another principal element of stockholders’ equity is the...

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4- 1Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.


Marshall,McManus,andViele11thEdition

AccountingWhattheNumbersMean

CHAPTER4: TheBookkeepingProcessandTransactionAnalysis


LearningObjectives

After studying this chapter you should understand and be able to:

LO 4-1: Illustrate the expansion of the basic accounting equation to include revenues and expenses.

LO 4-2: Describe how the expanded accounting equation stays in balance after every transaction.

LO 4-3: Describe how the income statement is linked to the balance sheet through stockholders’ equity.

LO 4-4: Explain the meaning of the bookkeeping terms journal, ledger, T-account, account balance, debit, credit and closing the books.

LO 4-5: Explain why the bookkeeping system is a mechanical adaptation of the expanded accounting equation.

LO 4-6: Analyze a transaction, prepare a journal entry, and determine the effects of the transaction on the financial statements.

LO 4-7: Apply the five questions of transaction analysis.


TheBalanceSheetEquation—AMechanicalKey

Assets = Liabilities + Stockholder’s Equity

A = L + PIC + REBEG + R - E

The basic accounting equation can be expanded to include revenues and expenses.

Another principal element of stockholders’ equity is the amount of capital invested by the owners/stockholders—that

is, the PIC (paid-in capital) and RE (retained earnings)

Learning Objective 4-1: Illustrate the expansion of the basic accounting equation to include revenues and expenses.


Transactionsa. The stockholders invested $2,000.b. The company borrowed $6,000 from a bank.c. Equipment costing $10,000 was purchased for $2,000 cash and signing a

note payable for $8,000.d. Equipment that cost $3,000 was sold for $3,000. The $3,000 will be

received within 30 days.e. The company provided services for $8,000 and received cash.f. Wages of $2,000 were paid in cash.

TheBalanceSheetEquation

Learning Objective 4-2: Describe how the expanded accounting equation stays in balance after every transaction.

= Liabilities +

Transaction Cash + Accounts

Receivable + Equipment = Notes

Payable + Paid-in Capital +

Retained Earnings + Revenues - Expenses

a 2,000 2,000 b 6,000 6,000 c (2,000) 10,000 8,000 d 3,000 (3,000)e 8,000 8,000 f (2,000) 2,000

Total 12,000 + 3,000 + 7,000 = 14,000 + 2,000 + 0 + 8,000 - 2,000 6,000

Assets Stockholders' Equity


= Liabilities +

Transaction Cash + Accounts

Receivable + Equipment = Notes

Payable + Paid-in Capital +

Retained Earnings + Revenues - Expenses

a 2,000 2,000 b 6,000 6,000 c (2,000) 10,000 8,000 d 3,000 (3,000)e 8,000 8,000 f (2,000) 2,000

Total 12,000 + 3,000 + 7,000 = 14,000 + 2,000 + 0 + 8,000 - 2,000 6,000

Assets Stockholders' Equity

Revenues 8,000$ Expenses 2,000 Net Income 6,000$

Income Statement

Beginning Balance -$ Add: Net Income 6,000 Less: Dividends - Ending Balance 6,000$

Statement of Changes in Retained Earnings

Cash 12,000$ Notes Payable 14,000$ Accounts Receivable 3,000 Equipment 7,000 Paid-in Capital 2,000

Retained Earnings 6,000

Total Assets 22,000$ Total Liabilities & Stockholders' Equity 22,000$

Stockholders' Equity

Balance SheetAssets Liabilities

TheBalanceSheetEquation

Learning Objective 4-3: Describe how the income statement is linked to the balance sheet through stockholders' equity.

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BookkeepingJargon

Transactions are initially recorded in a journal.

Then, transactions are recorded—posted to—individual accounts in

the ledger.

Accounts are used to organize or group transactions to facilitate financial statement preparation.

Learning Objective 4-4: Explain the meaning of the bookkeeping terms journal, ledger, T-account, account balance, debit, credit and closing the books.

I keep a journal. Don’t you?


T-Account

AT-account isatoolusedtorepresentanaccount.

Account Name

Left side

Right side



T-AccountThe left sideofthe

T-accountisalways thedebit side.

Account NameLeftside

Right side

Debit

The right side of the T-account is always the

credit side.

Credit

Learning Objective 4-4: Explain the meaning of the bookkeeping terms journal, ledger, T-account, account balance, debit, credit and closing the books. 4- 10

Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

DebitsandCredits

ASSETSDebit for Increase

Credit for Decrease

EQUITIES

Debit for

Decrease

Credit for Increase

LIABILITIES

Debit for

Decrease

Credit for Increase

Debits and credits affect the accounting equation as follows:

A = L + SE



ASSETS

Debit for

Increase

Credit for

Decrease

EQUITIES

Debit for

Decrease

Credit for

Increase

LIABILITIES

Debit for

Decrease

Credit for

Increase

A = L + SE

Paid-in capital

Retained earnings

Remember that stockholders' equity includes paid-in capital and

retained earnings.

DebitsandCredits

Learning Objective 4-5: Explain why the bookkeeping system is a mechanical adaptation of the expanded accounting equation.

