2 basics of bookkeeping

7/29/2019 2 Basics of Bookkeeping

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BASICS OF BOOKKEEPING

The topics to be covered in this section of the courseare described in Chapters 1 and 2 of the text

Chapter 1 pages 18 -24

Chapter 2 all


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TOPICS TO BE COVERED

NATURE OF ACCOUNTING

SINGLE ENTRY BOOKKEEPING

DOUBLE ENTRY BOOKKEEPINGTHE ACCOUNTING EQUATION

DEBITS AND CREDITS

THE ACCOUNTING CYCLE

PREPARATION OF THE BALANCE SHEET


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BASICS OF BOOKKEEPING

OBJECTIVE - to introduce students to themechanics of bookkeeping a solid foundation in bookkeeping is necessary to

be able to evaluate the effects of selectingalternative accounting policies

bookkeeping has specific procedures that must be

followed or the entries are incorrect

bookkeeping is only one component of accounting


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NATURE OF ACCOUNTING

Accounting is the process of identifying, measuring,recording, interpreting and communicating the resultsof economic activities of a business

identification and measurement require significantprofessional judgement

once it has been determined what should be

recorded, the bookkeeping or recording process isstraight forward

communication of the results of the economicactivities is done through the FINANCIAL

STATEMENTS


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SINGLE ENTRY ACCOUNTING

use of your cheque book is single entry accounting

cheques issued are recorded as a reduction inthe bank account, but there is not a separaterecord kept for each type of expense paid

for instance, if groceries were purchased, thereis no entry to show an increase to the total cost ofgroceries purchased during the year

the cheque register is part of the accounting system

it is referred to as an account


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Single entry accounting

Single entry accounting has been used forproprietorships where the owner prepares an incomestatement primarily for tax purposes

No balance sheet is prepared

Revenues and expenses are recorded from invoices

there is no way to determine if all have been

recorded

no attempt to record the changes in the assetand liability account balances


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DOUBLE ENTRY ACCOUNTING

Double entry accounting creates an account for eachtype of asset, liability, equity, revenue and expense

Every entry into a double entry accounting systemmust balance

If cash is received, the source must be recorded

If cash is paid out, the use must be recorded

If a sale is made on account, the receivable mustbe recorded

If a purchase is made on account, the debt must

be recorded


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double entry accounting permits preparation of both abalance sheet and an income statement

checks and balances are available to ensure alltransactions are recorded

Example

a bank reconciliation is prepared to ensure the

ending bank balance per the bank statementagrees to the balance in the accounting records

if it does not, any unrecorded amounts will beidentified and recorded


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the accounting equation is the foundation ofdouble entry accounting

ASSETS = LIABILITIES + EQUITIES

assets acquired by the business must be paid for,and the funds are either borrowed or invested by

the owners

Net Assets = Assets - Liabilities

THE ACCOUNTING EQUATION


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Double entry accounting requires that the accountingrecords of the business balance, just as the accountingequation balances

to accomplish this, left and right side entries arerecorded

DEBIT - an entry on the left side

- also used as a verb, to make an entry on the

left

CREDIT - an entry on the right side

- also used as a verb, to make an entry on

the right

MECHANICS OF BOOKKEEPING


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Assets appear on the left side of the accountingequation (debit side of the equal sign)

The normal balance for an asset account is a

debit balance

Assets are increased by a debit

Assets are decreased by a credit



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Liabilities appear on the right side of the accountingequation (credit side of the equal sign)

The normal balance for a liability account is acredit balance

Liabilities are increased by a credit entry

Liabilities are decreased with a debit entry



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Equities are on the right side of the accountingequation ( the credit side of the equal sign)

Accounts that increase equity are increased with

credit entries and decreased with debit entries

Accounts that decrease equity are increased withdebit entries and decreased with credit entries



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The permanent equity accounts have a normalcredit balance

Temporary accounts may have debit or creditbalances:

Revenues and gains increase equity and have

normal credit balances

Expenses and losses reduce equity and havenormal debit balances

Dividends distributed, if recorded in a separateaccount, have a normal debit balance


