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The Accounting Cycle

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    • 1. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin THE ACCOUNTING CYCLE: Capturing Economic Events Chapter 3
    • 2. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin The Role of Accounting RecordsThe Role of Accounting Records Establishes accountability for assets and transactions. Establishes accountability for assets and transactions. Keeps track of routine business activities. Keeps track of routine business activities. Obtains detailed information about a particular transaction. Obtains detailed information about a particular transaction. Evaluates efficiency and performance within company. Evaluates efficiency and performance within company. Maintains evidence of company’s business activities. Maintains evidence of company’s business activities.
    • 3. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin The LedgerThe Ledger The entire group of accounts is kept together in an accounting record called a ledger. The entire group of accounts is kept together in an accounting record called a ledger. Cash Accounts Payable Capital Stock Accounts are individual records showing increases and decreases. Accounts are individual records showing increases and decreases.
    • 4. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin The Use of AccountsThe Use of Accounts Increases are recorded on one side of the T- account, and decreases are recorded on the other side. Left or Debit Side Right or Credit Side Title of Account
    • 5. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Let’s see how debits and credits are recorded in the Cash account for JJ’s Lawn Care Service. Let’s see how debits and credits are recorded in the Cash account for JJ’s Lawn Care Service.
    • 6. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Cash 5/1 8,000 5/2 2,500 5/25 75 5/8 2,000 5/29 750 5/28 150 5/31 50 5/31 4,125 Bal. Receipts are on the debit side. Payments are on the credit side. The balance is the difference between the debit and credit entries in the account. The balance is the difference between the debit and credit entries in the account. Debit and Credit EntriesDebit and Credit Entries
    • 7. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin AA = LL + OEOEASSETSASSETS Debit for Increase Credit for Decrease EQUITIESEQUITIES Debit for Decrease Credit for Increase LIABILITIESLIABILITIES Debit for Decrease Credit for Increase Debits and credits affect accounts as follows: Debits and credits affect accounts as follows: Debit and Credit RulesDebit and Credit Rules
    • 8. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin AA = LL + OEOE Debit balances CreditCredit balancesbalances = In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits. In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits. Double Entry Accounting  The Equality of Debits and Credits Double Entry Accounting  The Equality of Debits and Credits
    • 9. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Let’s record selected transactions for JJ’s Lawn Care Service in the accounts.
    • 10. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Will Cash increase or decrease? Will Capital Stock increase or decrease?
    • 11. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Capital Stock 5/1 8,000 Cash 5/1 8,000 May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Cash increases $8,000 with a debit. Capital Stock increases $8,000 with a credit.
    • 12. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 2: JJ’s purchased a riding lawn mower for $2,500 cash. May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Will Cash increase or decrease? Will Tools & Equipment increase or decrease?
    • 13. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 2: JJ’s purchased a riding lawn mower for $2,500 cash. May 2: JJ’s purchased a riding lawn mower for $2,500 cash. Tools & Equipment 5/2 2,500 Cash 5/1 8,000 5/2 2,500 Cash decreases $2,500 with a credit. Tools & Equipment increases $2,500 with a debit.
    • 14. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. Will Truck increase or decrease? Will Cash and Notes Payable increase or decrease?
    • 15. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. Truck 5/8 15,000 Cash 5/1 8,000 5/2 2,500 5/8 2,000 Notes Payable 5/8 13,000 Truck increases $15,000 with a debit. Cash decreases $2,000 with a credit. Notes Payable increases $13,000 with a credit.
    • 16. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 11: JJ’s purchased some repair parts for $300 on account. May 11: JJ’s purchased some repair parts for $300 on account. Will Tools & Equipment increase or decrease? Will Accounts Payable increase or decrease?
    • 17. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 11: JJ’s purchased some repair parts for $300 on account. May 11: JJ’s purchased some repair parts for $300 on account. Tools & Equipment increases $300 with a debit. Accounts Payable increases $300 with a credit. Tools & Equipment 5/2 2,500 5/11 300 Accounts Payable 5/11 300
    • 18. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. Will Tools & Equipment increase or decrease? Will Accounts Receivable increase or decrease?