Includes:


RevenueandExpenses

Increases in stockholders'

equity.

Increase with a credit.

Decreases in stockholders'

equity.

Increase with a debit.


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DebitsandCredits

A = L + SE

Learning Objective 4-5: Explain why the bookkeeping system is a mechanical adaptation of the expanded accounting equation.4- 14


JournalEntryFormat

Date Debit Credit6/30 Cash 2,000

Paid-in Capital 2,000 To record an investmentby the stockholders.

Description

Here is the journal entry that is recorded when astockholder invests $2,000 in the business on June 30th


A general journal is the book of original entry for recording a transaction. The typical journal has a column

for the date, a description, a debit, and a credit.




Description

Provide a referencedate for each transaction. Debits are recorded first.

Credits are indented andrecorded after debits.

Total debits must equaltotal credits.

A brief description of the transaction to explain the entry.

JournalEntryFormat

Learning Objective 4-5: Explain why the bookkeeping system is a mechanical adaptation of the expanded accounting equation.4- 16


TheBookkeepingProcess



Description

Recorded in the Journal

Account NameDebit Credit

Posted to the Ledger


Transactions occur

Source Documents


TransactionAnalysisIllustratedLet’s prepare some journal entries and

post them to the ledger.Transactions (All transactions pertain to the current year)

a. On January 1, the stockholders invested $2,000.b. On January 15, the company borrowed $6,000 from a bank.c. On February 1, equipment costing $10,000 was purchased for

$2,000 cash and signing a note payable for $8,000.d. On February 15, equipment that cost $3,000 was sold for $3,000.

The $3,000 will be received within 30 days.e. On February 20, the company provided services for $8,000 and

received cash.f. On February 25, wages of $2,000 were paid in cash.

Learning Objective 4-6: Analyze a transaction, prepare a journal entry, and determine the effects of the transaction on the financial statements. 4- 18


The stockholders invested $2,000.

(a) 2,000

2,000

Cash2,000 (a)

2,000

Paid-in Capital

Page 1

Debit Credit

Jan 1 Cash 2,000 Paid-in Capital 2,000

Date Account Titles and Explanation

GENERAL JOURNAL

TransactionAnalysisIllustrated

Learning Objective 4-6: Analyze a transaction, prepare a journal entry, and determine the effects of the transaction on the financial statements.

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6,000 (b)

6,000

Notes Payable

The company borrowed $6,000 from a bank.

(a) 2,000 (b) 6,000

8,000

Cash

Page 1

Debit Credit

Jan 15 Cash 6,000 Notes Payable 6,000


GENERAL JOURNAL




Now, let’s see how to post this entry . . .

Equipment costing $10,000 was purchased for $2,000 cash and signing a note payable for

$8,000.

Page 1

Debit Credit

Feb. 1 Equipment 10,000 Cash 2,000 Notes Payable 8,000


GENERAL JOURNAL




(c) 10,000

10,000

Equipment

6,000 (b)8,000 (c)

14,000

Notes Payable(a) 2,000 2,000 (c)(b) 6,000

6,000

Cash

TransactionAnalysisIllustrated(ThePosting Process)

Recall: Equipment costing $10,000 was purchased for $2,000 cash and signing a note payable for $8,000.


The debit and credit amounts are posted to the corresponding accounts in the ledger. . .


Equipment that cost $3,000 was sold for $3,000. The $3,000 will be received within 30 days.

(d) 3,000

3,000

Accounts Receivable

Page 1

Debit Credit

Feb. 15 Accounts Receivable 3,000 Equipment 3,000


GENERAL JOURNAL

(c) 10,000 3,000 (d)

7,000

Equipment




The company provided services for $8,000 and received cash.

Page 1

Debit Credit

Feb. 20 Cash 8,000 Revenue 8,000


GENERAL JOURNAL

8,000 (e)

8,000

Revenue(a) 2,000 2,000 (c)(b) 6,000 (e) 8,000

14,000

Cash




Wages of $2,000 were paid in cash.

Page 1

Debit Credit

Feb. 25 Wages Expense 2,000 Cash 2,000


GENERAL JOURNAL

(f) 2,000

2,000

Wages Expense(a) 2,000 2,000 (c)(b) 6,000 2,000 (f)(e) 8,000

12,000

Cash



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Adjustments/AdjustingEntriesAt the end of the period,

we need to make adjustingentries to bring the

accounts up to date for the financial statements.



TwotypesofAdjustingEntries

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.

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.

ReclassificationsAccruals



Adjustments/AdjustingEntries

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.

Adjusting entries (Accruals and Reclassifications) occur at the end of the accounting period.



AccruingExpenses

Examples include:Wages and Salaries

Interest PayableProperty Taxes


Some company expenses haven’t been

recorded yet.

Let’supdateouraccounts!


$3,000 Wages Expense

On May 31, Webb Co. owes wages of $3,000. Pay day is Friday, June 2.

Monday,May 29

Friday, June 2

Wednesday,May 31

AccruingExpenses



GENERAL JOURNAL

Date Account Titles and Explanation Debit CreditMay 31 Wages Expense 3,000

Wages Payable 3,000To accrue wages owed to employees.

