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The Expanded The Expanded Ledger:Ledger:

Revenue, Expense, Revenue, Expense, and Drawingsand Drawings

Chapter 5

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Expanding the LedgerExpanding the LedgerThrough the first four chapters we have

looked at the fundamental accounting equation …

AAssets ssets == LLiabilities iabilities ++ OOwner’s wner’s EEquityquity

This resulted in a single account for owner’s equity.

By “default”, what types of entries have you charged to owner’s equity?

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Types of OE Entries?Types of OE Entries?1. Owner’s investment in the company.

2.2. RevenuesRevenues from the sale of goods or by providing a service.

3.3. ExpensesExpenses related to the operation of the business and the generation of revenues.

4.4. DrawingsDrawings or owner’s withdrawals from the business for personal use.

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The focus of Chapter 5 is the specific identification and use of accounts to track …

Expanding the LedgerExpanding the Ledger

REVENUESREVENUES

DRAWINGSDRAWINGS

EXPENSESEXPENSES

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The purpose of expanding the ledger is to provide essential information about the progress of the business.

This information is needed to assess the ongoing profitability of the company.

What do we mean when we say a company is profitable profitable or making a profitprofit?

What is meant by lossloss??

Expanding the LedgerExpanding the Ledger

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Example of Expanding the LedgerExample of Expanding the Ledger

What do we know about profitability of What do we know about profitability of this firm in the month of January?this firm in the month of January?Did they make a profit or a loss?Did they make a profit or a loss?

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How much was spent on advertising?

Are the wages fair?

Is the rent too high?

How much did the owner withdraw from the business?

Example of Expanding the LedgerExample of Expanding the Ledger

What types of economic events can we “speculate” impacted the owner’s

equity account?

8Owner’s EquityOwner’s Equity

$26,137$26,137

Example of Expanding the LedgerExample of Expanding the Ledger

Now … what can we determine Now … what can we determine about the profitability of this firm?about the profitability of this firm?

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Some of the information from these new accounts will be used to prepare an Income StatementIncome Statement.

What do you think an Income Income StatementStatement is?

Income StatementIncome Statement

What accounts do you think we would use to prepare in Income Income StatementStatement?

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Sample Income StatementSample Income Statement

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What is revenuerevenue? Selling goods or services

produces revenuerevenue. What impact does revenuerevenue have

on equity? Revenue is an increase in equity

resulting from the sale of goods or services in the usual course of business.

RevenueRevenue

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A company is paid $500 for services rendered. Before using revenue accounts:

RevenueRevenue

Dr. Cash $500 Cr. Owner’s Equity $500

Using revenue accounts: Dr. Cash $500 Cr. Revenue $500

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RevenueRevenue

Assets Owner’s EquityLiabilities== ++ Debit CreditDebit Credit Debit CreditDebit Credit Debit CreditDebit Credit (DR) (CR)(DR) (CR) (DR) (CR)(DR) (CR) (DR) (CR)(DR) (CR)Normal Balance

Normal Balance

Normal Balance

How do revenue accounts “behave”?

Revenue represents an increase in equity.

An increase in equity requires a credit entry.

Therefore, to book revenue, credit the revenue account.

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GAAP - Revenue RecognitionGAAP - Revenue Recognition

The revenue recognition convention The revenue recognition convention states that revenue must be recorded states that revenue must be recorded

in the accounts (i.e. recognized) in the accounts (i.e. recognized) at the time the transaction is at the time the transaction is

completed.completed.

What does this mean?Revenue is recorded when the bill is sent to the customer.For a cash transaction, revenue is recorded when the sale is complete and the cash is received.

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What is expensesexpenses? The costs associated with

producing revenue. What impact do expensesexpenses have

on equity? ExpensesExpenses represent a decrease in

equity resulting from the cost of producing revenue.

Examples????

ExpensesExpenses

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A company pays wages of $250. Before using expense accounts:

ExpensesExpenses

Dr. Owner’s Equity $250 Cr. Cash $250

Using expense accounts: Dr. Wages Expense $250 Cr. Cash $250

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ExpensesExpenses

Assets Owner’s EquityLiabilities== ++ Debit CreditDebit Credit Debit CreditDebit Credit Debit CreditDebit Credit (DR) (CR)(DR) (CR) (DR) (CR)(DR) (CR) (DR) (CR)(DR) (CR)Normal Balance

Normal Balance

Normal Balance

How do expense accounts “behave”?

Expenses represent a decrease in equity.

A decrease in equity requires a debit entry.

Therefore, expense accounts are typically debited.

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Using the revenue and expense accounts, a business can determine if they have earned a net income (profit) or a net loss.

Net IncomeNet Income is the difference between the total revenues and total expenses, where the revenues are greater than the expenses.

A Net LossNet Loss is created if expenses are greater than the revenues.

Net Income Net Income oror Net Loss Net Loss

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The owner usually looks to the profits of the business to provide a livelihood.

In a healthy business, the owner is able to take funds (generated by profits) out of the business.

These withdrawals of funds, by the owner, are known as DrawingsDrawings and decrease equity.

DrawingsDrawings

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Drawings are NOT expenses. They are not associated with

producing revenue. Drawings have nothing to do with

the determination of the net income or net loss.

Cash is the most common item withdrawn by an owner for personal use.

DrawingsDrawings

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There are four types of accounts in the equity section:

1.1. CapitalCapital – this account will now contain only the equity figure at the beginning of the fiscal period plus new capital from the owner.

2.2. RevenuesRevenues – increases in equity resulting from the sale of goods or services. A revenue account normally has a credit balance.

Expanding the LedgerExpanding the Ledger

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3.3. ExpensesExpenses – decreases in equity resulting from the costs of the materials or services used to produce the revenue. An expense account normally has a debit balance.

