acct1501 week 3 lecture notes (2 slides)

THE UNIVERSITY OF NEW SOUTH WALES

Australian School of Business School of Accounting

ACCT 1501: Accounting and Financial Management 1A

Week 3

The Double Entry System

Student Handout

Lecturer: Dr. Youngdeok Lim

School of Accounting UNSW

QUAD 3069

[email protected]

Blackboard: http://telt.unsw.edu.au.

WEEK 3: The Double Entry System

1. Introduction Last week we discussed the importance of the balance sheet and income statement to managers. It is therefore critical that every manager understand the impact of transactions on these financial reports. This week covers those skills by extending transaction analysis, which considers the impact of specific transactions on the accounting equation. The double entry system involving debits and credits, which forms the basis of modern accounting, is then addressed.

Learning objectives

At the end of this topic you should be able to:

• Carry out transaction analysis and determine the impact of transactions on elements of balance sheets and income statements

• Describe how debits and credits work in the double entry accounting system.

• Understand debits and credits in the context of transaction analysis

Required reading

Trotman, Gibbins & Carson Chapter 3

AASB: Framework for Presentation of Financial Statements (downloadable from your

course website or http://www.aasb.gov.au )

2. Tutorial Questions – Week 4

Students should attempt these questions before the tutorial. Preparation Questions:

DQ 3.2 3.4;

P3.16, P3.18

Tutorial Questions:

DQ 3.3, 3.5, 3.7

P3.12, P3.19

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Accounting and Financial Management 1A

Dr. Youngdeok Lim

Quad 3069

Week 3, Session 1, 2013

The Double Entry System

Today’s lecture objectives:

Carry out transaction analysis and determine the impact of transactions on elements of balance sheets and income statements

Hot: Describe how debits and credits work in the double entry accounting system.

Understand debits and credits in the context of transaction analysis

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Revisit balance sheet and income statement

A t-1L t-1

SE t-1

A tL t

SE t

RE

R – E = Profit for the period

Beginning period (t-1) Ending Period (t)

A t-1 = L t-1 + SE t-1 A t = L t + SE t

Incorporated into B/S

Capture of income

Retained profits: the sum of net profits earned over the life of a company less dividends declared to shareholders

Consolidated B/S –Woolworths Limited

Current Assets $5,802 M Current Liabilities $6,766 M

Noncurrent Assets

$15,779 M Noncurrent Liabilities $6,369 M

Total Liabilities $13,135 M

Equities $8,446 M

Total Assets $21,581 M Total Liabilities and Equities

$21,581 M

As at 24 June 2012

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Revenue $55,268 M

- Cost of sales (Cost of goods sold) ($40,792 M)

Gross profit $14,476 M

+/- other revenue/expense ($12,659 M)

Net profit $1,817 M

For the 52 weeks ended on 24 June 2012

Consolidated I/S –Woolworths Limited

Transactions

Transactions are events that affect the operations or finances of an organisation. Analyze each transaction from the perspective of a

company! Accounting systems record transactions.

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Business Model

Company(e.g. Woolworths)

Customers(e.g. You)

Suppliers(e.g. farmers)

Purchase Sale

Payment(Cash/Accounts

Payable)

Payment(Cash/Accounts

Receivable)

Investors (e.g. banks, shareholders)

Financing

Property Plant and Equipment,

financial securities etc

Investing

Transaction analysis

Transaction analysis involves an examination of each business transaction with the aim of understanding its effect on the accounting equation.

Example: Borrow $10 000 from the bank. A liability (source) has increased Loan An asset (resource) has increased Cash

After this transaction the accounting equation is in balance.

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Let’s consider seven transactions.

Transaction 1

Issued shares for $300 000 cash.

A = L + SE Does the accounting equation balance?

YES! It must balance!

Share capitalCash

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Transaction 1

Issued shares for $300 000 cash.

= Liabilities +

Cash

Accounts

Receivable/

Debtors Equipment Bank Loan

Share

Capital

Retained

Profits

1 +300,000 +300,000

Assets Shareholders’ equity

Transaction 2

Borrowed $50 000 cash from the bank.

A = L + SE Does the accounting equation balance?

YES! It must balance!

Bank LoanCash

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Transaction 2

Borrowed $50 000 cash from the bank.

= Liabilities +

Cash

Accounts

Receivable/


Share

Capital

Retained

Profits

1 +300,000 +300,000

2 +50,000 +50,000


Transaction 3

Purchase equipment for $100 000 cash.

A = L + SE

Does the accounting equation balance? YES! It must balance!

Equipment

Cash

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Transaction 3

Purchase equipment for $100 000 cash.