Initially, an expense and a liability are recorded.May 29


May 31

AccruingExpenses


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AccruingUnpaidExpenses

Wages Expense5/31 3,000

Wages Payable5/31 3,000

Income StatementCost incurred this period to generate

revenue.

Balance SheetLiability to be

paid in a future period.



AccruingExpenses$5,000 Weekly Wages

Let’s look at the entry for June 2.

Monday,May 29

Friday, June 2

Wednesday,May 31




OnFriday,Igetpaidforfivedaysofwork!


The liability for May wages is reducedwhen the debt is paid.

GENERAL JOURNAL

Date Account Titles and Explanation Debit CreditJune 2 Wages Expense (for June) 2,000

Wages Payable (accrued in May) 3,000Cash 5,000

Weekly payroll for May 29-June 2.

AccruingExpenses



AccruingRevenues

Examples Include:Interest Earned andWork Completed but not yet billed to the customer.


Some company revenues haven’t been

recorded yet.

Likewhat?


Saturday,Jan. 15

Tuesday, Feb. 15

$170 Interest Revenue

On Jan. 31, the bank owes Webb Co. interest of $170. Interest is paid on the 15th day of each month.

Monday,Jan. 31

AccruingRevenues



GENERAL JOURNAL

Date Account Titles and Explanation Debit CreditJan. 31 Interest Receivable 170

Interest Revenue 170To recognize interest revenue.

Initially, the revenue is recognized and a receivable is created.

AccruingRevenues


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Interest Revenue1/31 170

Interest Receivable1/31 170

Income StatementRevenue earned

this period.

Balance SheetReceivable to

be collected in a future period.

AccruingRevenues



Let’s look at the entry for February 15th.

Saturday,Jan. 15

Tuesday, Feb. 15

$320 Monthly Interest


Monday,Jan. 31


AccruingRevenues



The receivable is collected in a futureperiod.

GENERAL JOURNAL

Date Account Titles and Explanation Debit CreditFeb. 15 Cash 320

Interest Revenue (for February) 150Interest Receivable (accrued Jan. 31) 170

To record interest received.

AccruingRevenues



ReclassifyingAssetstoExpenses

Adjusting entries:Prepaid Insurance Insurance ExpenseSupplies Supplies Expense

Assets Expenses

End of month adjusting entries



Jan. 1 Dec. 31

$2,400 Insurance Policy Coverage for 12 Months

$200 Monthly Insurance Expense

On January 1, Webb Co. purchased a one-year insurance policy for $2,400.




GENERAL JOURNAL

Date Account Titles and Explanation Debit CreditJan. 1 Prepaid Insurance 2,400

Cash 2,400Purchased a one-year insurance policy.

Initially, costs that benefit more than one accounting period are recorded as assets.



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The costs are expensed as they are used to generate revenue.

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

(Monthly Adjusting Entry for Insurance)Jan. 31 Insurance Expense 200

Prepaid Insurance 200Insurance expense for January.




Insurance Expense1/31 200

Prepaid Insurance1/1 2,400 1/31 200

Bal. 2,200

Income StatementCost of assets

used this period to generate revenue.

Balance SheetCost of assets

that benefit future periods.




ReclassifyLiabilitiestoRevenues

Unearned Revenue Revenue

Unearned Rental Revenue Rental Revenue

Airline Ticket Advanced Sales Ticket Revenue

Liabilities Revenues

End of month adjusting entries



Jan. 1 Dec. 31

$6,000 Rental Contract Coverage for 12 Months

$500 Monthly Rental Revenue

On January 1, Webb Co. received $6,000 in advance for a one-year rental contract.




GENERAL JOURNAL

Date Account Titles and Explanation Debit CreditJan. 1 Cash 6,000

Unearned Rental Revenue 6,000Collected $6,000 in advance for rent.

Initially, revenues that benefit more than one accounting period are recorded as a liability.




Over time, the revenue is recognized as it is earned.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit(Monthly Adjusting Entry for Rent Revenue:)

Jan. 31 Unearned Rental Revenue 500Rental Revenue 500

Rental revenue for January.



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Rental Revenue1/31 500

Unearned Rental Revenue1/31 500 1/1 6,000

Bal. 5,500

Income StatementRevenue earned

this period.

Balance SheetLiability for

future periods.




TransactionAnalysisMethodology

Answer Five Questions:

1. What’s going on?

2. What accounts are affected?

3. How are they affected?

4. Does the balance sheet balance? (Do the debits equal the credits?)

5. Does my analysis make sense?

Learning Objective 4-7: Applythefivequestionsoftransactionanalysis.


ClosingtheBooksThe closing process simply transfers the year-end balances of all income statement accounts (e.g., revenues, expenses,

gains, and losses) to the retained earnings account.

Learning Objective 4-7: Applythefivequestionsoftransactionanalysis.4- 52


ClosingEntries

Expenses,losses,anddividendsdecreaseretainedearnings.

Revenuesandgainsincreaseretainedearnings.

Learning Objective 4-7: Applythefivequestionsoftransactionanalysis.


EndofChapter4