chapter 4 the bookkeeping process and transaction analysis
TRANSCRIPT
Chapter 4
The Bookkeeping Process and Transaction Analysis
Accounts and Charts of Accounts:
Each company collects huge amounts of data, therefore, the company needs a system to accumulate these data.
In manual accounting systems, each account is kept in a separate page. The book that contains these pages is called the General Ledger (the same is true for the
computerized accounting systems). Chart of accounts: a listing of all the accounts and their codes
The Double Entry System:
Invented in 1494 by Luca Pacioli The base of all what we do in accounting Based on the principle of duality: that every transaction has to have at least two effects, which
offset or balance each other One of the effects need to be a “DEBIT”, the other need to be a “CREDIT” so that the dollar
values balance with each other
The “T” account:
It is the simplest place to start It is formed of three basic parts:
1. Title2. Debit side (Left side)3. Credit side (Right Side)
Title of the Account
Debit Side Credit Side Left Side Right Side
1
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
Rules of Double Entry Bookkeeping:
1. Every transaction affects at least two accounts2. Total debits = Total credits
We talked before about the accounting equation:
Asssets = Liabilties + Capital + (Revenue - Expenses)
And from it we derived the following equation:
Asssets + Expenses = Liabilties + Capital + Revenue
You could re-read this equation as follows:
Assets + Expenses = Liability + Capital + RevenuesResources Owned Resources Used Resources
provided through Debt
Resources provided by
Owners
Resources provided by
the Firm
Debit Credit Debit Credit
Beginning Balance Beginning Balance
Increases Decreases Decreases Increases
End Balance End Balance
Natural balances are Debits Natural balances are credits
Make sure that you remember that Debits and Credits are the accountants ways of saying left and right and that they do not mean increase and decrease
2
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
Steps of the Accounting Equation:
1. Event occurs
Example 1 Example 2
Borrow 20000 from the bank Buy equipment for 8000 in cash
2. Collect and/or prepare source documents
these are the keys that trigger the beginning of the accounting process
Example 1 Example 2
Get the borrowing contract Get the invoice for the equipment
3. Analyze the event that occurred this is where you identify what accounts are affected and what the dollar amount is
Example 1 Example 2
Cash increased by 20,000
N/P increased by 20,000
Equipment increased by 8,000
Cash decreased by 8,000
3
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
4. Record the transactions in the general journal
The journal is a chronologically ordered accounting book that shows transactions when they happen. I.e. it is recorded based on its date
Example 1 Example 2
Cash is an Asset --- for an Asset to increase– we Debit it
N/P is a Liability – for a Liability to increase ---we Credit it
Equipment is an Asset --- for an Asset to increase– we Debit it
Cash is an Asset --- for an Asset to Decrease– we Cebit it
Example 1 Example 2
Debit Credit Debit Credit
Jan 15 th
Cash
N/P
Loan from XYZ Bank
20,000
20,000
Jan 21 st
Equipment
Cash
Purchase of Equipment
8,000
8,000
4
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
5. Post transactions to Ledger
We basically transfer the amounts to the appropriate accounts
The ledger is set by account. Each account has a separate page that shows the beginning balance,
increases to the account, decreases of the account and the end balance
Cash Equipment N/P
Debit Credit Debit Credit Debit Credit
20,000 8,000 8,000 20,000
12,000 8,000 20,000
Cash
Date Description Ref. Dr. Cr.Balance
Dr. Cr.
Jan 15 Borrowed Cash from bank 20,000 20,000
Jan 21 Bought Equipment for Cash 8,000 12,000
Equipment
Date Description Ref. Dr. Cr.Balance
Dr. Cr.
Jan 21 Bought Equipment for Cash 8,000 8,000
5
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
N/P
Date Description Ref. Dr. Cr.Balance
Dr. Cr.
Jan 15 Borrowed Cash from bank 20,000 20,000
6. Prepare Trial Balance
A Trial Balance in a list of all accounts in the accounting system with their ending balances
It is a periodical statement that is based on the equality of debits and credits
For each debit there is an equal and opposite credit
The Trial Balance can be prepared at any time, but it’s usually prepared at the end of each month
Account Debit Credit
Cash 12,000
Equipment 8,000
N/P 20,000
Totals 20,000 20,000
Remember the accounting equation:
Assets + Expenses + Withdrawals Liabilities + Investments + Revenues
All accounts on this side are increased with debits and decreased with credits
All accounts on this side are decreased with debits and increased with credits
The Trial Balance can tell us whether Debits equal Credits. However, the Trial Balance cannot
tell us if:1. The transactions are described correctly: you can debit and credit but the problem is that
you can debit and credit the wrong accounts. As a result, the trial; balance will balance but the individual accounts will be wrong.