4.4. DrawingsDrawings – decreases in equity resulting from the owner’s personal withdrawals. A drawings account normally has a debit balance. Drawings are NOT a factor in calculating net income or loss.

Expanding the LedgerExpanding the Ledger

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Complete each statement with a DR or CRa) The Bank account normally has a ____ balance.b) A Revenue account normally has a ____ balance.c) An Expense account normally has a ____ balance.d) Paying a creditor involves a ____ entry to the creditor’s

account.e) The Drawings account receives a ____ entry when the

owner withdraws money for personal use.f) A lawyer gives a cash refund to a customer. The Bank

account will receive a ____ entry and the Revenue account will receive a ____ entry.

g) Supplies are bought on credit. The Supplies account will receive a ____ entry and the supplier’s account payable will receive a ____ entry.

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Complete each statement with a DR or CRh) The Drawings account will not normally receive ____

entries.i) An increase in equity can be thought of as a ____ to the

Capital account.j) Net Income can be thought of as a ____ to the Capital

account.k) Net Loss can be thought of as a ____ to the Capital

account.l) The owner takes a computer from the business for his

personal (permanent) use. The Drawings account will receive a ____ entry.

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The income statementincome statement tells the owners and the managers how the business is doing.

By definition, an income statementincome statement is a financial statement that summarizes the items of revenue and expense, and shows the net income or net loss of a business for a given period of time.

The Income StatementThe Income Statement

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Net Income is not cash. It is the

difference between total

revenues and total expenses.

The word “expense” is not always required.

Why?In what order are expenses listed?

A company can have more than one source of

revenue.

Date?The accounting period for which the figures have

been accumulated

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Who uses the Income Statement?1. Owners and Managers

Shows if the business is making profit. Used for setting goals and policy. When compared to previous years, it

provides a trend … highlighting potential problems.

2. Bankers Supports loan decisions. Past profitability is one indicator of future

potential.

The Income StatementThe Income Statement

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Who uses the Income Statement?3. Income Tax Authorities

Every business is required by law to prepare an income statement.

The net income figure of a proprietorship must be included on the owner’s income tax return.

Corporations must file their own tax returns.

The income statement must be sent to the government along with the tax returns.

The Income StatementThe Income Statement

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Net income is measured over a specific length of time, known as the fiscal periodfiscal period.

The formal fiscal periodfiscal period is typically one year.

The fiscal yearfiscal year does not have to be the calendar year … it just has to run for 12 consecutive months (or in some cases, 52 consecutive weeks)

Fiscal PeriodFiscal Period

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The text indicates that the fiscal period is sometimes referred to as the accounting accounting periodperiod.

Companies prepare financial statements periodically in order to assess their financial condition and operating results. Accounting periodsAccounting periods are typically one month, one quarter, or one year.

If a company uses a one year accounting accounting periodperiod (i.e. they only prepare financial statements at year end) it is referred to as their fiscal periodfiscal period or or fiscal yearfiscal year.

Accounting PeriodAccounting Period

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GAAPGAAPThe Time Period ConceptThe Time Period ConceptThe time period concept provides The time period concept provides

that accounting will take place over that accounting will take place over specific time periods known as fiscal specific time periods known as fiscal

periods.periods.

What does this mean?Companies must use fiscal periods of equal length when measuring financial progress.

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GAAPGAAPThe Matching PrincipleThe Matching Principle

The matching principle states that The matching principle states that each expense item related to revenue each expense item related to revenue earned must be recorded in the same earned must be recorded in the same period as the revenue it helped earn.period as the revenue it helped earn.

What does this mean?Expenses must be recorded in the period in which the revenue is recognized.To do this, accountants make a number of mathematical adjustments in the accounts at the end of a fiscal year. (we cover this in detail in Chapter 9)

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To help organize the expanded ledger, it is customary to number the accounts in the ledger. These numbers are used for identification and reference, particularly in computer systems.

We will be using a computer system, Simply Accounting, later in the semester. The chart of accounts used by Simply Accounting is:

Assets 1000 – 1999 Liabilities 2000 – 2999 Capital & Drawings 3000 – 3999 Revenue 4000 – 4999 Expenses 5000 – 5999

Chart of AccountsChart of Accounts

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Expanded Basis Equation and Expanded Basis Equation and Debit / Credit RulesDebit / Credit Rules

LiabilitiesAssets Owner’s Equity+=

=Assets

Dr. Cr.

-Dr. Cr.

Expenses

Dr. Cr.

Revenues+

Dr. Cr.

Owner’s Drawings-

Dr. Cr.

Owner’s Capital+Liabilities

Dr. Cr.

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p. 134, Exercise 1:1) Identify the errors.2) Prepare corrected income statement.

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p. 134, Exercise 2:A. Prepare a trial balance.B. Prepare a chart of accounts based on

the Simply Accounting numbering system in this lesson.

C. Prepare an income statement.

p. 135, Exercise 5:Do all parts of this question … including

the questions about GAAP.

Class / HomeworkClass / Homework

Created by D. GilroyHeart Lake Secondary School

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Equity Equity Relationship Relationship and the Balance and the Balance

SheetSheet

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TotalExpenses$15,451

TotalIncome$23,660

NetIncome$8,209

(Rev – Exp)

Drawings$3,950

Increasein Equity

$4,259(NI – Drawings)

BeginningCapital$21,878

EndingCapital$26,137(Beg + Inc)

EndingEndingCapitalCapital$26,137$26,137

==BeginningBeginning

CapitalCapital$21,878$21,878

NetNetIncomeIncome$8,209$8,209

++NetNet

LossLoss$n/a$n/a

---- ---- DrawingsDrawings

$3,950$3,950

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