COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 1 Chapter 3 The Mechanics of Accounting Albrecht, Stice, Stice, Swain

2 The Accounting Cycle Step 1 Record the effects of the transactions. Step 2 Summarize the effects of transactions. 1. Posting journal entries. 2. Preparing a trial balance. Summarize the effects of transactions. 1. Posting journal entries. 2. Preparing a trial balance. Step 3 Prepare reports. 1. Adjusting entries. 2. Preparing financial statements. 3. Closing the books. Prepare reports. 1. Adjusting entries. 2. Preparing financial statements. 3. Closing the books. Step 4 Analyze transactions.

3 A = L + OE Analyze Transactions with the Accounting Equation Borrow money Invest in company Pay off a note Purchase equipment Borrow funds to settle a debt

4 Terminology to Help Analyze Transactions Account –Accounting record where similar transactions are recorded. T-Account –Simplified depiction of an account. Debit –Entry on the LEFT. Credit –Entry on the RIGHT. Name of Account Debit Credit

5 Double Entry Accounting Debits must ALWAYS equal credits! –If for every transaction, debits equal credits, then the accounting equation will balance.

6 Expanded Accounting Equation Assets DR CR + – = Liabilities DR CR – + + Owners’ Equity DR CR – + Capital Stock DR CR – + Retained Earnings DR CR – + Revenues DR CR – + Expenses DR CR + – Dividends DR CR + – Assets + Expenses + Dividends = Liabilities + Capital Stock + Revenues

7 Journals and Journal Entries Journal –An accounting record in which transactions are originally entered. –Chronological record. General Journal Entry Format: DateDebit Entry xx Credit Entry xx Explanation.

8 Journal Entries 3 steps for success: 1. Identify which accounts are involved. 2. Determine if the account is increased or decreased. 3. Determine by how much the account has changed.

9 Journal Entry Example You purchase $250 worth of inventory for cash on January 30. –Remember the 3 step process. January 30 Inventory Cash To record purchase of inventory. $250

10 Compound Journal Entry –A journal entry that involves more than one debit or more than one credit or both. You make a mortgage payment of $175. Of this, $150 reduces the mortgage while $25 is interest. Interest expense Mortgage payable Cash To record monthly mortgage payment. $25 $150 $175

11 Posting Journal Entries Posting –Transferring amounts from the journal to the ledger. Ledger –A book of accounts where journal transactions are posted and thereby summarized. Chart of accounts –A systematic listing of all accounts used by a company.

12 The General Ledger DateExplanation Ref. DebitsCredits Balance Jan. 1Balance100 2Issued 100 shares of capital stock at $10 per share GJ11,0001,100 3Purchased equipment GJ Sold inventory GJ Monthly payment on loan GJ Revenue GJ12,5003,130 ACCOUNT: CashAccount No. 101 After all the journal entries are posted to the ledger, the account balance can be computed by summing up all of the debits and credits.

13 The Trial Balance Trial Balance –A listing of all account balances. –Provides a means of ensuring debits equal credits. –From this data, the balance sheet and income statement can be prepared. –Prepared by listing all accounts and their respective balances.

14 Example Trial Balance The Example Company Trial Balance December 31, 2009 DebitsCredits Cash$ 21 Accounts Receivable15 Inventory12 Land200 Accounts Payable$ 30 Capital Stock150 Retained Earnings24 Sales Revenue919 Cost of Goods Sold850 Advertising Expense10 Miscellaneous Expenses 15______ Total$ 1,123$ 1,123 Debits = Credits

How Have Computers Changed the Accounting Cycle? Allows businesses to calculate vast amounts of data quickly. Eases posting of journal entries and summarizing the data into reports and financial statements. Computers can’t think. That is your job!