the income statement. Let’s get started.34
3Net income is the difference between Revenues and Expenses. Income StatementP1Net income is the difference between Revenues and Expenses.Net income is defined as the difference between revenues and expenses. If expenses exceed revenues, we have a net loss rather than net income. Financial statements have a three line title with the company name, the name of the statement, and the period covered by the report. In our case, we had total revenues of three thousand dollars and total expenses of eight hundred dollars, so net income for the month ended December 31, 2007, was two thousand, two hundred dollars. After completing the income statement, we may prepare the statement of retained earnings.-Income Statement (Statement of Earnings)- The amount of income A/K/A Revenues less expenses for a particular period of time. (Page 66 in text and last page of notes).The income statement describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.
4Statement of Retained Earnings P1The net income of $2,200 increases Retained Earnings by $2,200.-Statement of Retained Earnings- summarizes the change in retained earnings over a period of time. This statement is usually consolidated with and shown at the bottom of the income statement. (page 66 in text and last page of notesIn the statement of retained earnings, we start with the balance at the beginning of the period, add net income earned during the period, and deduct any dividends paid, resulting in the ending balance in retained earnings. The company was started this month, so the beginning balance in retained earnings was zero. During December net income of two thousand, two hundred dollars was earned. In addition, five hundred dollars in dividends was paid, so the ending balance in retained earnings is one thousand, seven hundred dollars. After we complete this statement, we can prepare the balance sheet.
5Balance SheetP1The Balance Sheet describes a company’s financial position at a point in time.-Balance Sheet (Statement of Financial Position)- a “snapshot” of a company that summarizes the total assets, liabilities and equity of a company as of a particular date. (Page 66 text and last page of notes). These can be prepared at the end of a year, month or quarter or as of any period.The balance sheet is an inventory of assets, liabilities and equity at the end of the month. Our total assets are equal to twenty six thousand, nine hundred dollars. This includes cash of ninety seven hundred dollars, supplies of twelve hundred dollars, and equipment of sixteen thousand dollars.Liabilities include accounts payable of twelve hundred dollars and notes payable of four thousand dollars. The common stock account has a balance of twenty thousand dollars and we just calculated the ending balance in retained earnings of seventeen hundred dollars. You can see that the books are in balance because total assets are equal to total liabilities plus equity.Creditors have claims against our assets of five thousand, two hundred dollars. The owner has claims to assets of twenty one thousand, seven hundred dollars.
6Statement of Cash Flows P1We will cover the statement of cash flows in detail in a later chapter. Notice that the statement is divided into three major sections; (1) cash flows from operating activities; (2) cash flows from investing activities; and (3) cash flows from financing activities. The statement reconciles to the ending cash balance of nine thousand, seven hundred dollars.Now that we’ve summarized the basic financial statements, lets discuss the basic elements of each statement.
7Asset Accounts Asset Accounts Cash Accounts Receivable Land Notes ReceivableBuildingsHere is a listing of common assets accounts we are likely to find in all businesses. Prepaid accounts may be new to you. Think about your auto insurance. Many of us pay our auto insurance semi-annually or annually. The payment is made in advance and is referred to as a prepaid amount.Assets- something that you ownWhat financial statements are these found on??Prepaid AccountsEquipmentSupplies
8Liability Accounts Liability Accounts Accounts Payable Notes Payable This is a listing of common liability accounts we are likely to see in the general ledger. An unearned revenue is one in which the cash has been received but the product or service has not be delivered. If you subscribe to a magazine, you generally pay a one-year subscription in advance. For the publishing company, cash is received but nothing has been done to earn the revenue. As the magazine is delivered to you, the publishing company recognizes a portion of the money received as revenue. At the end of the year, all the revenue will be earned and the liability no longer exists.Liabilities- something that you oweWhat Financial Statement are they found on?Unearned RevenueAccrued Liabilities
9Equity Accounts Equity Accounts Common Stock Dividends Revenues Owners equity- the owners actual interest in the business, is determined by subtracting total assets from total liabilities. Otherwise known as net assets or stockholders equity. Many people refer to owners equity as the residual interest in the business.What financial statements are the above found on??Note DIAGRAM on Blackboard to illustrate equity, revenue and expense!!Financial statement terminology relating to the income statement and statement of retained earnings:Revenues- Increase in company resources from the sale of goods or services. If I sell 10 Pepsi’s in a bar for $3 a can, I have $30 in revenue.Expenses- costs incurred in the normal course of business to generate these revenues. The bars cost to buy the bottles of pepsi, and salaries to the bartenders are examples.Net Income- an overall measure of performance for the period which equals revenues less expenses.Ending retained earnings is: Beginning Retained Earnings + Net Income – Dividends Paid = Ending Retained Earnings.Statements tie in and are all inter related, see page 66 in textbook, and handout on overhead.RevenuesExpenses
10= + Accounting Equation Liabilities Equity Assets Liabilities & Equity The basic accounting equation states that assets are equal to liabilities plus equity of a company. The equation makes sense because in a general way it states that assets must be equal to the claims against those assets. If you have an asset we can have two broad categories of claims against that asset. First, we may have claims by creditors, liabilities. Finally, after all creditor claims are satisfied, the residual owners, and stockholders, have a claim on those assets.Liabilities & EquityAssets
11Expanded Accounting Equation LiabilitiesEquityAssets=+LiabilitiesEquityAssets=+RevenuesExpensesCommon StockDividends_+Here is a breakdown of the equity section of the of the accounting equation to show the mathematical signs we will be using to keep track of investments by owners, common stock, payments to owners (dividends), revenues and expenses. Notice that revenues increase equity and expenses reduce equity.Retained Earnings
12Transaction Analysis Equation The accounting equation MUST remain in balance after each transaction.LiabilitiesEquityAssets=+During the process of recording business transactions, it is important that we always keep the accounting equation in balance. We can’t let our books get out of balance. You have probably heard this term before, but may not have been sure what we meant by keeping the books in balance.
