chapter 3 the accounting cycle: capturing economic events

Chapter

3THE ACCOUNTING CYCLE:Capturing Economic Events

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.

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.

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

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.

Cash5/1 8,000 5/2 2,500

5/25 75 5/8 2,0005/29 750 5/28 150

5/31 50 5/31 4,125Bal.

Cash5/1 8,000 5/2 2,500

5/25 75 5/8 2,0005/29 750 5/28 150

5/31 50 5/31 4,125Bal.

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

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

AA = LL + OEOEDebit

balancesCredit Credit

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 AccountingThe Equality of Debits and Credits

Double Entry AccountingThe Equality of Debits and Credits

Let’s record selected

transactions for JJ’s Lawn Care Service in the

accounts.

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?

Capital Stock5/1 8,000

Cash5/1 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.

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?

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 & Equipment5/2 2,500

Cash5/1 8,000 5/2 2,500

Cash decreases $2,500 with a credit.

Tools & Equipment increases $2,500

with a debit.

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?

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.

Truck5/8 15,000

Cash5/1 8,000 5/2 2,500

5/8 2,000

Notes Payable5/8 13,000

Truck increases $15,000 with a debit.

Cash decreases $2,000 with a credit.

Notes Payable increases $13,000

with a credit.

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?

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 & Equipment5/2 2,500

5/11 300

Accounts Payable5/11 300

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?

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 & Equipment5/2 2,500 5/18 150

5/11 300

Accounts Receivable5/18 150

Exhibit 3.1

Overview of the Accounting CycleOverview of the Accounting Cycle

1. Analyze transactions

based on source

documentsChapter 1 and 2

2. JournalizeChapter 3

3. PostChapter 3

9. Prepare post-closing trial balance

Chapter 5

8. CloseChapter 5

7. Prepare financial

statements Chapter 2 through 5

6. Prepare adjusted trial

balanceChapter 4

5. AdjustChapter 4

4. Prepare unadjusted trial

balanceChapter 3

Step 1 Examine source

documents …

Liabilities EquityAssets = +

… and analyze transactions.

Remember this step?Now let’s look at some

additional steps.

Steps in Processing TransactionsSteps in Processing Transactions

Step 4Prepare unadjusted

trial balance.

Step 1Examine source

documents…

Assets Liabilities Equity= +

… and analyze transactions.

Step 2 Record transactions

in a journal.

ACCOUNT NAME: ACCOUNT No.

Date Description PR Debit Credit Balance

Step 3Post the journal

information to a ledger.

Exhibit 3.14

Steps in Processing TransactionsSteps in Processing Transactions

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 ExplanationPR Debit Credit

2003

May 1 Cash 8,000

Capital Stock 8,000

Owners invest cash in the business.

The JournalThe Journal

Recording TransactionsRecording Transactions

Also called original book of entry. The process of recording the transactions is called journalizing. An example follows:

Also called original book of entry. The process of recording the transactions is called journalizing. An example follows:

Page G1Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000 Carol Finlay, Capital 30,000

Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

How To Record TransactionsHow To Record Transactions

Step 1 – Enter the year on the first line at the top of the first column.

Step 1 – Enter the year on the first line at the top of the first column.

Page G1Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000 Carol Finlay, Capital 30,000

Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

Recording TransactionsRecording Transactions

Step 2 and 3 – Enter the month in column one on the first line of the journal entry and the day in column two. Note that entries are recorded in

chronological order (by date).

Step 2 and 3 – Enter the month in column one on the first line of the journal entry and the day in column two. Note that entries are recorded in

chronological order (by date).Page G1

Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000 Carol Finlay, Capital 30,000

Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

Recording TransactionsRecording Transactions

Step 4 – Enter the titles of accounts debited. Account titles are taken from the chart of accounts and are

aligned with the left margin of the Account titles and explanation column. Accounts to be debited are always entered before accounts being credited.

Step 4 – Enter the titles of accounts debited. Account titles are taken from the chart of accounts and are

aligned with the left margin of the Account titles and explanation column. Accounts to be debited are always entered before accounts being credited.

Page G1Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000 Carol Finlay, Capital 30,000

Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

Recording TransactionsRecording Transactions

Step 5 – Enter the debit amount in the Debit column on the same line as the

accounts to be debited.

Step 5 – Enter the debit amount in the Debit column on the same line as the

accounts to be debited.Page G1

Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000 Carol Finlay, Capital 30,000

Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

Recording TransactionsRecording Transactions

Step 6 – Enter the titles of accounts credited. Account titles are indented from the left margin of the Account Titles and Explanation column

to distinguish them from debits.

Step 6 – Enter the titles of accounts credited. Account titles are indented from the left margin of the Account Titles and Explanation column

to distinguish them from debits.Page G1

Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000

Carol Finlay, Capital 30,000 Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

Recording TransactionsRecording Transactions

Step 7 – Enter the credit amount in the Credit column on the same line as the

accounts to be credited.

Step 7 – Enter the credit amount in the Credit column on the same line as the

accounts to be credited.Page G1

Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000

Carol Finlay, Capital 30,000 Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

Recording TransactionsRecording Transactions

Step 8 – Write a brief explanation of the transaction on the line below the entry.