= Liabilities +

Cash

Accounts

Receivable/


Share

Capital

Retained

Profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000


Transaction 4

Signed six-month agreement to provide catering service for a monthly fee of $2500 starting next month.

A = L + SEWhat if the company received $2500 in advance for the service to be provided in this month?

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Transaction 4

Not a transaction: no service provided. no current right to receive. no cash movement that needs to be recorded.

Transaction 5

Catering services provided for an office function; billed customer for $2500.

A = L + SE Does the accounting equation balance? YES! It must balance!

Accounts receivable

Revenue

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Transaction 5

Catering services provided for an office function; billed customer for $2500.

= Liabilities +

Cash

Accounts

Receivable/


Share

Capital

Retained

Profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000

4

5 +2,500 +2,500

Assets Shareholders' equity

Revenue

Transaction 6

Customer paid $2500 they owed on their account.

A = L + SE


Accounts receivable

Cash

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Transaction 6

Customer paid $2500 they owed on their account.

Assets = Liabilities + Shareholders’ equity

Cash Accsrec.

Equipment Bank loan Share capital

Retained profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000

4

5 +2,500 +2,500

6 +2,500 -2,500

Revenue

Transaction 7

Paid the bank $5000 as part repayment of the loan.

A = L + SE


Bank loanCash

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Transaction 7

Paid the bank $5000 as part repayment of the loan.


Cash Accsrec.


Retained profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000

4

5 +2,500 +2,500

6 +2,500 -2,500

7 -5,000 -5,000

Revenue

Transaction analysis complete


Cash Accsrec.


Retained profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000

4

5 +2,500 +2,500

6 +2,500 -2,500

7 -5,000 -5,000

247,500 0 100,000 = 45,000 + 300,000 2,500

347,500 = 45,000 + 302,500

A = L + SE

Revenue

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Balance sheet

ASSETS LIABILITIES Cash 247 500 Bank loan 45 000 Equipment 100 000 SHAREHOLDERS’ EQUITY Share capital 300 000 Retained profits 2 500 347 500 347 500

Income statement

Revenue 2 500 Expense 0 Net profits 2 500

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MCQ: Inventory was purchased for cash, when:

1. an asset increased and another asset decreased

2. an asset decreased and an expense increased

3. an asset decreased and a liability decreased

4. a liability increased and an expense increased

Transaction analysis: The accounting equation extended

The equation you were introduced to earlier is as follows:

Assets = Liabilities + Equity

This is extended to:

A = L + SECA + NCA = CL + NCL + SEWhat is SE made up of?

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Accounting equation, cont.

Shareholders’ equity contributions by shareholders

Profit revenues expenses

Distribution to shareholders(dividends)

Expanding the accounting equation

A = L + SE CA + NCA = CL + NCL + SE Where SE:

SC + opening RP at the start of the period + RP for the period SC + opening RP + profit – dividends SC = Capital contributions by equity holders (share capital) RP = Retained profits Op RP = Opening retained profits Profit = R – E R = Revenue E = Expenses Dividends = Distributions to equity holders

CA + NCA = CL + NCL + SC + Op. RP + R – E – D

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Link between the balance sheet and the income statement

Income statement

Balance sheet

CA + NCA = CL + NCL + SC + Op. RP + R – E – D

CA + NCA = CL + NCL + SE

An illustrative example: Prepare transaction analysis

LRM Ltd: Balances as at 1 April 2012

Cash 140 000Inventory 55 000Land and buildings 300 000Equipment 90 000Accounts payable 15 000Notes payable 70 000Loans 300 000Share capital 200 000

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Transactions for April 2012

8 Cash sales of $30 000; Cost of goods sold = $12 000.9 Credit sales of $40 000; Cost of goods sold = $16 000.10 $8000 payments to suppliers.11 $20 000 wages paid for first 2 weeks of April.12 Received invoice for $2000 for an advertisement on

April 5. 13 Received $25 000 from accounts receivable.14 At end of month: $18 000 wages is owing for last 2

weeks of the month. Due to be paid on May 1.

