Chapter 2 Principles of financial accounting

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Chapter 2 financial Accounting with examples

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Chapter 2 Principles of financial accounting

  1. 1. Chapter 1  Business Activities and the Role of Accounting
  2. 2. Chapter 2 Mugan-Akman 2007 2-52 CASH BASIS OF ACCOUNTING ACCRUAL BASIS OF ACCOUNTING VS Accounting Methods for Measuring Performance
  3. 3. Chapter 2 Mugan-Akman 2007 3-52 Accounting Methods for Measuring Performance (a) Cash basis of accounting – Revenues are recognized when cash is received and expenses are recognized when cash is paid (b) Accrual basis of accounting(b) Accrual basis of accounting – Revenues and expenses are recognized on anRevenues and expenses are recognized on an economic basis regardless of when cash is paid oreconomic basis regardless of when cash is paid or receivedreceived
  4. 4. Chapter 2 Mugan-Akman 2007 4-52 Accounting Methods for Measuring Performance (a) Cash basis of accounting(a) Cash basis of accounting – Revenues are recognized when cash is received andRevenues are recognized when cash is received and expenses are recognized when cash is paidexpenses are recognized when cash is paid (b) Accrual basis of accounting – Revenues and expenses are recognized on an economic basis regardless of when cash is paid or received
  5. 5. Chapter 2 Mugan-Akman 2007 5-52 Recognition of Revenues Receipt of the computer 6 May Receipt of the bill 7 May Sales order 3 May Shipment of the goods 5 May Payment of the bill 20 May MILLENIUM CO. CUSTOMER
  6. 6. Chapter 2 Mugan-Akman 2007 6-52 Recognition of Expenses Expenses are recognized when they are incurred and helped to produce revenue, regardless of the cash payment date
  7. 7. Chapter 2 Mugan-Akman 2007 7-52 Generally Accepted Accounting Principles and Concepts • Entity - Every entity is a separate economic unit and should be kept distinct from the activities of its owners and other companies • Monetary Unit - only economic events that have monetary transactions will be reported in the financial statements • Cost Principle - assets are presented at their original (historical) cost • Going Concern - companies are established with the goal that they will operate for an indefinitely long period of time • Periodicity - economic activities of any firm can be divided into discrete time periods for reporting purposes • Matching Principle -all revenues must be recorded in the accounting period in which the goods are sold or services are rendered and all expenses must be recorded in the accounting period in which they are incurred to produce such revenues
  8. 8. Chapter 2 Mugan-Akman 2007 8-52 Accounting Cycle Analyze and record the transactions Post the transactions and prepare trial balance Adjust the accounts and prepare trial balance Close the accounts and prepare trial balance Prepare the financial statements
  9. 9. Chapter 2 Mugan-Akman 2007 9-52 Analysis and Recording Business Transactions • Business transaction is an economic event that causes a change in the financial position • Financial Position: – What we own – How we own
  10. 10. Chapter 2 Mugan-Akman 2007 10-52 Fundamental Accounting Equation ASSETS = EQUITIES ASSETS = LIABILITIES + OWNERS' EQUITY
  11. 11. Chapter 2 Mugan-Akman 2007 11-52 How do we use the “balance sheet” equation? • Recall the Balance Sheet Equation: • Assets = Liabilities + Shareholders’ Equity • Implications: • If assets increase : either Liabilities and/or Shareholders’ should also increase and vice versa • For example: borrow cash, cash (asset) will increase and Liabilities will increase • when it is paid back: cash (asset) will decrease and liabilities will decrease
  12. 12. Chapter 2 Mugan-Akman 2007 12-52 How do we record? • an ACCOUNT: accounting report of a specific asset, liability or owners’ equity item • Has 3 elements: title, debit side and credit side (also called the “T-Account”) • Changes in the accounts are entered manually into a book called a ledger • computerized • Basic forms of book ledgers: the two-column account format, and the four-column account format • Chart of accounts
  13. 13. Chapter 2 Mugan-Akman 2007 13-52 Forms of Ledgers Date Item Post. Ref. * Debit Date Item Posting Reference Credit Account No:Account Left-hand or Right-hand or Debit Side Credit Side Account Name Account No: Two-Column Account T-Account form that depicts the two-column account:
  14. 14. Chapter 2 Mugan-Akman 2007 14-52 How do accounts behave? Assets = Liabilities + Shareholders’ Equity + + + So Assets increase on the left hand or debit side then they decrease on the credit side Assets + - debit credit
  15. 15. Chapter 2 Mugan-Akman 2007 15-52 Behavior of Accounts Liabilities and Owners’ Equity accounts increase on the credit side, decrease on the debit side Liabilities or Owners’ Equity Accounts - + debit credit
  16. 16. Chapter 2 Mugan-Akman 2007 16-52 Transaction Analysis and The Duality Concept if an asset account increases, because of duality concept there must be a corresponding 1. increase in a specific liability account 2. or a decrease in a another asset account 3. or an increase in owners' equity account.
