Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Accounting Cycle: Capturing Economic Events Chapter 3

3-2 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 The Ledger The entire group of accounts is kept together in an accounting record called a ledger. Cash Accounts Payable Capital Stock Accounts are individual records showing increases and decreases.

3-4 The Use of Accounts Increases are recorded on one side of the T account, and decreases are recorded on the other side. Left or Debit Side Right or Credit Side Title of Account

3-5 Receipts are on the debit side. Payments are on the credit side. The balance is the difference between the debit and credit entries in the account. Debit and Credit Entries

3-6 ALOE A = L + OEASSETS Debit for Increase Credit for DecreaseEQUITIES Debit for Decrease Credit for IncreaseLIABILITIES Debit for Decrease Credit for Increase Debits and credits affect accounts as follows: Debit and Credit Entries

3-7 ALOE 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. Double Entry Accounting  The Equality of Debits and Credits

3-8 Let’s record selected transactions for JJ’s Lawn Care Service in the accounts.

 May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Will Cash increase or decrease? Will Capital Stock increase or decrease? Cash increases $8,000 with a debit. Capital Stock increases $8,000 with a credit. 3-9

 May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Will Cash increase or decrease? Will Tools & Equipment increase or decrease? Cash decreases $2,500 with a credit. Tools & Equipment increases $2,500 with a debit. 3-10

 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. Will Truck increase or decrease? Will Cash and Notes Payable increase or decrease? Truck increases $15,000 with a debit. Cash decreases $2,000 with a credit. Notes Payable increases $13,000 with a credit. 3-11

 May 11: JJ’s purchased some repair parts for $300 on account. Will Tools & Equipment increase or decrease? Will Accounts Payable increase or decrease? Tools & Equipment increases $300 with a debit. Accounts Payable increases $300 with a credit. 3-12

 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. Will Tools & Equipment increase or decrease? Will Accounts Receivable increase or decrease? Tools & Equipment decreases $150 with a credit. Accounts Receivable increases $150 with a debit. 3-13

3-14 In an actual accounting system, transactions are initially recorded in the journal. The Journal

3-15 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 Posting Journal Entries to the Ledger Accounts

3-17 Posting Journal Entries to the Ledger Accounts

3-18 Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service. Posting Journal Entries to the Ledger Accounts

3-19 This ledger format is referred to as a running balance. Ledger Accounts After Posting

3-20 T accounts are simplified versions of the ledger account that only show the debit and credit columns. Ledger Accounts After Posting

3-21 Net income is not an asset  it’s an increase in owners’ equity from profits of the business. ALOE A = L + OE IncreaseDecrease 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 What is Net Income?

3-22 ALOE A = L + OE Retained Earnings 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 The income statement summarizes the profitability of a business for a specified period of time. The Income Statement: A Preview

3-24 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. 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 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 The Matching Principle: When To Record Revenue Matching Principle Revenue should be recognized at the time goods are sold and services are rendered.

3-27 The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up.

3-28 The Accrual Basis of Accounting Current Accounting Period Future Accounting Period Jan. 1, 2009 Dec. 1, 2009 Jan. 1, 2010 Dec. 1, 2010 Cash is received or paid here The income statement reports revenue or expense here The income statement reports revenue or expenses here Cash is received or paid here OR But...

3-29 Debit and Credit Rules for Revenue and Expenses EQUITIES Debit for Decrease Credit for Increase Expenses decrease owners’ equity. Revenues increase owners’ equity. EXPENSES Credit for Decrease Debit for Increase REVENUES Debit for Decrease Credit for Increase

3-30 EQUITIES Debit for Decrease Credit for Increase Payments to owners decrease owners’ equity. Owners’ investments increase owners’ equity. DIVIDENDS Credit for Decrease Debit for Increase Dividends CAPITAL STOCK Debit for Decrease Credit for Increase

3-31 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. 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.

 May 29: JJ’s provided lawn care services for a client and received $750 in cash. Will Cash increase or decrease? Will Sales Revenue increase or decrease? Cash increases $750 with a debit. Sales Revenue increases $750 with a credit. 3-32

 May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Will Cash increase or decrease? Will Gasoline Expense increase or decrease? Cash decreases $50 with a credit. Gasoline Expense increases $50 with a debit. 3-33

 May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Will Cash increase or decrease? Will Dividends increase or decrease? Cash decreases $200 with a credit. Dividends increase $200 with a debit. 3-34

3-35 Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May.

3-36 All balances are taken from the ledger accounts on May 31 after considering all of JJ’s transactions for the month.

3-37 The Accounting Cycle in Perspective Accountants spend much of their time focusing on the more analytical aspects of their discipline.

3-38 End of Chapter 3