Principle of Accounting Chapter 4The double-entry Recording Process BA in International Business Foreign Trade University
Outline• An introduction to double-entry accounting• State the rules of double-entry for the different types of accounts.• Footing and balancing ledger accounts• The role of trial balance• Detecting errors through a trial balance• Chart of account• Three-column ledger accounts• Accounting for drawings
The Account Accounting’s main summary device is the account, the record of changes.Accounts are grouped in three broad categories, according to the accounting equation: Cash
The Account Assets are the economic resources that benefit the business now and in the futureCash LandAccounts receivable BuildingsInventory Equipment,Notes receivable furniture,Prepaid expenses and fixtures
The Account Liabilities are the debts of the company.Notes payableAccounts payableAccrued liabilities (for expenses incurred but not paid)Long-term liabilities (bonds)
The Account Stockholders’ (owners’) equity is theowners’ claims to the assets of a corporation.
Accounting TransactionsTransactions are economic events that requirerecording in the financial statements. • May be external or internal. • Not all activities represent transactions. • Each transaction has a dual effect on the accounting equation.
Accounting TransactionsQuestion: Are the following events recorded in theaccounting records? Discuss Purchased a productEvent computer. design with Pay rent. potential customer.Criterion Is the financial position (assets, liabilities, or stockholders’ equity) of the company changed?Record/Don’t Record
Double-Entry Accounting Double-entry bookkeeping means to record the dual effects of each business transaction.
The T-Account Account Title Debit CreditLEFT SIDE RIGHT SIDE Three parts : 1) the Title of the account 2) a left or Debit side 3) a right or Credit side
Debits and Credits• Debit (dr.) - an entry or balance on the left side of an account• Credit (cr.) - an entry or balance on the right side of an account• Remember: – Debit is always the left side! – Credit is always the right side!
Recording entries in ledger accounts Identify the transaction and state two ledger accounts affected by the transaction Classify the ledger accounts according to their report classification Determine whether each account is increased or decreased by the transaction State whether the accounts will have a debit or a credit entry
Recording entries in ledger accounts Air & Sea received $50,000 from issuing stock. Stockholders’ Assets = Liabilities + Equity Cash Common Stock Debit Credit for for Increase, Increase, 50,000 50,000
Recording entries in ledger accounts Air & Sea purchased land for $40,000 cash. Stockholders’ Assets = Liabilities + Equity Cash Common Stock Bal. 50,000 Credit Bal. 50,000 for Decrease, 40,000 Land Debit for Increase, 40,000
Recording Transactions in the JournalJournal Page 1Date Accounts and Explanation Debit CreditApril 2 Cash 50,000 Common Stock 50,000 Issued common stock
Analysis chart • An analysis chart provides an analysis of a financial transaction to determine the double- entry to be recorded in ledger accounts. • An analysis chart helps to ensure that the double-entry for each transaction is correctly determined. • ExampleTransaction A/c names Classifica- Increase/ Debit/ tion Decrease CreditBought vehicle for Vehicle Asset Increase Dr$18,000 by cash at Cash at Asset Decrease Crbank bank
Double-entry accounting Vehicles Cash at bank Mar 1 Cash at bank 18,000 Mar 1 Vehicles 18,000 Mar 4 Wages 400 Wages Mar 4 Cash at bank 400
Revenue and Expense Transactions• Retained Income is merely accumulated revenues less expenses, but we cannot just increase or decrease the Retained Income account directly. – This would make preparing the income statement very difficult• By accumulating revenues and expenses separately, a more meaningful income statement can be easily prepared.
Revenue and Expense Transactions• Revenue and expense accounts are a part of Retained Income. Retained Income Decrease Increase Expense Revenue Debit Credit Increase Increase
Revenue and Expense Transactions• Summary of revenue and expense transactions: – A credit to a revenue increases the revenue and increases Retained Income. – A debit to a revenue decreases the revenue and decreases Retained Income. – A credit to an expense decreases the expense and increases Retained Income. – A debit to an expense increases the expense and decreases Retained Income.
Debits and Credits Summary Liabilities Normal Debit / Dr. Credit / Cr. Normal Balance Balance Debit Credit Normal Balance Assets Chapter Stockholders’ Equity Stockholders’ 3-24 Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Normal Balance Normal Balance Chapter Expense 3-23 Revenue Chapter 3-25 Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Normal Balance Normal Balance Chapter 3-27 Chapter 3-26 SO 3 Define debits and credits and explain their use in recording business transactions.
Debits and Credits SummaryReview Question Debits: a. increase both assets and liabilities. b. decrease both assets and liabilities. c. increase assets and decrease liabilities. d. decrease assets and increase liabilities. SO 3 Define debits and credits and explain their use in recording business transactions.