  17. 17. Chapter 2 Mugan-Akman 2007 17-52 Illustration of Express Travel Agency 1. Ms. Fodor invested TL100.000 at the inception Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 Total 100.000 0 100.000 GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 1 Jan 2004Cash 100 100.000 Capital 500 100.000 Investment by the shareholders
  18. 18. Chapter 2 Mugan-Akman 2007 18-52 2. On 1 January employed a full time secretary and a sales representative. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change Total 100.000 0 100.000
  19. 19. Chapter 2 Mugan-Akman 2007 19-52 3. On 1 January rented an office building and paid 3 months rent of TL 600. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change Total 100.000 0 100.000 GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 1 Jan 2004Prepaid Rent 180 600 Cash 100 600 Payment of 3 months of rent in advance
  20. 20. Chapter 2 Mugan-Akman 2007 20-52 4. On 2 January office furniture and equipment is purchased for TL 15.000 , for which TL 5.000 is paid in cash and the rest would be paid later in January and February 2007. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 Total 110.000 10.000 100.000 GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No Debit Credit 2 Jan 2004Furniture and Equipment 255 15.000 Cash 100 5.000 Accounts Payable 320 10000 Purchase of furniture and equipment
  21. 21. Chapter 2 Mugan-Akman 2007 21-52 5. On 3 January insured the office building and the equipment effective from 1 January to 31 December 2004 and paid TL 120 for the whole period. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 Total 110.000 10.000 100.000 GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 3 Jan 2004Prepaid Insurance 180 120 Cash 100 120 Purchase of insurance policy
  22. 22. Chapter 2 Mugan-Akman 2007 22-52 6. On 5 January the company agreed with Turkish Airlines to sell airline tickets of THY and receive commissions in return. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change Total 110.000 10.000 100.000
  23. 23. Chapter 2 Mugan-Akman 2007 23-52 7. On 10 January Express Travel Agency borrowed TL 15.000 from the bank at an annual interest rate of 24% for six months. The principal and the interest of the loan will be paid together on 10 July 2007. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 7 +15.000 +15.000 No change Total 125.000 25.000 100.000
  24. 24. Chapter 2 Mugan-Akman 2007 24-52 7. On 10 January Express Travel Agency borrowed TL 15.000 from the bank at an annual interest rate of 24% for six months. The principal and the interest of the loan will be paid together on 10 July 2004. GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 10 Jan 2004Cash 100 15.000 Bank Loan 300 15.000 Borrowing from the bank
  25. 25. Chapter 2 Mugan-Akman 2007 25-52 8. On 10 January purchased office supplies for TL 2.500 in cash. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 Total 125.000 25.000 100.000
  26. 26. Chapter 2 Mugan-Akman 2007 26-52 8. On 10 January purchased office supplies for TL 2.500 in cash. GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 10 Jan 2004Office Supplies 136 2.500 Cash 100 2.500 Purchase of office supplies
  27. 27. Chapter 2 Mugan-Akman 2007 27-52 9. During the first half of January the agency sold tickets to various customers and on 16 January issued a commission invoice to THY amounting to TL 5.000 that will be collected later in January 2007. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 Total 130.000 25.000 105.000
  28. 28. Chapter 2 Mugan-Akman 2007 28-52 9. During the first half of January the agency sold tickets to various customers and on 16 January issued a commission invoice to THY amounting to TL 5.000 that will be collected later in January 2004. Left or Debit Side Right or Credit Side Decrease Increase Revenue Accounts GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 16 Jan 2004Accounts Receivable 120 5.000 Commission Revenue 600 5.000 Recognition of commission on ticket sales
  29. 29. Chapter 2 Mugan-Akman 2007 29-52 10. On 20 January the company paid TL 5.000 for the furniture and equipment that were purchased on 2 January.Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 10 -5000 -5000 No change Total 125.000 20.000 105.000