6
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
2. There are omitted transactions
7
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
In Class Exercise (1)
For each of the following transactions indicate:1. What accounts are affected 2. How are they affected (increased or decreased) 3. Whether it is debited or credited, and by what amount
Description Account Amount Increased / Decreased
Debit Credit
1 Borrowed 20,000 Cash from a bank
Cash
N/P
20,000
20,000
Increased
Increased
20,000
20,000
2 Purchased Equipment for 50,000 in Cash
3 Bought 1,000 worth of inventory on Credit
4 Sold inventory costing 300 for 500 in Cash
5 Paid employees their wages of 200
6 Sold inventory costing 550 for 700 on Credit
7 Collected the 700 from the previous step
8
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
Matching Issues
Cash Basis Accounting:
The important part is the Cash transactions This method recognizes events in the accounting system on the basis of a cash
exchange with another party. This could be cash received from investors (creditors or owners), or cash received from customers for sales.
Because the use of credit for purchases/sales, & because not all costs are paid when incurred (wages, utilities), there is frequently a difference in timing between when a resource is consumed/acquired and when cash is consumed/acquired.
Under the Cash Basis Accounting, Revenues and Expenses are recorded when cash is received or paid .
The problem is that cash paid to buy inventory may be paid in a different period than when the inventory is sold, and cash is collected from the sale
As a result, the revenue and expense of the same transaction may be recorded at different periods
The Matching rule Revenue must be assigned to the accounting period in which the goods are sold or the
services are performedExpenses must be assigned to the accounting period in which they produce the revenue.
Accrual Basis of Accounting:
Aims to record the financial transactions of a company in the period when they occur rather than when cash exchanges hands.
Accrual basis of accounting measurement: measures and records transactions at the time resources are acquired, sold or consumed, regardless of whether cash has changed hands yet.
This means that we : Recognize revenue when earned (e.g. sale is made or service is rendered)Recognize expense when incurred (e,g, asset is used or sold)
Accrual accounting also results in adjustment to keep the accounting books up to dateAdjusting entries are entries that accountants use to apply accrual accounting transaction
that span more than one periodAdjusting entries never effect the cash account
9
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
CASH vs. ACCRUAL
Event Cash Accounting Accrual AccountingCash Sale Cash
SalesIncreaseIncrease
Cash Sales Inventory COGS
IncreaseIncreaseDecreaseIncrease
Credit Sale
Cash Collected
Nothing
CashSales
IncreaseIncrease
Accounts Receivable SalesInventoryCOGS
CashAccounts Receivable
IncreaseIncreaseDecreaseIncrease
IncreaseDecrease
Wages Accrued
Wages Paid
Nothing
CashWage Expense
DecreaseIncrease
Wages PayableWages Expense
Wages PayableCash
IncreaseIncrease
DecreaseDecrease
Interest Accrued
Interest Paid
Nothing
CashInterest Expense
DecreaseIncrease
Interest PayableInterest Expense
Interest PayableCash
IncreaseIncrease
DecreaseDecrease
Asset Bought Cash Asset
Nothing
DecreaseIncrease
Cash Asset
Depreciation ExpenseAccumulated Depreciation(Asset Decreases)
DecreaseIncrease
IncreaseIncrease
Depreciation:
is the systematic allocation of the cost of an asset over the economic useful life of this asset. It is very important to note that it is not a cash item but it is an allocation of cost.
As indicated by the accrual accounting methods there are timing differences between the time when revenues and expenses are recorded for an item and when the related cash is received or paid
There are two types of differences:
- Deferrals: Cash received and paid before revenues and expenses are recorded 10
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
- Accruals: Cash received and paid after revenues and expenses are recorded
1. Deferred Expenses : Cash is recorded before related expense is recorded
Prepaid Expenses
These are expenses that are paid in advance (e.g. rent, insurance … etc.)E.g. You pay $3,000 for 3 months rent in advance
When cash is paid
Dr. Prepaid Rent 3,000 Cr. Cash 3,000
At the end of the 1st month (This is called an adjusting entry)
Dr. Rent Expense 1,000 Cr. Prepaid Rent 1,000
Prepaid Rent Rent Expense3,000 1,000 1,000
2,000 1,000
Depreciation: We allocate the cost of long term assets over more than one periodThe useful life of the asset is estimatedIf you Buy a machine for $10,000 in cash that you estimate its useful life to be 10 years
Depreciation per year = 10,000/10 = 1,000 per yearWhen the machine is bought
Dr. Machine 10,000 Cr. Cash 10,000
At the end of the 1st year (adjusting entry)
Dr. Depreciation Expense 1,000 Cr. Accumulated Depreciation 1,000
Note that we did not credit (decrease) the asset account directly but instead we credited an account that is called Accumulated Depreciation.