Examples – Exercise 4.3Transaction Account Classifi- Increase/ Debit/ names cation Decrease CreditBanked $60,000 cash Cash at bank A Increase Drto start business Capital OE Increase CrPaid the 1st month Expenserent $4,000 cashBought shop fittings Shop fittingfor cash $12,000 CashPurchased CDs for Stock control$4,300 on credit CreditSold CDsCost $2,000
Example – Exercise 4.3 (Cont’d)Transaction Account Classifi- Increase/ Debit/ names cation Decrease CreditSold CDs for cash $4,300Paid 1 month’s advertising$600Borrowed cash from bank$5,000Sold CDs on credit at cost$600(Record Cost of sale)Sold CDs on credit for $1,200(Record revenue)Purchased stock for cash$3,600
Example – Exercise 4.3 (Cont’d)Transaction Account Classifi Increase/ Debit/ names -cation Decrease CreditRepaid the National Bank$2,000Paid wages $800Cash sales of stock at cost$1,200 (record cost of sale)Cash sales of stock for$2,200(record revenue)Purchased inventory oncreditfor $3,400
Footing – Example E 4.3 Cash at bank Feb 1 Capital $60,000 Feb 2 Rent $ 4,000 5 Sales $ 3,400 3 Shop fittings $ 12,000 8 Loan $ 5,000 6 Advertising $ 600 10 Sales $ 2,200 9 Stock control $ 3,600 14 Loan $ 5,000 47,600 15 Wages $ 800 $70,600 $23,000
Balancing – Example E 4.3 Cash at bank Feb 1 Capital $60,000 Feb 2 Rent $ 4,000 5 Sales $ 3,400 3 Shop fittings $ 12,000 8 Loan $ 5,000 6 Advertising $ 600 10 Sales $ 2,200 9 Stock control $ 3,600 14 Loan $ 2,000 15 Wages $ 800 Balance $ 47,600 $70,600 $70,600 Balance $47,600
Closing the Accounts• Once the financial statements are prepared, the ledger accounts must be prepared to record the next period’s transactions. This process is called closing the books. – The balances in all “temporary” stockholders’ equity accounts are transferred to a “permanent” stockholders’ equity account. – The revenue and expense accounts are “reset” to zero and the current net
Closing the Accounts• The Closing Process: – The revenue accounts are closed to Income Summary in the first entry. – The expense accounts are closed to Income Summary in the second entry. – The amount of Net Income (revenues - expenses) is then transferred from
Preparing the Trial Balance• Once all transactions have been posted to the ledger, a trial balance is prepared.• Trial balance - a list of all of the accounts with their balances – assets first, followed by liabilities, and then stockholders’ equity. It is prepared as a test or check before continuing the recording process.
Preparing the Trial Balance• The purposes of the trial balance: – To help check on accuracy of posting by proving whether the total debits equal the total credits – To detect errors in double-entry recording – To establish a convenient summary of balances in all accounts for the preparation of formal financial statements
Trial balance – An example Dr Cr Capital – Mammone 60,000 Rent 4,000 Shop fittings 12,000 Stock control 7,500 Advertising 600 Loan 3,000 Wages 800 Sales 6,800 Costs of sales 3,800 Debtors 1,200 Creditors 7,700 Cash at bank 47,600 77,500 77,500
Trial balance (Cont’d)Some errors may not be detected by a trial balance:• Entering an incorrect amount for both the debit and credit.• Entering a debit or credit in the wrong account.• The debit and credit entries are reversed.• Omitting a transaction completely.• Compensating errors.
Chart of accounts• An organized index to the ledger accounts• Groups the account together according to their accounting report classifications• Facilitate report preparation
Three-column ledger accounts• A simpler form of ledger with three columns: debit entry, credit entry and the balance of account.• Advantage: the balances of all accounts are readily available.• Ideal for computerized system.Eg: Three-column ledger – Cash at bank account Date Account Dr Cr Balance 1 Capital 25,000 25,000 Dr 2 Loan 10,000 35,000 Dr 4 Loan 500 34,500 Dr 5 Stock control 600 33,900 Dr
Accounting for Drawings• Drawings: withdrawals of assets by the owner for personal use.• The balance of drawings is accounted for as a deduction against the owners’ equity.Example: – The proprietor withdraws $500 cash for personal use. – Balances of accounts under owners’ equity section are as follows: Capital account: $50,000 Profit earned for the year: $20,000 Drawings for the year: $10,000 Requirement: Record the transaction and prepare an extract of the statement of financial position, owners’ equity section.
Accounting for Drawings (Cont’d)Dr Drawings a/c $500 Cr Cash at bank a/c $500Extract statement of financial positionOwners’ equityCapital $50,000Plus Net profit $20,000 $70,000Less Drawings $10,000 $60,000
Flow of Accounting Data Transaction AmountsTransaction Transaction Entered in Posted to Occurs Analyzed the Journal the Ledger
Ledger Accounts• Ledger - a group of related accounts kept current in a systematic manner – Think of a ledger as a book with one page for each account. – The ledger is a company’s “books.”• General ledger - the collection of accounts that accumulates the Ledger amounts reported in the major financial statements
QuizGive appropriate terms for the below definitions.2. A numerical list of all the accounts used by a company.3. An entry on the left side of an account.4. A list of each account and its balance at a specific point in time used to prove the equality of debits and credits.5. A system of accounting in which every transaction is recorded with equal debits and credits.6. An entry on the right side of an account.7. An analysis of a financial transaction leading to determine the double-entry to be recorded in ledger accounts.
QuizGive appropriate terms for the below definitions.2. A numerical list of all the accounts used by a company. (chart of account)3. An entry on the left side of an account.(debit)4. A list of each account and its balance at a specific point in time used to prove the equality of debits and credits. (balancing ledger accounts)5. A system of accounting in which every transaction is recorded with equal debits and credits. (trail balance)6. An entry on the right side of an account (credit)7. An analysis of a financial transaction leading to determine the double-entry to be recorded in ledger accounts. (an analysis chart)