Chapter 03 financial accounting summary

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Summary – Ch 03
Learning Objectives
1. Analyze the effect of business transactions on the basic accounting
equation.
2. Explain what an account is and how it helps in the recording process.
3. Define debits and credits and explain how they are used to record business
transactions.
4. Identify the basic steps in the recording process.
5. Explain what a journal is and how it helps in the recording process.
6. Explain what a ledger is and how it helps in the recording process.
7. Explain what posting is and how it helps in the recording process.
8. Explain the purposes of a trial balance.
9. Classify cash activities as operating, investing, or financing.
Chapter Outline
Learning Objective 1 - Analyze the Effect of Business Transactions on the
Basic
Accounting Equation
 Accounting Information System
 collects and processes transactions.
 communicates financial information to decision makers.
 Factors that shape the Accounting Information System include:
o nature of the company’s business
o types of transactions
o company size
o the volume of data
o information demands of management and others.
 Most businesses use computerized accounting systems, sometimes
referred to as electronic data processing (EDP) systems.
 Accounting Transactions
 economic events that require recording in the financial statements
 occur when assets, liabilities, or stockholders’ equity items change as
a result of some economic event
 Analyzing Transactions--Transaction analysis - the process of identifying
the specific effects of economic events on the accounting equation
Summary – Ch 03


The accounting equation must always balance
Each transaction has a dual effect on the equation
1.
On October 1, cash of $10,000 is invested in the business by investors, in
exchange for $10,000 of Sierra Corporation common stock. Both Cash (an
asset) and Common Stock (a component of stockholders’ equity) increase
by $10,000.
2.
On October 1, Sierra issued a 3-month, 12%, $5,000 note payable to
Castle Bank. This transaction results in an equal increase in assets and
liabilities: Cash (an asset) increases $5,000 and Notes Payable (a liability)
increases $5,000.
3.
On October 2, Sierra purchased equipment by paying $5,000 cash to
Superior Equipment Sales Co. An equal increase and decrease in Sierra’s
assets occur. Cash decreases by $5,000 and Equipment increases by
$5,000.
4.
On October 2, Sierra received a $1,200 cash advance from R. Knox, a
client, for guide services for multi-day trips that are expected to be
completed in the future. Both Cash and Unearned Service Revenue (a
liability) increase by $1,200
5.
On October 3, Sierra received $10,000 cash from Copa Company for
guide services performed for a corporate event. Sierra received an asset
(cash) in exchange for services (revenue). Revenue increases
stockholders’ equity. Both assets and stockholders’ equity would increase.
Cash is increased $10,000 and Service Revenue is increased $10,000.
6.
On October 3, Sierra paid its office rent for the month of October in cash,
$900. Both Cash and stockholders equity (Rent Expense) decrease.
Expenses decrease stockholders’ equity.
7.
On October 4, Sierra paid $600 for a one-year insurance policy that will
expire next year on September 30. Cash decreases and another asset
Prepaid Insurance increases.
8.
On October 5, Sierra purchased supplies on account from Aero Supply for
$2,500. Both Supplies and Accounts Payable (a liability) increase by
$2,500.
9.
Hired four new employees. This is not a business transaction.
10.
On October 20, Sierra paid a $500 dividend. Both Cash and Stockholders’
Equity (Dividends) decrease by $500.
Summary – Ch 03
11.
Employees have worked 2 weeks, earning $4,000 in salaries, which were
paid on October 26. Both Cash and stockholders’ equity (Salaries
Expense) decrease.
 Summary of Transactions