13Analyzing and Recording Process Record relevant transactions and events in a journalAnalyze each transaction and event form source documentsPost journal information to ledger accountsOnce we identify a business transaction, we record it in a journal. A journal is arranged in chronological order. Transactions are recorded by date of occurrence.Analyzing and Processing Transactions:Throughout the year, as transactions occur for a business, the individual transactions are recorded. The ends of the year financial statements are a summary of all the transactions that occur during the year. The general “bookkeeping” process is recording of the day-to-day transactions, while the process of “accounting” is summarizing these day to day transactions in the financial statements.In order to account for the large volume of transactions that an entity may have, take McDonalds for example, accountants have devised a process to account for transactions of an entity and named this process the Accounting Cycle the procedure for analyzing, recording, summarizing, and reporting the transactions of a business.Prepare and analyze the trial balance
14Analyzing and Recording Process Exchanges of economic consideration between two parties.In accounting we generally record transactions involving exchanges of economic consideration between two parties. We have many transactions with external parties like creditors, customers, financial institutions and owners. In addition, we must also look at internal transactions. These type of transactions may involve exchanges between divisions within a company or payments to employees.External Transactions occur between the organization and an outside party.Internal Transactions occur within the organization.
15Employee Earnings Records Source DocumentsC 2Bills from SuppliersChecksPurchase OrdersEmployee Earnings RecordsBank StatementsAlmost all businesses use sales orders, purchase orders, statements from suppliers, canceled checks, bank statements, shipping notices, packing slips, and the like to support the existence of a transaction. In today’s highly computerized environment many source documents are stored digitally. Knowing how to access these digital source documents is an important part of accounting.Sales Tickets
16The 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.Here are more complete definitions of account balances and ledger accounts.
17The Account and its Analysis Assets Accounts=+Liability AccountsEquity AccountsAt all times, assets must always equal liabilities plus owners equity, therefore if an event occurs that increases assets, something must change to either liabilities or owners equity, so that the equation is always equal. This is the concept behind double entry accounting a system of recording transactions in a way that maintains the equality of the accounting equation.What is the effect of each transaction on the accounting equation?Investment of $50,000 capital by owners of the business.Company borrowed a $25,000 note from the bank.Company purchased $14,000 worth of inventory on credit to be paid at a later date.Company purchased equipment costing $15,000. Was purchased for cash.You should notice that in each case, the total net effect on the accounting equation is zero, or assets still equal liabilities + owners equity.
18Ledger and Chart of Accounts The ledger is a collection of all accounts for an information system. A company’s 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.A chart of accounts is a listing of all accounts in the ledger. Notice that all assets accounts begin with an account number of one, all liabilities with two, equities with three, revenues with four, and expenses with six. Instead of just recording transactions to general assets, liability or equity accounts, we create actual accounts as shown above, and record to specific accounts. Accounts that begin with a #1 are assets, #2 are liabilities, #3 equity, # 4 revenue and #5 expense.
