chapter 4 double entry recording process
TRANSCRIPT
Principle of AccountingPrinciple of Accounting
Chapter 4
The double-entry Recording Process
BA in International BusinessForeign Trade University
OutlineOutline• 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 AccountThe Account
Cash
Accounting’s main summary deviceis the account, the record of changes.
Accounts are grouped in three broad categories,according to the accounting equation:
The AccountThe Account
Assets are the economic resources that benefit the business now and in the future
CashAccounts receivableInventoryNotes receivablePrepaid expenses
LandBuildingsEquipment, furniture, and fixtures
The AccountThe Account
Liabilities are the debts of the company.
Notes payableAccounts payableAccrued liabilities (for expenses incurred but not paid)Long-term liabilities (bonds)
The AccountThe Account
Stockholders’ (owners’) equity is theowners’ claims to the assets of a corporation.
The AccountThe Account
Transactions are economic events that require recording 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 TransactionsAccounting TransactionsAccounting TransactionsAccounting Transactions
Question:Question: Are the following events recorded in the accounting records?
Event
Purchased a
computer.
Criterion
Is the financial position (assets, liabilities, or stockholders’ equity) of the company
changed?
Pay rent.
Record/ Don’t Record
Accounting TransactionsAccounting TransactionsAccounting TransactionsAccounting Transactions
Discuss product
design with potential customer.
Double-Entry AccountingDouble-Entry Accounting
Double-entry bookkeeping means to recordthe dual effects of each business transaction.
The T-AccountThe T-Account
Account Title
Debit
LEFT SIDE RIGHT SIDE
Credit
Three parts :
1) the Title of the account
2) a left or Debit side
3) a right or Credit side
Ledger AccountsLedger Accounts• T-accounts and the balance sheet
equation:
Assets = Liabilities + Owners’ Equity
Assets
Increases Decreases
Liabilities
Decreases Increases
Owners’ Equity
Decreases Increases
Debits and CreditsDebits 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 Recording entries in ledger accountsaccounts
Identify the transaction and state two ledger accounts affected by the transaction
Determine whether each account is increased or decreased by the transaction
State whether the accounts will have a debit or a credit entry
Classify the ledger accounts according to their report classification
Recording entries in ledger Recording entries in ledger accountsaccounts
Air & Sea received $50,000 from issuing stock.
Assets = Liabilities +Stockholders’
Equity
Debitfor
Increase,50,000
Creditfor
Increase,50,000
Cash Common Stock
Recording entries in ledger Recording entries in ledger accountsaccounts
Air & Sea purchased land for $40,000 cash.
Common Stock
Bal. 50,000
CashCredit
forDecrease,
40,000
Bal. 50,000
LandDebit
forIncrease,
40,000
Assets = Liabilities +Stockholders’
Equity
Recording TransactionsRecording Transactionsin the Journalin the Journal
Date Accounts and Explanation Debit CreditJournal Page 1
April 2 Cash 50,000Common Stock 50,000
Issued common stock
Analysis chartAnalysis 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.
• Example
Transaction A/c names Classifica-tion
Increase/Decrease
Debit/Credit
Bought vehicle for $18,000 by cash at bank
VehicleCash at bank
AssetAsset
IncreaseDecrease
DrCr
Double-entry accountingDouble-entry accounting
Cash at bank
Vehicles
Wages
Mar 1 Vehicles 18,000
Mar 4 Wages 400
Mar 1 Cash at bank 18,000
Mar 4 Cash at bank 400
Revenue and Expense Revenue and Expense TransactionsTransactions
• 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 Revenue and Expense TransactionsTransactions
• Revenue and expense accounts are a part of Retained Income.
Retained Income
Expense Revenue
Decrease Increase
Debit
Increase
Credit
Increase
Revenue and Expense Revenue and Expense TransactionsTransactions
• 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.
Chapter 3-23
AssetsAssets
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
Chapter 3-27
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
ExpenseExpense
Chapter 3-24
LiabilitiesLiabilities
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
Chapter 3-25
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
StockholdersStockholders’’ EquityEquity
Chapter 3-26
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
RevenueRevenue
Normal Balance Credit
Normal Balance Credit
Normal Balance Debit
Normal Balance Debit
Debits and Credits SummaryDebits and Credits SummaryDebits and Credits SummaryDebits and Credits Summary
SO 3 Define debits and credits and explain their use in recording business SO 3 Define debits and credits and explain their use in recording business transactions.transactions.