Each transaction is analyzed in terms of its effect on assets, liabilities,
and stockholders’ equity.
The two sides of the equation must always be equal.
The cause of each change in stockholders’ equity must be indicated.
Learning Objective 2 - Explain What an Account is and How it Helps in
the
Recording Process
 Account - an individual accounting record of increases and decreases in a
specific asset, liability, or stockholders’ equity item.
 An account consists of three parts: (1) the title of the account, (2) a
left or debit side, and (3) a right or a credit side.
 In its simplest form it is referred to as a T account because the
alignment of the parts of the account resembles the letter T.
Learning Objective 3 - Define Debits and Credits and Explain How
They are Used to Record Business Transactions
 Debits and Credits--The term debit means left, and credit means right.
They DO NOT mean increase or decrease.
 Debit is abbreviated Dr. and credit is abbreviated Cr.
 The act of entering an amount of the left side of an account is called
debiting. Making an entry on the right side is called crediting.
 When the totals of the two sides are compared, an account will have a
debit balance if the left side (dr. side) is greater. Conversely, the
account will have a credit balance if the right side (cr. side) is greater.
 Debit and Credit Procedures--Each transaction must affect two or more
accounts to keep the basic accounting equation in balance.
 Under the double-entry system the equality of debits and credits
keeps the equation balanced.
 The two-sided effect of each transaction is recorded in appropriate
accounts.
 This helps to ensure the accuracy of the recorded amounts and helps to
detect errors.
 Dr./Cr. Procedures for Assets and Liabilities
o Debits increase assets and decrease liabilities.
o Credits decrease assets and increase liabilities.
Summary – Ch 03



Dr./Cr. Procedures for Stockholders’ Equity
o Debits Decrease Common Stock, Retained Earnings, and
Revenue, but Increase Dividends and Expenses.
o Credits Increase Common Stock, Retained Earnings, and
Revenue, but decrease Dividends and Expenses.
The normal balance of an account is on its increase side
o The normal balance for Assets, Dividends, and Expenses is a debit
balance.
o The normal balance for Liabilities, Common Stock, and is a credit
balance.
Stockholders’ Equity Relationships
o Common stock and retained earnings: in the stockholders’ section
of the balance sheet.
o Dividends: on the retained earnings statement.
o Revenues and expenses: on the income statement.
On October 1, cash of $10,000 is invested in the business by investors, in
exchange for $10,000 of Sierra Corporation common stock. Both Cash and
Common Stock would increase by $10,000.
Cash
Common Stock
10,000
10,000
Encourage students not to try to memorize the rules of debit and credit. Rather
they need to understand the process. Ask them to think of the balance sheet
equation:
Assets = Liabilities + Stockholders’ Equity
A debit, or a left hand entry, increases accounts on the left of the equation. A
credit, or a right hand entry, increases accounts on the right of the equation.
Now think of the elements in Stockholders’ Equity. Three of these elements:
Common Stock,
Retained Earnings, and
Revenue
increase stockholders’ equity. Therefore these three accounts—Common Stock,
Retained Earnings, and Revenue are increased by credit entries and decreased
by debit entries.
Summary – Ch 03
The fourth and fifth elements—Expenses and Dividends, decrease stockholders’
equity. Therefore Expenses and Dividends are increased by debit entries and
decreased by credit entries.
Learning Objective 4 - Identify the Basic Steps in the Recording
Process
 Steps in the Recording Process--The basic steps in the accounting
process are used by most businesses in the recording process. The steps
are:
 Analyze each transaction in terms of its effect on the accounts. A
source document, such as a sales slip, a check, a bill, or a cash
register tape provides evidence of the transaction.
 Enter the transaction information in a journal.
 Transfer the journal information to the appropriate accounts in the
ledger (book of accounts).
Learning Objective 5 - Explain What A Journal is and How it Helps in
the Recording Process
 The Journal--Transactions are initially recorded in
chronological order in
journals before they are transferred to the accounts.

