chapter 4 the accounting process. powerpoint slides t/a accounting: what the numbers mean marshall,...

CHAPTER 4

The Accounting Process

PowerPoint Slides t/a Accounting: What the Numbers MeanMarshall, McCartney, van Rhyn, McManus, VieleSlides prepared by Sandra Chapple Copyright 2005 McGraw-Hill Australia Pty Ltd

4-2

Overview

• Basic accounting equation expanded to

include revenues and expenses

• Transactions and balancing the equation

• Linking the income statement to the balance

sheet through owners’ equity

• Horizontal model

• Adjustments

• Transaction analysis


4-3

The Accounting Process

Transactions are economic interchanges between entities that are accounted for and reflected in financial

statements.

Borrow cash

from the bank


4-4

AA = = LL + + OEOE

The Accounting Equation

ASSETS LIABILITIESOWNERS’ EQUITY


4-5

AA = = LL + + OEOE


The basic accounting equation can be expanded to include revenues

and expenses.


4-6

AA = = LL + + OEOE


Contributed capital

Retained earnings

Retained earnings beginning of period

Revenue - expenses


4-7

AA = = LL + + OEOE


AA = = LL + + CC +RE + R - ECC +RE + R - E

Where:

CC = contributed capitalRE = retained earnings beginningR = revenueE = expenses


4-8

Let’s see how

some transactions

affect the

operation of this

equation.

Transactions


4-9

Transactions

ASSETS = LIABILITIES + OWNERS EQUITYTrans'n Cash Acc Inv Equip Loan Acc Cont Ret Rev Exp

Rec Pay Pay Cap Income

1 +30 +30

1. Investment of $30 by owners.1. Investment of $30 by owners.


4-10

Transactions



1 +30 +30

2 -25 +25

2. Equipment costing $25 was purchased for cash.2. Equipment costing $25 was purchased for cash.


4-11

Transactions



1 +30 +30

2 -25 +25

3 +15 +15

3. The firm borrowed $15 from the bank.3. The firm borrowed $15 from the bank.


4-12

Transactions


Rec Pay Pay Cap Earn

1 +30 +30

2 -25 +25

3 +15 +15

4 -10 +20 +10

4. Inventory costing $20 was purchased for resale. $10 was paid in cash and $10 was on account.

4. Inventory costing $20 was purchased for resale. $10 was paid in cash and $10 was on account.


4-13

Transactions



1 +30 +30

2 -25 +25

3 +15 +15

4 -10 +20 +10

5 +2 +5 -7

5. Equipment that cost $7 was sold . $2 was received in cash and $5 will be received later.

5. Equipment that cost $7 was sold . $2 was received in cash and $5 will be received later.


4-14

Transactions



1 +30 +30

2 -25 +25

3 +15 +15

4 -10 +20 +10

5 +2 +5 -7

6 +5 -5

Total 17 + 0 + 20 + 18 = 15 + 10 30

6. The $5 account from the sale of equipment was collected.

6. The $5 account from the sale of equipment was collected.


4-15

TransactionsASSETS = LIABILITIES + OWNERS EQUITY

Trans'n Cash Acc Inv Equip Loan Acc Cont Ret Rev ExpRec Pay Pay Cap Income

1 +30 +30

2 -25 +25

3 +15 +15

4 -10 +20 +10

5 +2 +5 -7

6 +5 -5

Total 17 + 0 + 20 + 18 = 15 + 10 30

7. Rev +20 +20

8. Exp -12 -127. Sold inventory on account for $20. Original cost was

$12.7. Sold inventory on account for $20. Original cost was

$12.


4-16

TransactionsASSETS = LIABILITIES + OWNERS EQUITY


1 +30 +30

2 -25 +25

3 +15 +15

4 -10 +20 +10

5 +2 +5 -7

6 +5 -5

Total 17 + 0 + 20 + 18 = 15 + 10 30

7. Rev +20 +20

8. Exp -12 -12

+3 -3

8. Wages of $3 have been recorded as an expense, but not paid.

8. Wages of $3 have been recorded as an expense, but not paid.


4-17

Transactions= LIABILITIES + OWNERS EQUITY


1 +30 +30

2 -25 +25

3 +15 +15

4 -10 +20 +10

5 +2 +5 -7

6 +5 -5

Total 17 + 0 + 20 + 18 = 15 + 10 30

7. Rev +20 +20

8. Exp -12 -12

+3 -3

Total 17 + 20 + 8 + 18 = 15 + 13 + 30 + 0 + 20 - 15

Columns totalled.Columns totalled.


4-18

Transactions

If the accounting period was to end after

these transactions, the financial

statements could be prepared using the

totals from the columns.

If the accounting period was to end after

these transactions, the financial

statements could be prepared using the

totals from the columns.