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.
Review Question
Debits and Credits SummaryDebits and Credits SummaryDebits and Credits SummaryDebits and Credits Summary
SO 3 Define debits and credits and explain their use in recording business SO 3 Define debits and credits and explain their use in recording business transactions.transactions.
Examples – Exercise 4.3Examples – Exercise 4.3Transaction Account
namesClassifi-cation
Increase/Decrease
Debit/Credit
Banked $60,000 cash to start business
Cash at bankCapital
AOE
IncreaseIncrease
DrCr
Paid the 1st month rent $4,000
Expensecash
Bought shop fittings for cash $12,000
Shop fittingCash
Purchased CDs for $4,300 on credit
Stock controlCredit
Sold CDsCost $2,000
Example – Exercise 4.3 Example – Exercise 4.3 (Cont’d)(Cont’d)
Transaction Account names
Classifi-cation
Increase/Decrease
Debit/Credit
Sold CDs for cash $4,300
Paid 1 month’s advertising $600
Borrowed cash from bank $5,000
Sold 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 Example – Exercise 4.3 (Cont’d)(Cont’d)
Transaction Account names
Classifi-cation
Increase/Decrease
Debit/Credit
Repaid the National Bank $2,000
Paid wages $800
Cash sales of stock at cost $1,200 (record cost of sale)
Cash sales of stock for $2,200 (record revenue)
Purchased inventory on creditfor $3,400
Footing – Example E 4.3Footing – Example E 4.3
Feb 1 Capital $60,000
5 Sales $ 3,400
8 Loan $ 5,000
10 Sales $ 2,200
Feb 2 Rent $ 4,000
3 Shop fittings $ 12,000
6 Advertising $ 600
9 Stock control $ 3,600
14 Loan $ 5,000
15 Wages $ 800
$70,600 $23,000
47,600
Cash at bank
Balancing – Example E 4.3Balancing – Example E 4.3
Feb 1 Capital $60,000
5 Sales $ 3,400
8 Loan $ 5,000
10 Sales $ 2,200
Feb 2 Rent $ 4,000
3 Shop fittings $ 12,000
6 Advertising $ 600
9 Stock control $ 3,600
14 Loan $ 2,000
15 Wages $ 800Balance $ 47,600
$70,600 $70,600
Balance $47,600
Cash at bank
Closing the AccountsClosing 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 income is transferred to Retained Income.
Closing the AccountsClosing 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 Income Summary to Retained Income.
Preparing the Trial BalancePreparing 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 BalancePreparing 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 exampleTrial 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)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 accountsChart 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 accountsThree-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 DrawingsAccounting 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: $50,000Profit earned for the year: $20,000Drawings for the year: $10,000Requirement: Record the transaction and prepare an
extract of the statement of financial position, owners’ equity section.
Accounting for Drawings Accounting for Drawings (Cont’d)(Cont’d)
Dr Drawings a/c $500 Cr Cash at bank a/c $500
Extract statement of financial positionOwners’ equity
Capital $50,000Plus Net profit $20,000 $70,000Less Drawings $10,000 $60,000
Flow of Accounting DataFlow of Accounting Data
TransactionOccurs
TransactionAnalyzed
TransactionEntered inthe Journal
AmountsPosted to
the Ledger
Ledger AccountsLedger 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 amounts reported in the major financial statements
Ledger
The General Ledger
HomeworkHomework
Exercise 4.5Exercise 4.9Exercise 4.11
QuizQuizGive appropriate terms for the below definitions.1. A numerical list of all the accounts used by a company.2. An entry on the left side of an account.3. A list of each account and its balance at a specific point
in time used to prove the equality of debits and credits.4. A system of accounting in which every transaction is
recorded with equal debits and credits. 5. An entry on the right side of an account.6. An analysis of a financial transaction leading to
determine the double-entry to be recorded in ledger accounts.
QuizQuizGive appropriate terms for the below definitions.1. A numerical list of all the accounts used by a company.
(chart of account)2. An entry on the left side of an account.(debit)3. 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)
4. A system of accounting in which every transaction is recorded with equal debits and credits. (trail balance)
5. An entry on the right side of an account (credit)6. An analysis of a financial transaction leading to
determine the double-entry to be recorded in ledger accounts. (an analysis chart)