  30. 30. Chapter 2 Mugan-Akman 2007 30-52 10. On 20 January the company paid TL 5.000 for the furniture and equipment that were purchased on 2 January. GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 20 Jan 2004Accounts Payable 320 5.000 Cash 100 5.000 Payment for an accounts payable
  31. 31. Chapter 2 Mugan-Akman 2007 31-52 11. On 22 January received TL 7.500 from a customer for organizing the accounting conference that will be held on February 2, 2004.Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 10 -5.000 -5.000 No change 11 +7.500 +7.500 No change Total 132.500 27.500 105.000
  32. 32. Chapter 2 Mugan-Akman 2007 32-52 11. On 22 January the company received TL 7.500 from a customer for organizing the accounting conference that will be held on 2 February 2007. GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 22 Jan 2004Cash 100 7.500 Unearned Revenues 340 7.500 Receipt of advance payment from a customer
  33. 33. Chapter 2 Mugan-Akman 2007 33-52 12. The company received the full payment of commission charged to THY of TL 5.000 on 23 January. Event No Assets Liabilities Owners’ Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 10 -5.000 -5.000 No change 11 +7.500 +7.500 No change 12 +5.000 No change No change -5.000 Total 132.500 27.500 105.000
  34. 34. Chapter 2 Mugan-Akman 2007 34-52 12. The company received the full payment of commission charged to THY of TL 5.000 on 23 January. GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 23 Jan 2004Cash 100 5.000 Accounts Receivable 120 5.000 Receipt of payment from a customer
  35. 35. Chapter 2 Mugan-Akman 2007 35-52 13. On 24 January paid salaries of TL 9.000 employees in cash. Event No Assets Liabilities Owners’ Equity 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 10 -5.000 -5.000 No change 11 +7.500 +7.500 No change 12 +5.000 No change No change -5.000 13 -9.000 No change -9.000 Total 123.500 27.500 96.000
  36. 36. Chapter 2 Mugan-Akman 2007 36-52 13. On 24 January paid salaries of TL 9.000 employees in cash. Left or Debit Side Right or Credit Side Increase Decrease Expense Accounts GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 24 Jan 2004Salary Expense 770 9.000 Cash 100 9.000 Payment of salaries
  37. 37. Chapter 2 Mugan-Akman 2007 37-52 14. During the second half of January the agency sold tickets to various customers and on 31 January issued a commission invoice to THY amounting to TL 7.500 which will be collected in February 2004. EventNo Assets Liabilities Owners’Equity 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 10 -5.000 -5.000 No change 11 +7.500 +7.500 No change 12 +5.000 No change No change -5.000 13 -9.000 No change -9.000 14 +7.500 No change +7.500 Total 131.000 27.500 103.500
  38. 38. Chapter 2 Mugan-Akman 2007 38-52 14. During the second half of January the agency sold tickets to various customers and on 31 January issued a commission invoice to THY amounting to TL 7.500 which will be collected in February 2007. GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No.Debit Credit 31 Jan 2004Accounts Receivable 120 7.500 Commission Revenues 600 7.500 Recognition of commission on ticket sales
  39. 39. Chapter 2 Mugan-Akman 2007 39-52 15. Ms. Fodor withdrew TL 3.000 on 31 January for personal use. Event No Assets Liabilities Owners’ Equity 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 10 -5.000 -5.000 No change 11 +7.500 +7.500 No change 12 +5.000 No change No change -5.000 13 -9.000 No change -9.000 14 +7.500 No change +7.500 15 -3.000 No change -3.000 Total 128.000 27.500 100.500
  40. 40. Chapter 2 Mugan-Akman 2007 40-52 15. Ms. Fodor withdrew TL 3.000 on 31 January for personal use. Left or Debit Side Right or Credit Side Increase Decrease Owners' Withdrawals or Dividends GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 31 Jan 2004Withdrawals XXX 3.000 Cash 600 3.000 Withdrawal by the owner
  41. 41. Chapter 2 Mugan-Akman 2007 41-52 Summary 1. determine the effects of transactions on three components of the accounting equation, 2. determine which specific accounts are affected, and 3. assure that total of the increases should be equal to either increases on the other side of the equation or to decreases on the same side, or a combination there of.