This account is a contra asset accountA Contra Asset is an account that is related and opposite to another accountIt is shown as a deduction from the related account (Asset account)
11
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
We use Contra Asset accounts instead of the deduction from the Asset account to show that it is an estimate and to show the actual cost of the Asset.
2. Accrued Expense : Expenses are recorded before the related cash is paid
Wages of $5,000 are accrued and owed to the employees for their work during January (but not yet paid) and will be paid in February.
When the wages are accrued
When the wages are paid ( adjusting entry)
Dr. Wages Payable 5,000 Cr. Cash 5,000
Wages Payable Wages Expense5,000 5,000 5,000
0 5,000
3. Deferred Revenue: When we receive cash before the related revenue is earned
Unearned Revenue ( Liability) Cash that is received in advance before the related revenue is earned A publishing company received $6,000 in advance to cover the subscriptions for the magazine for
the next 3 month
When the cash is received
Dr. Cash 6,000 Cr. Unearned revenue 6,000
At the end of the 1st month (adjusting entry)
Dr. Unearned Revenue 2,000Cr, Revenue 2,000
Unearned Revenue Revenue2,000 6,000 2,000
12
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
Dr. Wages Expense 5,000 Cr. Wages Payable 5,000
4,000 2,000
13
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
4. Accrued Revenue: Revenue that is recorded before the collection of related cash
Credit sales The company sold $30,000 worth of goods for $50,000 on credit
When the sale is made
Dr. Accounts Receivable 50,000 Cr. Revenue 50,000
When cash is received
Dr. Cash 50,000 Cr. Accounts Receivable 50,000
14
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
In Class Exercise (2)
Perfect Clean Cleaning Company had the following transactions during July of 2008:
1. The owners invested additional $10,000 in the business.2. The company sold detergents for $20,000 on credit in July and billed the customers (they did
not collect any of this amount).3. The cost of the detergents that were sold during July are $16,000. These detergents were
bought in April. 4. The company paid $3,000 for the utility bill of June.5. They collected $15,000 from customers for services rendered during June.6. The executive director was paid $9,000 for his salary for May, June, and July7. Detergents totaling $5,000 were sold for customers who had previously paid for them in June8. The company bought a new machine for $30,000 in cash
Required:Complete the following table for the above transactions for the month of July. What would the results of operations be under (1) Accrual and (2) Cash flow accounting?
Effect on Income Statement Effect on Cash Flow
1. *** (+) 10,000
2.
3.
4.
5.
6.
7.
8.
15
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
In Class Exercise (3)
George borrowed $300,000 on January 1, 2008 to start a computer software company. Annual interest on the loan is $12,000. Complete the following table using the related assumptions. Assume that each situation is independent from he other.
a. The interest payments will be made at the end of each quarter. The first payment will be paid on March 31st
January February March Quarter Total
Interest Expense
Interest Paid (cash)
b. The interest payments will be made at the end of each month. The first payment will be paid on January 31st
January February March Quarter Total
Interest Expense
Interest Paid (cash)
16
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis
In Class Exercise (4)
North Fork Operations began operations on January 1, 2008. The following events occurred during 2008:
The Company issued $4,500,000 of Stock to investors and $3,000,000 of Long Term Debt The Company bought Land and Machines for $7,200,000 in cash The Company performed services wroth $2,550,000. Customers paid $2,100,000 and the
Company was owed $450,000 for services provided during the period. The Company paid $1,500,000 for Wages, Interest, and Operating activities for resources
consumed during 2008
1. What was North Fork's Net Cash Flow from Financing, Investing, and Operating activities for 2008? And what was the total Cash Flow for the period?
2. Prepare an Accrual basis Income Statement for North Fork's first year (2008) in business.
17
____________________________________________________________________________
Dr. Khaled DahawyCh 4: The Bookkeeping Process & Transaction Analysis