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If a company earns $10,000, this amount in notpayable to creditors. The value of the company willincrease and it is the shareholders that benefit

Revenue and expense accounts are used tomeasure the profit or loss in the year

These accounts are really part of the equity of thebusiness, but are kept separate to facilitate thepreparation of the income statement

Equity in a business


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ASSETS = LIABILITIES + EQUITY

EQUITY = SHARE CAPITAL + RETAINED EARNINGS

RETAINED EARNINGS = OPENING RETAINED

EARNINGS + NET INCOME - DIVIDENDS

NET INCOME = REVENUES - EXPENSES

COMPONENTS OF EQUITY OF A

CORPORATION


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Components of Equity of a

Proprietorship

For a proprietorship, contributions by the owner andprofits not withdrawn are combined in one account

Owners name, capital

Heather Johnston, capital

EQUITY = OPENING CAPITAL + NET INCOME -DRAWINGS


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Dividends are a distribution of the after-tax profits of abusiness to the shareholders (owners)

the term dividend only applies to a corporation

for a proprietorship and partnership, distributionsof profit to the owners are called drawings

Dividends reduce the equity in the business

Dividends are increased with a debit and have a

normal debit balance


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SHARE CAPITAL and RETAINED EARNINGS ( or

OWNERS CAPITAL) are referred to as permanentaccounts because they carry forward on the BalanceSheet from one year to the next

REVENUES, EXPENSES, GAINS and LOSSES arereferred to as temporary accounts because theyaccumulate the transactions for the year only, and thentheir balances are closed to Retained Earnings to

allow the next years transactions to be accumulated


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THE ACCOUNTING CYCLE

Steps carried out throughout the period: transaction analysis

journal entry preparation

posting journal entries to the general ledger

End of period procedures:

prepare trial balance

prepare adjusting journal entries

adjusted trial balance

financial statement preparation

closing journal entries


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Transaction analysis

determine whether an event should be recorded inthe accounting records at this time

if yes, determine which accounts are affected

determine whether each account affected isincreased or decreased by this transaction

requires significant professional judgement in the realworld

in this course, most events are very straightforward


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General journal entries

method of recording transactions in the accountingrecords

two columns needed for dollar amounts

left column for debit entries

right column for credit entries

formal journal entry page on page 69 of text


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simplification for the purposes of this course

omit description and date (unless you are asked

to prepare entries for several dates at one time)

Example

Heather contributes $10,000 cash to her business,

Heathers Shoes, Ltd. and receives 1,000 shares

Debit Credit

Cash 10,000

Share Capital 10,000


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General Ledger

The general ledger is made up of a series ofaccounts that resemble the cheque register

Each account lists all increases and decreases to the

account, in chronological order, and the accountbalance

Actual format shown on page 65 of text

T - account used in this course shown on page 59 account balance determined only after allentries to the account are posted


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Cash

10,000


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There should be a separate account in the generalledger for each type of asset, liability, equity, revenue,gain, expense and loss

Example

Assets:

Cash

Accounts receivable

Inventory

Prepaid expenses


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Land

Building

Equipment

Furniture

Goodwill


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Liabilities

Demand loan payable

Accounts payable

Salaries payable

Interest payable

Income tax payable

Unearned revenue / Deposits from customers

Current portion of long term debt


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Revenues

Sales revenue

Service revenue

Interest revenue

Gains (Losses)

Gain (Loss) on sale of fixed assets

Gain (Loss) on sale of investments

Gain (Loss) on repurchase of bonds


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Expenses

Cost of goods sold

Salaries expense

Rent expense

Repairs and maintenance

Office Supplies expense

Utilities expense

Interest expense

Income tax expense


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End of Period Procedures

Trial Balance

a listing of all general ledger accounts, withbalance

total debits must equal total credits

if not, must correct errors before proceedingfurther

Adjusting journal entries

record end of period adjustments that are notsupported by transactions


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Adjusted trial balance

another listing of general ledger accounts and

balances

same purpose, to ensure total debits equal totalcredits

done to ensure accounts are in balance prior topreparation of the financial statements

done twice to make identification of the erroreasier - fewer steps to review


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Preparation of the financial statements