  42. 42. Chapter 2 Mugan-Akman 2007 42-52 Behavior Summary Assets = Liabilities + Owners’ Equity + - - + - + Dr Cr Dr Cr Dr Cr Expense Revenue + - - + Dr Cr Dr Cr Withdrawals/Dividends + - Dr Cr
  43. 43. Chapter 2 Mugan-Akman 2007 43-52 Accounting Cycle Analyze and record the transactions Post the transactions and prepare trial balance Adjust the accounts and prepare trial balance Close the accounts and prepare trial balance Prepare the financial statements
  44. 44. Chapter 2 Mugan-Akman 2007 44-52 Posting to The Ledger GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit Credit 1 Jan 2004Cash 100 100.000 Capital 500 100.000 Investment by the shareholders LEDGER - Cash Acc. No. 100 Date Description Ref Debit Credit Debit Balance Credit Balance 1 Jan 2004Investment by the shareholders P 1 100.000 100.000 LEDGER - Capital Acc. No. 500 Date Description Ref Debit Credit Debit Balance Credit Balance 1 Jan 2004Investment by the shareholders P 1 100.000 100.000
  45. 45. Chapter 2 Mugan-Akman 2007 45-52 LEDGER - Cash Acc. No. 100 Date Description Ref Debit Credit Debit Balance 1 Jan Investment by the shareholders P 1 100.000 100.000 1 Jan Payment of office rent P 1 600 99.400 2 Jan Purchase of office furniture and equipment P 1 5.000 94.400 3 Jan Payment of insurance P 1 120 94.280 10 Jan Borrowing from the bank P 1 15.000 109.280 10 Jan Purchase of office supplies P 1 2.500 106.780 20 Jan Payment for an accounts payable P 1 5.000 101.780 22 Jan Receipt of advance payment from a customer P 1 7.500 109.280 23 Jan Receipt of payment from a customer P 1 5.000 114.280 24 Jan Payment of salaries P 1 9.000 105.280 31 Jan Withdrawal by the owner P 1 3.000 102.280
  46. 46. Chapter 2 Mugan-Akman 2007 46-52 Trial Balance Accounts Debit Credit Cash 102.280 Accounts Receivable 7.500 Office Supplies 2.500 Prepaid Rent 600 Prepaid Insurance 120 Office Furniture and Equipment 15.000 Bank Loan 15.000 Accounts Payable 5.000 Unearned Revenues 7.500 Capital 100.000 Withdrawal 3.000 Commission Revenues 12.500 Salary Expenses 9.000 Total 140.000 140.000 Express Travel Agency Trial Balance 31 January 2004 in TL
  47. 47. Chapter 2 Mugan-Akman 2007 47-52 Category of the Account Increase Recorded By Normal Balance Assets Debits Debit Liabilities Credits Credit Shareholders’ Equity Capital Credits Credit Dividends or Withdrawals Debits Debit Revenues Credits Credit Expenses Debits Debit Normal Balances of Accounts
  48. 48. Chapter 2 Mugan-Akman 2007 48-52

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