LRM Ltd: Exhibit 3.3, page 100

Transaction CashAccounts receivable Inventory

Land and building Equipment

Accounts payable

Notes payable

Wages payable Loans

Share Capital

Retainedprofits

Balance 140,000 0 55,000 300,000 90,000 15,000 70,000 0 300,000 200,000 0

8 30,000 30,000 Revenues

-12,000 -12,000 Expenses

9 40,000 40,000 Revenues

-16,000 -16,000 Expenses

10 -8,000 -8,000

11 -20,000 -20,000 Expenses

12 2,000 -2,000 Expenses

13 25,000 -25,000

14 18,000 -18,000 Expenses

Total 167,000 15,000 27,000 300,000 90,000 9,000 70,000 18,000 300,000 200,000 2,000

Assets 599,000 Liabilities 397,000Stockholder's equity 202,000

A=L+SE

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LRM Ltd

Income statement for the month ended 30 April 2012 $ $ Sales 70 000 Cost of goods sold 28 000

Gross profit 42 000 Operating expenses

Wages 38 000 Advertising 2 000 40 000 Net profit 2 000


LRM Ltd

Balance sheet as at 30 April 2012 Assets Liabilities and shareholders equity $ $ Current assets Current liabilities Cash 167 000 Accounts payable 9 000 Accounts receivable 15 000 Notes payable 70 000 Inventory 27 000 Wages payable 18 000 209 000 97 000 Non-current assets Non-current liabilities Land and building at cost

300 000 Loans 300 000

Office equipment at cost

90 000 Total liabilities 397 000

390 000 Shareholders’ equity Share capital 200 000 Retained profit * 2 000

Total shareholders’ equity 202 000

Total assets 599 000 Total liabilities and shareholders’ equity 599 000

* Retained profit = opening retained profits (0) + profit (2000) – dividends declared (0) = 2000


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Double entry accounting

A = L + SE

The accounting equation must always balance

It means Debits = Credits.

The Golden Rule:

In accounting we use debit (Dr) and credit (Cr) to describe changes in accounts

Debit–credit convention

Remember the equation:Assets = Liabilities + Equity

We define increases in Assets to be debits (DR) –decreases in Assets therefore must be credits (CR)

DR = CR, therefore increases in Liabilities (and Equity) must be credits, decreases must be debits.

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Assets (A) Liabilities (L)

Capital (SE)

Expenses (+E) Revenues (+R)

Uses of Capital Sources of Capital Always record on the right-hand side

Always record on the left-hand side

Simultaneous recording of the use of capital and the source of capital

Basic orientation of the “double-entry bookkeeping system”

Double entry system: Debit and Credit

Debit Credit

+A +L

+SE

+E +R

-L -A

-SE

-R -E

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Remembering debits/credits

Type Normal Incr. Decr.Assets Debit Debit CreditLiabilities Credit Credit DebitShareholder’s equity Credit Credit DebitRevenues Credit Credit DebitExpenses Debit Debit Credit

Debit and credit

Company record v.s. Bank statement

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Journal entries

Journal entries are, essentially, a shorthand version on transaction analysis.

They are prepared using the rules of debit and credit. Debits must always equal credits.

Journal entries

ExampleMachinery is purchased for $10 000 cash.

Journal entry:

Dr Machinery 10 000Cr Cash 10 000

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MCQ. Identify the journal entry required to correctly record each of the

following transactions.

Cash received from accounts receivable

1. Dr Accounts Receivable Cr Cash

2. Dr Cash Cr Accounts Payable

3. Dr Cash Cr Accounts Receivable

4. none of the above

Link transaction analysis and journal entries

Back to the previous transactions.

Prepare journal entries for transaction 1-7.

Prepare journal entries for LRM ltd.

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Transaction 1-7

1: Issued shares for $300 000 cash.

2: Borrowed $50 000 cash from the bank.

3: Purchase equipment for $100 000 cash.

4: Signed six-month agreement to provide catering service for a monthly fee of $2500 starting next month.

5: Catering services provided for an office function; billed customer for $2500.

6: Customer paid $2500 they owed on their account.

7: Paid the bank $5000 as part repayment of the loan.

Solution: Transaction 1-7 1.

2.

3.

4.

5.

6.

7.

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LRM ltd transactions for April 2012

8 Cash sales of $30 000; Cost of goods sold = $12 000.9 Credit sales of $40 000; Cost of goods sold = $16 000.10 $8000 payments to suppliers.11 $20 000 wages paid for first 2 weeks of April.12 Received invoice for $2000 for an advertisement on

April 5. 13 Received $25 000 from accounts receivable.14 At end of month: $18 000 wages is owing for last 2

weeks of the month. Due to be paid on May 1.

Solution: LRM ltd case 8.

9.

10.

11.

12.

13.

14.

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Wrap-Up

• Double entry system: Debit and Credit– Debit Credit

+A +L

+SE

+E +R

-L -A

-SE

-R -E

Relationship between transaction analysis and journal entries

A negative figure in transaction analysis implies the abnormal side in journal entries.

Next Lecture…

Record-Keeping

Please bring comprehensive class example from the black board.

acct1501 week 3 lecture notes (2 slides)

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