4-19

Revenues 20$ Expenses 15 Net Profit 5$

Income Statement

Transactions

ASSETS = LIABILITIES + OWNERS EQUITYCash Acc Inv Equip Loan Acc Cont Ret Rev Exp


Total 17 + 20 + 8 + 18 = 15 + 13 + 30 + 0 + 20 - 15

Statement of changes in owners’ equity


4-20

Transactions



Total 17 + 20 + 8 + 18 = 15 + 13 + 30 + 0 + 20 - 15

Beginning Balance -$ Contributed Capital 30$ Add: Net profit 5 Less: Dividends - Ending Balance 35$

Statement of Changes in Owners Equity

From income statement

Balance Sheet


4-21

Transactions



Total 17 + 20 + 8 + 18 = 15 + 13 + 30 + 0 + 20 - 15

Cash 17$ Loan Payable 5$

Accounts Receivable 20 Accounts Payable 13$

Inventory 8

Equipment 8 Contributed Capital 30

Retained Earnings 5

Total Assets 53$ Total Liabilities & Owners' Equity 53$

Owners' Equity

Balance Sheet

Assets Liabilities

Statement of changes in owners equity


4-22

Transactions

• What have we learned from the foregoing?

– Net profit on the income statement gets into the balance sheet via the retained income section of owners’ equity.

– On the previous worksheet, revenues and expenses were treated as a part of owners’ equity to keep the equation in balance, but in financial statements they are shown in the income statement.


4-23

Transactions

• What have we learned from the foregoing?

– If any retained income is distributed to the owners as a dividend, it is shown on the statement of changes in owners’ equity, not on the income statement.

– A dividend is not an expense. It is a distribution of income to the owners of the firm.


4-24

Transactions

Horizontal Financial Statement Relationship Model

Horizontal Financial Statement Relationship Model

Balance sheet

Assets = Liabilities + Owners’ equity

Income statement

Net profit = Revenues – Expenses

The key to using this model is to keep the balance sheet in balance.


4-25

Transactions

An investment of $30 by ownersAn investment of $30 by owners

Balance sheet


Income statement


Cash + 30

Contributed capital + 30


4-26

Transactions

$12 paid for advertising$12 paid for advertising

Balance sheet


Income statement


Cash - 12 Advertising expense - 12

Note that a minus sign for expenses means that net profit (and owners’ equity) is reduced.


4-27

Transactions$40 received for services provided in a

prior period$40 received for services provided in a

prior period

Balance sheet

Assets = Liabilities +Owners’ equity

Income statement


Cash - 40

Accounts receivable + 40

A transaction can affect two accounts in a single balance sheet or income statement category.


4-28

Transactions$60 worth of services provided, $45 collected

in cash and $15 to be collected later

$60 worth of services provided, $45 collected in cash and $15 to be collected later

Balance sheet


Income statement


Cash + 45

Accounts receivable + 15 Service revenues + 60

A transaction can affect more than two accounts.


4-29

Adjustments

ACCRUAL ACCOUNTING

Requires adjustments at end of the period

To recognise revenues

and expenses as they

occur


4-30

Adjusting

entries are

needed whenever

revenue or expenses

affect more than one

accounting

period.

Every adjusting

entry involves a change in either a

revenue or expense

and an asset or liability.

Adjustments/Adjusting Entries


4-31

Adjusting Entries - Categories

The initial recording of a

transaction does not

result in assigning

revenues to the period in

which they were earned

or expenses to the

period in which they

were incurred.

The initial recording of a

transaction does not

result in assigning

revenues to the period in

which they were earned

or expenses to the

period in which they

were incurred.

ReclassificationsReclassifications

Transactions for which

cash has NOT yet been

received or paid, but the

effect of which must be

recorded in the accounts

in order to accomplish a

matching of revenues

and expenses.

Transactions for which

cash has NOT yet been

received or paid, but the

effect of which must be

recorded in the accounts

in order to accomplish a

matching of revenues

and expenses.

AccrualsAccruals


4-32

Examples:

• interest

• wages and salaries

• property taxes

• revenue earned but not billed

• income tax.

Hey, when do we get

paid?

Adjustments - Accruals


4-33

On 31 March, wages of $60 are owed. Pay day is in April.

On 31 March, wages of $60 are owed. Pay day is in April.


April

$60 Wages Expense

March 31

Paid


4-34


Balance sheet


Income statement


Wages payable + 60 Wage expense - 60

Using the horizontal model, the accrued wages adjustment has the following effect on the financial statements:


4-35

Examples:

• supplies used

• prepaid insurance policies

• revenues received in advance.

Adjustments - Reclassifications


4-36


Purchase of supplies at a cost of $100 during February was recorded initially as an increase in the supplies (asset) account and a decrease in cash.

The cost of supplies used during February of $35 must be removed from the asset account and recorded as supplies expense.


4-37


Balance sheet


Income statement


Supplies - 35 Supplies expense - 35

Using the horizontal model, the supplies adjustment has the following effect on the financial statements:


4-38

Transaction Analysis Methodology

Answer these questions:

1. What is going on?

2. What accounts are affected?

3. How are they affected?

4. Does the balance sheet still

balance? (Do the changes balance

out?)

5. Does my analysis make sense?

chapter 4 the accounting process. powerpoint slides t/a accounting: what the numbers mean marshall,...

Documents

oethe accounting equationa

sale of equipment

original cost

balance sheet

economic interchanges

contributed capitalre

earnings beginningr

income statement