Income Statement prepared first Statement of Retained Earnings prepared second

need net income from income statement

Balance Sheet prepared third need retained earnings balance at end ofperiod

Cash Flow Statement prepared last

uses information from other statements


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Closing Journal Entries

journal entries prepared at the end of the fiscal yearof the business

the temporary equity accounts (revenues, expenses,

gains and losses) are closed into Retained Earnings temporary account balances are reduced to zero

retained earnings increased by net incomeamount, or reduced by amount of loss

if dividends declared are recorded in a temporaryaccount, it is closed to Retained Earnings,reducing the retained earnings balance


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BALANCE SHEET

The classified Balance Sheet was introduced lastmodule and will be expanded on here

Example from text page AR - 13 from the appendixfollowing page 651 in volume 1

Loblaws Consolidated Balance Sheet

Consolidated - balance sheet is for more thanone corporation controlled by the same group of

people. (pages AR-4 and AR-5 identify thebusinesses included


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Balance sheet prepared as at January 3, 1998

January 3 is the year end of the business

this is a fiscal year end

a calendar year end is December 31

the fiscal year end may be a calendar yearend, it may be another date


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Loblaws Consolidated Balance SheetLoblaws Consolidated Balance Sheet

this is a reportform balance sheet assets are listed on top

liabilities and equities are listed on the bottom

assets = liabilities + equities

4,013 = 2,518 + 1,495

shown right on the statement

4,013 = 4,013

amounts stated in millions of dollars


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Assets divided between current and non-currentcurrent all listed under the headingCurrent

listed in order of liquidity

non-current listed by type

Franchise investment and receivables

Fixed assets

Goodwill

Other assets


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Liabilities divided between current and non-current all current liabilities reported together under theheading of Current

listed in order of maturity

non-current listed by type

long term debt

other liabilities

deferred income taxes


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Equity accounts that appear on the Balance Sheetare the permanent account balances only

Share capital

the amount received from selling shares whenoriginally issued by the company

not affected by sales betweenshareholders

does not reflect current fair market value ofthe shares


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Retained earnings this is the balance at the end of the year, in thiscase January 3, 1998 (even though it is noted as1997 in the column above the amounts reported)

this only agrees to the actual amount in theRetained Earnings account in the general ledgerimmediately after the temporary accounts areclosed, before any transactions for the next year

are recorded agrees to the amount reported on theConsolidated Statement of Retained Earnings


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BOOKKEEPING EXAMPLE

the text has excellent examples of bookkeepingentries in Chapters 2, 3, and 4

the text examples are for a proprietorship

this example is a corporation


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Heathers Shoe Store Ltd.

Heathers Shoe Store Ltd. intends to begin sellingshoes on January 1, 2000. The company will have aDecember 31 year end. In preparation for the openingof the retail store on January 1, 2000, the business

carried out the following transactions duringDecember, 1999:

1) Heather contributed $10,000 in cash to the businessand received 1,000 common shares in return

2) Display shelves costing $4,000 were purchased onaccount.


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3) a cheque for $500 was issued to the lawyer for thecost of incorporating the business

4) cash of $4,000 was deposited. The cash was theproceeds of a bank loan obtained to finance the

purchase of the display shelves5) the invoice for the display shelves was paid in full

6) shoe inventory with a cost of $12,000 was orderedon account

7) a shipment of shoes with a cost of $5,500 wasreceived before the end of December; the remainingshoes will be delivered in January


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8) insurance premium of $2,400 was paid for insurance

coverage from January 1 to December 31, 20009) rent for the month of January of $2,200 was paid,plus $2,200 for the last months rent in advance

10) a customer who knew the shoe store was openinggave Heather $100 for special order shoes. The shoeshave not yet been ordered

Required: prepare the necessary journal entries forDecember 1999 and post to T-accounts. Prepare a trialbalance and balance sheet as at December 31, 1999


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Solution - Heathers Shoe Store Ltd.

