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Analyzing Business transactions 2. Measurement Issues OBJECTIVE 1: Explain how the concepts of recognition, valuation, and classification apply to business.

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Presentation on theme: "Analyzing Business transactions 2. Measurement Issues OBJECTIVE 1: Explain how the concepts of recognition, valuation, and classification apply to business."— Presentation transcript:

1 Analyzing Business transactions 2

2 Measurement Issues OBJECTIVE 1: Explain how the concepts of recognition, valuation, and classification apply to business transactions and why they are important factors in ethical financial reporting.

3 Figure 1: The Role of Measurement Issues

4 Measurement Issues Three measurement issues must be resolved before a business transaction is recorded. –Recognition issue—When should the transaction be recorded? –Valuation issue—What dollar amount should be recorded? –Classification issue—Which accounts are affected?

5 Measurement Issues A sale is recognized when title passes to the buyer (recognition point).

6 Measurement Issues Transactions should be recorded at their original cost (historical cost). –The fair value is the exchange price, which results from an agreement between the buyer and seller that can be verified by evidence at the time of the transaction. –Assets are valued at the initial fair value or cost unless there is evidence that the fair value has changed and an adjustment must be made.

7 Measurement Issues OBJECTIVE 1: Explain how the concepts of recognition, valuation, and classification apply to business transactions and why they are important factors in ethical financial reporting.

8 Measurement Issues Three measurement issues must be resolved before a business transaction is recorded. –Recognition issue—When should the transaction be recorded? –Valuation issue—What dollar amount should be recorded? –Classification issue—Which accounts are affected?

9 Measurement Issues A sale is recognized when title passes to the buyer (recognition point).

10 Measurement Issues Transactions should be recorded at their original cost (historical cost). –The fair value is the exchange price, which results from an agreement between the buyer and seller that can be verified by evidence at the time of the transaction. –Assets are valued at the initial fair value or cost unless there is evidence that the fair value has changed and an adjustment must be made.

11 Measurement Issues Transactions must classified according to the appropriate categories or accounts.

12 Measurement Issues Recognition, valuation, and classification are important factors in ethical financial reporting.

13 ©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicate, or posted to a publicly accessible website, in whole or in part.

14 Double-Entry System OBJECTIVE 2: Explain the double-entry system and the usefulness of T accounts in analyzing business transactions.

15 Table 1: Normal Account Balances of Major Account Categories

16 Figure 2: Relationships of Owner’s Equity Accounts

17 Double-Entry System Describe the nature of the double-entry system of accounting. –Principle of duality

18 Double-Entry System Accounts are the basic storage units for accounting data and are used to accumulate amounts from similar transactions.

19 Double-Entry System A T account (the simplest form of an account) has three parts. –A title expressing the name of the asset, liability, etc. –A debit (left) side –A credit (right) side

20 Double-Entry System The T Account Illustrated

21 Double-Entry System State the rules of double entry. –Increases in assets are debited. –Decreases in assets are credited. –Increases in liabilities and owner’s equity are credited. –Decreases in liabilities and owner’s equity are debited. –Increases in revenues are credited. –Increases in expenses are debited.

22 Double-Entry System

23 The normal balance of an account is what it takes (debit or credit) to increase the account.

24 Double-Entry System Typical owner’s equity accounts, such as Owner’s Capital and Withdrawals.

25 ©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicate, or posted to a publicly accessible website, in whole or in part.

26 Business Transaction Analysis OBJECTIVE 3: Demonstrate how the double- entry system is applied to common business transactions.

27 Exhibit 1: Summary of Transactions of Miller Design Studio

28 Exhibit 1: Summary of Transactions of Miller Design Studio (cont.)

29 Business Transaction Analysis Explain the five-step process for analyzing and applying transactions. –State the transaction. –Analyze the transaction to determine which accounts are affected and how (increased or decreased). –Apply the rules of double-entry accounting using T accounts to show how the transaction affects the accounting equation. –Show the transaction in journal form. –Provide a comment that will help you apply the rules of double-entry accounting.

30 Business Transaction Analysis

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42 ©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicate, or posted to a publicly accessible website, in whole or in part.

43 The Trial Balance OBJECTIVE 4: Prepare a trial balance, and describe its value and limitations.

44 The Trial Balance A trial balance tests the equality of debits and credits in the ledger before the financial statements are prepared. A three-step process is followed. –List each ledger account and its debit or credit balance. –Add each column. –Compare the column totals.

45 The Trial Balance If the trial balance does not balance, one or more of the following has occurred: –A debit was entered as a credit, or vice versa. –The balance was computed incorrectly. –The balance was carried to the trial balance incorrectly. –The trial balance was summed incorrectly.

46 The Trial Balance It is possible to make an error in the records that does not cause the trial balance to be out of balance, such as the following: –A transaction was omitted or entered twice. –Both debit and credit amounts are incorrect but equal. –The wrong account was debited or credited.

47 Cash Flows and the Timing of Transactions OBJECTIVE 5: Show how the timing of transactions affects cash flows and liquidity.

48 Exhibit 2: Trial Balance

49 ©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicate, or posted to a publicly accessible website, in whole or in part.

50 Figure 3: Transactions of Miller Design Studio

51 The Trial Balance Discuss the importance of maintaining good liquidity. Discuss the timing of cash flows in maintaining a company’s adequate liquidity to pay bills.

52 ©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicate, or posted to a publicly accessible website, in whole or in part.

53 Recording and Posting Transactions SUPPLEMENTAL OBJECTIVE 6: Define the chart of accounts, record transactions in the general journal, and post transactions to the ledger.

54 Figure 4: Analyzing and Processing Transactions

55 Exhibit 3A: Chart of Accounts for a Small Business

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57 Exhibit 4: The General Journal

58 Exhibit 5: Accounts Payable in the General Ledger

59 Exhibit 6: Posting from the General Journal to the Ledger

60 Recording and Posting Transactions Chart of Accounts –An account is the basic storage unit for accounting data. –An account occupies its own page in the general ledger. –A chart of accounts lists all the accounts in the ledger.

61 Recording and Posting Transactions Chart of Accounts (cont.) –Discuss typical asset accounts, such as Cash, Accounts Receivable, Notes Receivable, Supplies, Inventory, Prepaid Expenses, Land, Buildings, and Equipment. –Discuss typical liability accounts, such as Accounts Payable, Notes Payable, Wages Payable, Income Taxes Payable, Rent Payable, Interest Payable, and Unearned Revenue.

62 Recording and Posting Transactions General Journal –Transactions are initially recorded in the journal (book of original entry). –Every journal entry contains five components. The date The account names The dollar amounts debited and credited An explanation The account identification number, if appropriate

63 Recording and Posting Transactions General Journal (cont.) –A space should be skipped between journal entries. –A compound entry is an entry with more than one debit or credit. –Illustrate the ledger account form, and state its advantage over the T account form.

64 Recording and Posting Transactions Journal entries are posted (transferred) to the ledger when convenient (usually daily). –Post the date and amounts. –Compute a new account balance. –Place the journal page number in the Post. Ref. column of the ledger account. –Place the account number in the Post. Ref. column of the journal.

65 Recording and Posting Transactions Rules and customs regarding ruled lines, dollar signs, commas, and periods should be followed.

66 ©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicate, or posted to a publicly accessible website, in whole or in part.


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