Chapter

3

McGraw-Hill/Irwin

THE ACCOUNTING
CYCLE:
Capturing Economic Events

© The McGraw-Hill Companies, Inc., 2002
The Role of Accounting Records
The Role of Accounting Records
Establishes accountability for
Establishes accountability fo...
The Ledger
The Ledger
Cash
Accounts
Payable
Capital
Stock

McGraw-Hill/Irwin

Accounts are
Accounts are
individual records...
The Use of Accounts
The Use of Accounts
Increases are
recorded on one
side of the Taccount, and
decreases are
recorded on ...
Let’s see how
Let’s see how
debits and credits
debits and credits
are recorded in the
are recorded in the
Cash account for...
Debit and Credit Entries
Debit and Credit Entries
Receipts
are on
the debit
side.

5/1
5/25
5/29
5/31
Bal.

McGraw-Hill/Ir...
Debit and Credit Rules
Debit and Credit Rules
Debits and credits affect accounts as
Debits and credits affect accounts as
...
Double Entry Accounting  The
Double Entry Accounting  The
Equality of Debits and Credits
Equality of Debits and Credits
...
Let’s record
selected
transactions for
JJ’s Lawn Care
Service in the
accounts.
McGraw-Hill/Irwin

© The McGraw-Hill Compan...
May 1: Jill Jones and her family invested $8,000
May 1: Jill Jones and her family invested $8,000
in JJ’s Lawn Care Servic...
May 1: Jill Jones and her family invested $8,000
May 1: Jill Jones and her family invested $8,000
in JJ’s Lawn Care Servic...
May 2: JJ’s purchased a riding lawn mower
May 2: JJ’s purchased a riding lawn mower
for $2,500 cash.
for $2,500 cash.

Wil...
May 2: JJ’s purchased a riding lawn mower
May 2: JJ’s purchased a riding lawn mower
for $2,500 cash.
for $2,500 cash.

Cas...
May 8: JJ’s purchased a $15,000 truck. JJ’s
May 8: JJ’s purchased a $15,000 truck. JJ’s
paid $2,000 down in cash and issue...
May 8: JJ’s purchased a $15,000 truck. JJ’s
May 8: JJ’s purchased a $15,000 truck. JJ’s
paid $2,000 down in cash and issue...
May 11: JJ’s purchased some repair parts for
May 11: JJ’s purchased some repair parts for
$300 on account.
$300 on account...
May 11: JJ’s purchased some repair parts for
May 11: JJ’s purchased some repair parts for
$300 on account.
$300 on account...
May 18: JJ’s sold half of the repair parts to
May 18: JJ’s sold half of the repair parts to
ABC Lawns for $150, a price eq...
May 18: JJ’s sold half of the repair parts to
May 18: JJ’s sold half of the repair parts to
ABC Lawns for $150, a price eq...
The Journal
The Journal
In an actual accounting system, transactions
In an actual accounting system, transactions
are init...
Posting Journal Entries to the Ledger
Posting Journal Entries to the Ledger
Accounts
Accounts

Posting
involves
copying
in...
Posting Journal Entries to the Ledger
Posting Journal Entries to the Ledger
Accounts
Accounts
GENERAL JOURNAL
Date

Accoun...
Posting Journal Entries to the Ledger
Posting Journal Entries to the Ledger
Accounts
Accounts
GENERAL JOURNAL
Date

Accoun...
Posting Journal Entries to the Ledger
Posting Journal Entries to the Ledger
Accounts
Accounts
GENERAL JOURNAL
Date

Accoun...
Ledger Accounts After Posting
Ledger Accounts After Posting
Date
2003
May 1
2

General Ledger
Cash
Debit
Credit
8,000
2,50...
What is Net Income?
What is Net Income?
Net income is not an asset  it’s an increase in
Net income is not an asset  it’s...
Retained Earnings
Retained Earnings

A = L + OE
Capital
Stock

Retained
Earnings

The balance in the Retained Earnings acc...
Revenue and Expenses
Revenue and Expenses
The price for
goods sold
and services
rendered during a
given accounting
period....
The Realization Principle: When
The Realization Principle: When
To Record Revenue
To Record Revenue
Realization Principle
...
The Matching Principle: When To
The Matching Principle: When To
Record Expenses
Record Expenses
Matching Principle
Expense...
Debits and Credits for Revenue and
Debits and Credits for Revenue and
Expense
Expense
Expenses
decrease
owner’s
equity.

E...
Investments by and Payments to
Investments by and Payments to
Owners
Owners
Payments to
owners
decrease
owners’
equity.

E...
Let’s analyze the
Let’s analyze the
revenue, and
revenue, and
expense
expense
transactions for
transactions for
JJ’s Lawn ...
May 29: JJ’s provided lawn care services for
May 29: JJ’s provided lawn care services for
a client and received $750 in ca...
May 29: JJ’s provided lawn care services for
May 29: JJ’s provided lawn care services for
a client and received $750 in ca...
May 31: JJ’s purchased gasoline for the lawn
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
May 31: JJ’s purchased gasoline for the lawn
mower and the truck for $50 cash...
May 31: JJ’s Lawn Care paid Jill Jones and
May 31: JJ’s Lawn Care paid Jill Jones and
her family a $200 dividend.
her fami...
May 31: JJ’s Lawn Care paid Jill Jones and
May 31: JJ’s Lawn Care paid Jill Jones and
her family a $200 dividend.
her fami...
Now, let’s look at
Now, let’s look at
the Trial Balance
the Trial Balance
for JJ’s Lawn Care
for JJ’s Lawn Care
Service fo...
JJ's Lawn Care Service
Unadjusted Trial Balance
May 31, 2003
Cash
$ 3,925
Accounts receivable
75
Tools & equipment
2,650
T...
The Accounting Cycle

Journalize
transactions.

Post entries to
the ledger
accounts.

Prepare trial
balance.

Prepare afte...
End of Chapter 3
End of Chapter 3

McGraw-Hill/Irwin

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

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