Journal entries for December 1999 Debit Credit1) Cash 10,000

Common shares 10,000

2) Fixtures 4,000Accounts payable 4,000

3) Incorporation costs 500Cash 500

4) Cash 4,000Bank loan payable 4,000


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Debit Credit5) Accounts payable 4,000

Cash 4,000

6) no entry is required - no liability until shoes are

received

7) Inventory 5,500Accounts payable 5,500

8) Prepaid insurance 2,400Cash 2,400


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Debit Credit9) Prepaid rent 4,400

Cash 4,400

10) Cash 100Unearned revenue 100


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Cash Common shares

(1) 10,000 10,000 (1)


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Cash Common shares

(1) 10,000 10,000 (1)

Fixtures Accounts payable

(2) 4,000 4,000 (2)


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Cash Incorporation costs

(1) 10,000 500 (3) (3) 500(4) 4,000 4,000 (5)

Bank loan payable Accounts payable

4,000 (4) (5) 4,000 4,000 (2)


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Cash Inventory

(1) 10,000 500 (3) (7) 5,500(4) 4,000 4,000 (5)

2,400 (8)

Prepaid insurance Accounts payable

(8) 2,400 (5) 4,000 4,000 (2)5,500 (7)


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Cash Prepaid rent

(1) 10,000 500 (3) (9) 4,400(4) 4,000 4,000 (5)

(10) 100 2,400 (8)4,400 (9)

Unearned revenue

100 (!0)


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Cash Inventory

(1) 10,000 500 (3) (7) 5,500(4) 4,000 4,000 (5)

(10) 100 2,400 (8)4,400 (9)2,800

Prepaid insurance Prepaid rent

(8) 2,400 (9) 4,400


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Fixtures Incorporation costs

(2) 4,000 (2) 500

Bank Loan Payable Accounts payable

4,000 (4) (5) 4,000 4,000 (2)

5,500 (7)

5,500


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Unearned revenue Common shares

100 (!0) 10,000 (1)

Solution - Heathers Shoe StoreLtd.

S l ti H th Sh St Ltd


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Trial Balance

Debits CreditsCash 2,800Inventory 5,500Prepaid insurance 2,400Prepaid rent 4,400Fixtures 4,000Incorporation costs 500Bank loan payable 4,000

Accounts payable 5,500

Unearned revenue 100Common shares 10,000

19,600 19,600


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Balance Sheetas at December 31, 1999

ASSETSCURRENT

Cash $ 2,800Inventory 5,500

Prepaid insurance 2,400Prepaid rent 4,400

15,100

CAPITALFixtures 4,000

INCORPORATION COSTS 500$ 19,600

Heathers Shoe Store Ltd


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Heather s Shoe Store Ltd.

Balance Sheetas at December 31, 1999

LIABILITIES

CURRENT

Bank loan payable $ 4,000

Accounts payable 5,500Unearned revenue 100

9,600

SHAREHOLDERS EQUITYSHARE CAPITAL

Common shares 10,000$ 19,600


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TIPS TO HELP LOCATE ERRORS

Supplemental topic Chapter 2 - page 80

If total debits do not equal total credits, it is possible tonarrow down the places to look. If debits = 14,720 and

credits = 14,270, the difference is 14,720 - 14270 =450. Since 450 is divisible evenly by 9, it is likely to bea transposition error. 450 / 9= 50.

The result, 50, also provides guidance on where to

look. The transposed numbers are 5 digits apart, andthe transposition is between the hundreds and tenscolumn. For example 1,380 recorded as 1,830 or 940recorded as 490.


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QUESTIONS FOR PRACTICE - NOT FOR MARKS

Chapter 1 6,13,14,15,17

Exercises E1-8, E1-9,

Problems P1-1, P1-4, P1-7, P1-9

Chapter 2 4,7,9,10,15,18

Exercises E2-3, E2-6, E2-8, E2-11

Problems P2- 2, P2- 4, P2- 6, P2- 8, P2-10

The problems listed always go from least to mostdifficult.

2 basics of bookkeeping

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