Step 8 – Write a brief explanation of the transaction on the line below the entry.

Page G1Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000 Carol Finlay, Capital 30,000

Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

Recording TransactionsRecording Transactions

Step 9 – Skip a line between each journal entry for clarity.

Step 9 – Skip a line between each journal entry for clarity.

Page G1Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 30,000 Carol Finlay, Capital 30,000

Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

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

Posting EntriesPosting Entries

Entries are then posted from the journal into the general ledger on a transaction by transaction

basis; first the debit, then the credit.

Entries are then posted from the journal into the general ledger on a transaction by transaction

basis; first the debit, then the credit.

#101Account Titles and Explanations PR Debit Credit Balance

Jan. 1 G1 30,000 30,000 2 G1 2,500 27,500 3 G1 20,000 7,500

10 G1 2,200 9,700

Cash Account in the General LedgerDate2001

Posting EntriesPosting Entries

Step 1 – Identify the ledger account that was debited in the journal entry and find it in the

general ledger. Example – first entry on Jan. 1 had a debit to the cash account for $30,000.

Step 1 – Identify the ledger account that was debited in the journal entry and find it in the

general ledger. Example – first entry on Jan. 1 had a debit to the cash account for $30,000.

#101Account Titles and Explanations PR Debit Credit Balance

Jan. 1 G1 30,000 30,000 2 G1 2,500 27,500 3 G1 20,000 7,500

10 G1 2,200 9,700

Cash Date2001

Posting EntriesPosting Entries

Step 2 – Enter the date of the journal entry in this ledger account.

Step 2 – Enter the date of the journal entry in this ledger account.

#101Account Titles and Explanations PR Debit Credit Balance

Jan. 1 G1 30,000 30,000 2 G1 2,500 27,500 3 G1 20,000 7,500

10 G1 2,200 9,700

Cash Date

2001

Posting EntriesPosting Entries

Step 3 – Enter the amount debited from the journal entry into the Debit column of the

ledger account.

Step 3 – Enter the amount debited from the journal entry into the Debit column of the

ledger account.

#101Account Titles and Explanations PR Debit Credit Balance

Jan. 1 G1 30,000 30,000 2 G1 2,500 27,500 3 G1 20,000 7,500

10 G1 2,200 9,700

Cash Date2001

Posting EntriesPosting Entries

Step 4 – Enter the source of the debit in the PR (post-reference) column. The letter G indicates

the entry came from the general journal.

Step 4 – Enter the source of the debit in the PR (post-reference) column. The letter G indicates

the entry came from the general journal.

#101Account Titles and Explanations PR Debit Credit Balance

Jan. 1 G1 30,000 30,000 2 G1 2,500 27,500 3 G1 20,000 7,500

10 G1 2,200 9,700

Cash Date2001

Posting EntriesPosting Entries

Step 5 – Compute and enter the account’s new balance in the Balance column. Remember, a debit balance would be increased by a debit

and decreased by a credit.

Step 5 – Compute and enter the account’s new balance in the Balance column. Remember, a debit balance would be increased by a debit

and decreased by a credit.

#101Account Titles and Explanations PR Debit Credit Balance

Jan. 1 G 30,000 30,000 2 G 2,500 27,500 3 G 20,000 7,500

10 G 2,200 9,700

Cash Account (in general ledger)Date2001

Recording TransactionsRecording Transactions

Step 6 – Finally, enter the ledger account number in the PR column of the journal entry.

Step 6 – Finally, enter the ledger account number in the PR column of the journal entry.

Page G1Account Titles and Explanations PR Debit Credit

Jan. 1 Cash 101 30,000 Carol Finlay, Capital 30,000

Investment by owner

2 Supplies 2,500 Cash 2,500

Purchased store supplies for cash

3 Furniture 20,000 Cash 20,000

Purchased furniture for cash

6 Supplies 1,100 Furniture 6,000 Accounts Payable 1,100 Note Payable 6,000

Purchased supplies and furniture on credit

Date2001

General Journal

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

2003

May 1 Cash 8,000

Capital Stock 8,000

Owners invest cash in the business.General LedgerCash

Date Debit Credit Balance2003

May 1 8,000 8,000

Posting Journal Entries to the Ledger Accounts

Posting Journal Entries to the Ledger Accounts

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

2003

May 1 Cash 8,000

Capital Stock 8,000

Owners invest cash in the business.General LedgerCapital Stock

Date Debit Credit Balance2003

May 1 8,000 8,000

Posting Journal Entries to the Ledger Accounts

Posting Journal Entries to the Ledger Accounts

GENERAL JOURNAL

Date Account Titles and ExplanationPR 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

General LedgerCash

Date Debit Credit Balance2003

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

Generally, dollar signs and Rs. Signs are not used in the

journals or ledgers.

Generally, dollar signs and Rs. Signs are not used in the

journals or ledgers.

RoundingRoundingRound numbers in financial

statements to the nearest dollar.

Round numbers in financial statements to the nearest

dollar.

ACCOUNT NAME: ACCOUNT No.

Date Description PR Debit Credit Balance

Formatting ConventionsFormatting Conventions