CHAPTER 4 The Accounting Process

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-2 Overview Basic accounting equation expanded to include revenues and expenses Transactions and balancing the equation Linking the income statement to the balance sheet through owners’ equity Horizontal model Adjustments Transaction analysis

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-3 The Accounting Process Transactions are economic interchanges between entities that are accounted for and reflected in financial statements. Borrow cash from the bank

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-4 A = L + OE The Accounting Equation ASSETSLIABILITIES OWNERS’ EQUITY

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-5 A = L + OE The Accounting Equation The basic accounting equation can be expanded to include revenues and expenses.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-6 A = L + OE The Accounting Equation Contributed capital Retained earnings Retained earnings beginning of period Revenue - expenses

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-7 A = L + OE The Accounting Equation A = L + CC +RE + R - E Where: CC = contributed capital RE = retained earnings beginning R = revenue E = expenses

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-8 Let’s see how some transactions affect the operation of this equation. Transactions

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-9 Transactions 1.Investment of $30 by owners.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-10 Transactions 2.Equipment costing $25 was purchased for cash.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-11 Transactions 3.The firm borrowed $15 from the bank.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-12 Transactions 4.Inventory costing $20 was purchased for resale. $10 was paid in cash and $10 was on account.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-13 Transactions 5.Equipment that cost $7 was sold. $2 was received in cash and $5 will be received later.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-14 Transactions 6.The $5 account from the sale of equipment was collected.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-15 Transactions 7.Sold inventory on account for $20. Original cost was $12.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-16 Transactions 8.Wages of $3 have been recorded as an expense, but not paid.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-17 Transactions Columns totalled.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-18 Transactions If the accounting period was to end after these transactions, the financial statements could be prepared using the totals from the columns.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-19 Transactions Statement of changes in owners’ equity

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-20 Transactions From income statement Balance Sheet

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-21 Transactions Statement of changes in owners equity

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-22 Transactions What have we learned from the foregoing? – Net profit on the income statement gets into the balance sheet via the retained income section of owners’ equity. – On the previous worksheet, revenues and expenses were treated as a part of owners’ equity to keep the equation in balance, but in financial statements they are shown in the income statement.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-23 Transactions What have we learned from the foregoing? – If any retained income is distributed to the owners as a dividend, it is shown on the statement of changes in owners’ equity, not on the income statement. – A dividend is not an expense. It is a distribution of income to the owners of the firm.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-24 Transactions Horizontal Financial Statement Relationship Model Balance sheet Assets = Liabilities + Owners’ equity Income statement Net profit = Revenues – Expenses The key to using this model is to keep the balance sheet in balance.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-25 Transactions An investment of $30 by owners Balance sheet Assets = Liabilities + Owners’ equity Income statement Net profit = Revenues – Expenses Cash + 30 Contributed capital + 30

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-26 Transactions $12 paid for advertising Balance sheet Assets = Liabilities + Owners’ equity Income statement Net profit = Revenues – Expenses Cash - 12 Advertising expense - 12 Note that a minus sign for expenses means that net profit (and owners’ equity) is reduced.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-27 Transactions $40 received for services provided in a prior period Balance sheet Assets = Liabilities +Owners’ equity Income statement Net profit = Revenues – Expenses Cash- 40 Accounts receivable+ 40 A transaction can affect two accounts in a single balance sheet or income statement category.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-28 Transactions $60 worth of services provided, $45 collected in cash and $15 to be collected later Balance sheet Assets = Liabilities + Owners’ equity Income statement Net profit = Revenues – Expenses Cash+ 45 Accounts receivable+ 15 Service revenues+ 60 A transaction can affect more than two accounts.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-29 Adjustments ACCRUAL ACCOUNTING Requires adjustments at end of the period To recognise revenues and expenses as they occur

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-30 Adjusting entries are needed whenever revenue or expenses affect more than one accounting period. Every adjusting entry involves a change in either a revenue or expense and an asset or liability. Adjustments/Adjusting Entries

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-31 Adjusting Entries - Categories The initial recording of a transaction does not result in assigning revenues to the period in which they were earned or expenses to the period in which they were incurred. Reclassifications Transactions for which cash has NOT yet been received or paid, but the effect of which must be recorded in the accounts in order to accomplish a matching of revenues and expenses. Accruals

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-32 Examples: interest wages and salaries property taxes revenue earned but not billed income tax. Hey, when do we get paid? Adjustments - Accruals

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-33 On 31 March, wages of $60 are owed. Pay day is in April. Adjustments - Accruals April $60 Wages Expense March 31 Paid

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-34 Adjustments - Accruals Balance sheet Assets = Liabilities + Owners’ equity Income statement Net profit = Revenues – Expenses Wages payable + 60 Wage expense- 60 Using the horizontal model, the accrued wages adjustment has the following effect on the financial statements:

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-35 Examples: supplies used prepaid insurance policies revenues received in advance. Adjustments - Reclassifications

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-36 Adjustments - Reclassifications Purchase of supplies at a cost of $100 during February was recorded initially as an increase in the supplies (asset) account and a decrease in cash. The cost of supplies used during February of $35 must be removed from the asset account and recorded as supplies expense.

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-37 Adjustments - Reclassifications Balance sheet Assets = Liabilities + Owners’ equity Income statement Net profit = Revenues – Expenses Supplies - 35 Supplies expense - 35 Using the horizontal model, the supplies adjustment has the following effect on the financial statements:

PowerPoint Slides t/a Accounting: What the Numbers Mean Marshall, McCartney, van Rhyn, McManus, Viele Slides prepared by Sandra Chapple Copyright  2005 McGraw-Hill Australia Pty Ltd 4-38 Transaction Analysis Methodology Answer these questions: 1.What is going on? 2.What accounts are affected? 3.How are they affected? 4.Does the balance sheet still balance? (Do the changes balance out?) 5.Does my analysis make sense?