19Debits and CreditsC 5A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions.To obtain an understanding of an account we often analyze accounts in a T-account a simplified deception of an account in the form of a letter T. The account is a specific record used to track, classify and monitor transactions. The “T” Account is the ledger function of the accounting function as shown above. After one records the transactions into the Journal to be described next, the transactions are then posted to “T” Accounts.The left side of a T-Account is called the debit side and the right side is called the credit side of the account. Just like assets always must equal liabilities plus equity, debits must always equal credits; therefore if you debit one account for $100, you must also credit another account for $100.Look at the examples below that we previously discussed and record each transaction in a “T” account1. Investment of $50,000 capital by owners of the business.2. Company borrowed a $25,000 note from the bank.3. Company purchased $14,000 worth of inventory on credit to be paid at a later date.4. Company purchased equipment costing $15,000. Was purchased for cash.Notice in each case that for each transaction one account has a ‘debit’ and one account has a ‘credit’ for each transaction. Also be aware that per double entry accounting each transaction must have a MININUM of two accounts impacted, but there is no upper limit, e.g. a payroll journal entry for a large company could impact literally thousands of accounts.
20Double-Entry Accounting An account balance is the difference between the increases and decreases in an account.Notice the T-AccountWe have determined the balance in accounts in the last chapter, but in this chapter we will look at a more comprehensive way to determine an account balance.The cash account is an asset, so increases, or receipts, are shown on the debit, or left side, and decreases, or payments, are shown on the credit side, or right side. To determine if an account has a debit or credit balance, we total the right and left sides and place the balance on the larger side. In this example, our increases in cash amount to thirty-six thousand one hundred dollars and the decreases total thirty-one thousand three hundred dollars so the cash account has a debit, or positive balance of four thousand eight hundred dollars.
21Journalizing & Posting Transactions Step 1: Analyze transactions and source documents.LiabilitiesEquityAssets=+Step 2: Apply double-entry accountingStep 3: Record journal entryIn the accounting process you first analyze a transaction by looking at proper source documentation. Next, we apply the rules of double-entry accounting and record a general journal entry. The general journal is a chronological listing of the transactions. At the end of the accounting period we post the information from the general journal to the proper general ledger account. The general ledger groups all transaction that impact a particular account. That is, all the transactions that increase or decrease the cash account are posted to the cash general ledger account.Step 4: Post entry to ledger
22Journalizing Transactions P1Journalizing TransactionsTransaction DateTitles of Affected AccountsHere is an example of the proper recording of a general journal transaction. We have seen a similar transaction before. In this case, the owner of the business contributes thirty thousand dollars cash to start the business and receives shares of common stock. Let’s see how we get the various pieces.Part IThe transaction occurred on December 1, The date in important when recording general journal transactions and is recorded on the left side of the journal.Part IINext we identify the accounts affected by the transactions. The cash account is an asset that has increased. We show increases in accounts with a debit to that account. The common stock account also increased and we show increases in equity accounts with a credit. Debits are always listed first in the journal followed by credits that are slightly indented below the debits.Part IIIThe dollar amount is place in the appropriate debit or credit column. In this case, the cash account was debited for thirty thousand dollars, so we place that amount in the debit column.Part IVFinally, we prepare a brief description of the transaction so that other people who view our work will understand the nature of the transaction. This explanation is indented about as far as the credited account titles to avoid confusing it with accounts and it is italicized.Take the transactions that we have currently used with the accounting equation and ‘T’ accounts and now record them in journal entries.Dollar amount of debits and creditsTransaction explanation
23Analyzing Transactions Analysis:Double entry:Let’s see if we can analyze transactions and get them into the proper form for double-entry accounting. This will be helpful when you turn to your homework.In the first transaction, on December first, a shareholders invests thirty thousand dollars to start a company called FastForward. From our previous work we know that the cash account and the common stock account will increase.In this course, we will utilize ‘T’ Accounts as the ledger, so if asked on a quiz or exam to post a transaction, this means to post all transactions from the journal to ‘T’ Accounts.We record this information in the general journal with a debit, increase, to cash, and a credit, increase, to common stock. Notice that the account number for the cash account is one-zero-one and common stock is three-zero-one. We are going to post the information in the journal to the general ledger. We will use t-accounts to accomplish this.We place the thirty thousand dollars on the left, or debit, side of the cash account and on the right, or credit, side of the common stock account. Our books are in balance because total assets are equal to total liabilities plus equity. Let’s move to another transaction.101301Posting:
24Analyzing Transactions Analysis:Double entry:In our second transaction, FastForward purchases office supplies paying twenty-five hundred dollars cash. We have exchanged one asset, cash, for another asset, supplies. The cash account will decrease and the supplies account will increase. Can you make the general journal entry to record this transaction?We increase the supplies account with a debit and decrease the asset account, cash, with a credit. Let’s post the amounts.The general ledger account for supplies increased by twenty-five hundred dollars so the amount is placed on the debit side of the account. The cash account, an asset, decreased by twenty-five hundred dollars, so the amount is placed on the credit side of the general ledger account. Let’s move on to another transaction.126101Posting:
25Analyzing Transactions Analysis:Double entry:In our third transaction, FastForward purchases equipment paying twenty-six thousand dollars cash. Once again, we have exchanged one asset, cash, for another asset, equipment. The cash account will decrease and the equipment account will increase. This general journal entry will look similar to the one we just completed.We increase the equipment account with a debit and decrease the asset account, cash, with a credit. Let’s post the amounts.The general ledger account for equipment increased by twenty-six thousand dollars so it is placed on the debit side of the account. The cash account, an asset, decreased by twenty-six thousand dollars, so the amount is placed on the credit side of the general ledger account. Let’s look at another transaction.167101Posting:
26Analyzing Transactions Analysis:Double entry:In this transaction, FastForward purchases seventy-one hundred dollars of office supplies on account. The supplies account, an asset, will increase and the liability account, accounts payable will increase. Let’s make the general journal entry to record this transaction.We increase the supplies account with a debit and increase the liability account, accounts payable, with a credit. It time to post the transaction.The general ledger account for supplies increased by seventy-one hundred dollars so the amount is placed on the debit side of the account. The accounts payable account, a liability, increased by the same amount, so we place it on the credit side of the general ledger account. Let’s analyze another transaction.126201Posting:
27Analyzing Transactions Analysis:Double entry:FastForward provided consulting services and collected forty-two hundred dollars cash. The asset account, cash, increased by forty-two hundred dollars and the equity account, consulting revenue, increased by the same amount. See if you can make the general journal entry to record this transaction before moving to the next slide.We increase the cash account with a debit and increase the revenue account, consulting revenue, with a credit. Let’s post the amounts.The general ledger account for cash increased by forty-two hundred dollar so the amount is placed on the debit side of the account. The consulting revenue account increased by the same amount, so it is placed on the credit side of the general ledger account. We could continue on with more transaction, but your homework will help reinforce what we have done here. Let’s take a look at the trial balance of FastForward at the end of December.403101Posting:
28A1After processing its remaining transactions for December, FastForward’s Trial Balance is prepared.DebitsCreditsCash4,350$Accounts receivable-Supplies9,720Prepaid Insurance2,400Equipment26,000Accounts payable6,200Unearned consulting revenue3,000Common stock30,000Dividends200Consulting revenue5,800Rental revenue300Salaries expense1,400Rent expense1,000Utilities expense230Total45,300FastForwardTrial BalanceDecember 31, 2007The trial balance lists all account balances in the general ledger. If the books are in balance, the total debits will equal the total credits.On the trial balance we list all the account in our general ledger and their related balances. The total of all our debit account balances must equal all our credit account balances. If this is not the case, we may have made an error posting the journal entry into the ledger. We cannot prepare the financial statement until the books are in balance as determine by the trial balance.Each account has a normal balance or balance that an account should generally have. In other words, any asset’s normal balance is a debit balance, while liabilities and equity normally have a credit balance. To increase an asset, you would debit it, and it normally has a debit balance, while to increase a liability or equity one would credit it, meaning that its normal balance is a credit balance.Assets = Liabilities + Owners EquitySince assets are on the LEFT side of the equal sign, they are considered DEBIT accounts, are increased with a debit and shown on the debit side of the trial balance. Since Liabilities and Equity are on the right (Credit) side of the equation, they are credit accounts and increased with a credit.Why are revenues credit accounts and expenses debit accounts?
29Six 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.Verify that each journal entry is posted correctly.You may want to refer back to this screen if you run into trouble with your homework. We have listed six steps to follow when your trail balance if out of balance.See if debit or credit accounts are mistakenly placed on the trial balance.Verify that each original journal entry has equal debits and credits.
30Income StatementP3Here is the information for FastForward for the month ended December 31, The company had total revenues of sixty one hundred dollars and total expenses of two thousand six hundred and thirty dollars. For the month FastForward generated three thousand four hundred and seventy dollars in net income. Look back at our trial balance to verify the amount shown on the income statement.
31Statement of Retained Earnings P3The beginning balance in retained earnings was zero because the company was started on December 1, We earned income of three thousand four hundred and seventy dollars. During the month dividends of two hundred dollars were paid. The ending balance in retained earnings is three thousand two hundred seventy dollars. This amount will appear on the equity section of the balance sheet. Let’s look at the balance sheet now.
32Balance SheetP3Total assets equal forty-two thousand four hundred seventy dollars. Total liabilities are ninety two hundred dollars and our equity balance is thirty-three thousand two hundred seventy dollars. The accounting equation is in balance because assets are equal to liabilities plus equity.The last two pages are summarized together on page 66 of your textbook.