    • 19. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days. Tools & Equipment decreases $150 with a credit. Accounts Receivable increases $150 with a debit. Tools & Equipment 5/2 2,500 5/18 150 5/11 300 Accounts Receivable 5/18 150
    • 20. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin In an actual accounting system, transactions are initially recorded in the journal. In an actual accounting system, transactions are initially recorded in the journal. GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit 2003 May 1 Cash 8,000 Capital Stock 8,000 Owners invest cash in the business. The JournalThe Journal
    • 21. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Posting involves copying information from the journal to the ledger accounts. Posting Journal Entries to the Ledger Accounts Posting Journal Entries to the Ledger Accounts
    • 22. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit 2003 May 1 Cash 8,000 Capital Stock 8,000 Owners invest cash in the business.General Ledger Cash Date Debit Credit Balance 2003 May 1 8,000 8,000 Posting Journal Entries to the Ledger Accounts Posting Journal Entries to the Ledger Accounts
    • 23. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit 2003 May 1 Cash 8,000 Capital Stock 8,000 Owners invest cash in the business.General Ledger Capital Stock Date Debit Credit Balance 2003 May 1 8,000 8,000 Posting Journal Entries to the Ledger Accounts Posting Journal Entries to the Ledger Accounts
    • 24. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit 2003 May 2 Tools & Equipment 2,500 Cash 2,500 Purchased lawn mower. Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service. Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service. Posting Journal Entries to the Ledger Accounts Posting Journal Entries to the Ledger Accounts
    • 25. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin General Ledger Cash Date Debit Credit Balance 2003 May 1 8,000 8,000 2 2,500 5,500 This ledger format is referred to as a running balance (as opposed to simple T accounts). This ledger format is referred to as a running balance (as opposed to simple T accounts). Ledger Accounts After PostingLedger Accounts After Posting
    • 26. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Net income is not an asset  it’s an increase in owners’ equity from profits of the business. Net income is not an asset  it’s an increase in owners’ equity from profits of the business. AA = LL + OEOEIncrease Decrease Increase Either (or both) of these effects occur as net income is earned . . . . . . but this is what “net income” really means. What is Net Income?What is Net Income?
    • 27. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin AA = LL + OEOE Retained EarningsRetained Earnings Capital Stock Retained Earnings The balance in the Retained Earnings account represents the total net income of the corporation over the entire lifetime of the business, less all amounts which have been distributed to the stockholders as dividends.
    • 28. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Revenue and ExpensesRevenue and Expenses The price for goods sold and services rendered during a given accounting period. Increases owner’s equity. The costs of goods and services used up in the process of earning revenue. Decreases owner’s equity.
    • 29. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin The Realization Principle: When To Record Revenue The Realization Principle: When To Record Revenue Realization Principle Revenue should be recognized at the time goods are sold and services are rendered.
    • 30. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin The Matching Principle: When To Record Expenses The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up.
    • 31. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Debits and Credits for Revenue and Expense Debits and Credits for Revenue and Expense EQUITIESEQUITIES Debit for Decrease Credit for Increase REVENUESREVENUES Debit for Decrease Credit for Increase EXPENSESEXPENSES Credit for Decrease Debit for Increase Expenses decrease owner’s equity. Revenues increase owner’s equity.
    • 32. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin EQUITIESEQUITIES Debit for Decrease Credit for Increase CAPITAL STOCKCAPITAL STOCK Debit for Decrease Credit for Increase DIVIDENDSDIVIDENDS Credit for Decrease Debit for Increase Payments to owners decrease owners’ equity. Owners’ investments increase owners’ equity. Investments by and Payments to Owners Investments by and Payments to Owners
    • 33. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Let’s analyze the revenue, and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction. Let’s analyze the revenue, and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction.
    • 34. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 29: JJ’s provided lawn care services for a client and received $750 in cash. May 29: JJ’s provided lawn care services for a client and received $750 in cash. Will Cash increase or decrease? Will Sales Revenue increase or decrease?
    • 35. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Sales Revenue 5/29 750 May 29: JJ’s provided lawn care services for a client and received $750 in cash. May 29: JJ’s provided lawn care services for a client and received $750 in cash. Cash increases $750 with a debit. Sales Revenue increases $750 with a credit. Cash 5/1 8,000 5/2 2,500 5/29 750 5/8 2,000
    • 36. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Will Cash increase or decrease? Will Gasoline Expense increase or decrease?
    • 37. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Gasoline Expense 5/31 50 May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Cash decreases $50 with a credit. Gasoline Expense increases $50 with a debit. Cash 5/1 8,000 5/2 2,500 5/29 750 5/8 2,000 5/31 50
    • 38. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Will Cash increase or decrease? Will Dividends increase or decrease?
    • 39. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Dividends 5/31 200 May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Cash decreases $200 with a credit. Dividends increase $200 with a debit. Cash 5/1 8,000 5/2 2,500 5/29 750 5/8 2,000 5/31 50 5/31 200
    • 40. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May. Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May.
    • 41. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin JJ's Lawn Care Service Unadjusted Trial Balance May 31, 2003 Cash 3,925$ Accounts receivable 75 Tools & equipment 2,650 Truck 15,000 Notes payable 13,000$ Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Total 21,900$ 21,900$ All balances are taken from the ledger accounts on May 31 after considering all of JJ’s transactions for the month. Proves equality of debits and credits.
    • 42. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Make end-of- year adjustments. Prepare adjusted trial balance. Prepare financial statements. Prepare after closing trial balance. Journalize and post closing entries. The Accounting Cycle
    • 43. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin End of Chapter 3End of Chapter 3

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