The journal shows the debit and credit effects on specific
accounts for each transaction.
 Companies may use various types of journals, but every company
has the most basic form of journal, a general journal.
 Entering transaction data in the journal is known as journalizing.
 The journal makes three significant contributions to the recording
process:
○ The journal discloses in one place the complete effect of a
transaction.
○
The journal provides a chronological record of
transactions.
○ The journal helps prevent or locate errors because the debit
and credit amounts for each entry can be readily compared.
Date
10/1
Account Titles and Explanation
Debit
Credit
Cash .....................................................................10,000
Common Stock...............................................
(Issued stock for cash)
10,000
Summary – Ch 03
Learning Objective 6 - Explain What a Ledger is and How it Helps in
the Recording Process
 The Ledger--The entire group of accounts maintained by a company is
referred to as the ledger.
 The general ledger contains all of the asset, liability and
stockholders’ equity accounts.
 Information in the ledger provides management with the balances in
various accounts.
 Chart of accounts—Is a list of the accounts used by a company. They
are typically listed in the following order: assets, liabilities, stockholders’
equity, revenues, and expenses.
Learning Objective 7 - Explain What Posting is and How it Helps in
the Recording Process
 Posting--the process of transferring journal entries to the ledger
accounts.
 Posting accumulates the effects of journal transactions in the
individual ledger accounts. It involves these steps.
o In the ledger, enter in the appropriate columns of the debited
account(s) the date and debit amount shown in the journal.
o In the ledger, enter in the appropriate columns of the credited
account(s) the date and credit amount shown in the journal.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2014
Oct
1
Cash ...................................................................................10,00
0
Common Stock ...........................................................
10,00
0
(Issued stock for cash)
1
2
2
Cash ...................................................................................5,000
Notes Payable ............................................................
(Issued 3-month, 12% note payable for cash)
5,000
Equipment ..........................................................................5,000
Cash ...........................................................................
(Purchased for cash equipment)
5,000
Cash ...................................................................................1,200
Unearned Service Revenue .......................................
(Received advance from R. Knox for future
services)
1,200
Summary – Ch 03
3
Cash ...................................................................................10,00
0
Service Revenue ........................................................
10,00
0
(Received cash for services provided)
3
4
5
20
26
Rent Expense .................................................................... 900
Cash ...........................................................................
(Paid cash for October office rent)
900
Prepaid Insurance.............................................................. 600
Cash ...........................................................................
(Paid 1-year policy; effective date October 1)
600
Supplies .............................................................................2,500
Accounts Payable.......................................................
(Purchased supplies on account from Aero
Supply)
2,500
Dividends ........................................................................... 500
Cash ...........................................................................
(Declared and paid a cash dividend)
500
Salaries and Wages Expense ...........................................4,000
Cash ...........................................................................
(Paid salaries to date)
4,000
GENERAL LEDGER
Oct. 1
1
2
3
Bal.
Oct. 5
Bal.
Cash
10,000 Oct. 2
5,000
3
1,200
4
10,000
20
26
15,200
5,000
900
600
500
4,000
Unearned Service Revenue
Oct. 2 1,200
Bal.
1,200
Supplies
2,500
2,500
Prepaid Insurance
Oct. 4
600
Common Stock
Oct. 1 10,000
Bal.
10,000
Oct.
20
Dividends
500
Summary – Ch 03
Bal.
Oct. 2
Bal.
600
Bal.
Equipment
5,000
5,000
Notes Payable
Oct. 1
Bal.
Accounts Payable
Oct. 5
Bal.
500
Service Revenue
Oct. 3 10,000
Bal.
10,000
5,000
5,000
Salaries and Wages Expense
Oct. 26 4,000
Bal.
4,000
2,500
2,500
Rent Expense
3
900
900
Oct.
Bal.
Learning Objective 8 - Explain the Purposes of a Trial Balance
 The trial balance--list accounts and their balances on a specific date.The
primary purpose of the trial balance is to prove the mathematical equality of
debits and credits after posting.
 A trial balance
 uncovers errors in journalizing and posting.
 is useful in the preparation of financial statements.
 is limited in that it will balance but not uncover errors when:
o A transaction is not journalized.
o A correct journal entry is not posted.
o A journal entry is posted twice,
o Incorrect accounts are used in journalizing or posting, or
o Offsetting errors are made in recording the amount of a
transaction.
Learning Objective 9 – Classify Cash Activities as Operating,
Investing, or Financing.
 Keeping An Eye On Cash—The Statement of cash flows categorizes
the inflows and outflows of cash during in a given period into three types
of activities.
 Operating activities are the types of activities the company performs
to generate profits. These can include cash received or spent to
directly support the company’s operations, like cash used to pay an
accounts payable or cash spent to purchase inventories.
Summary – Ch 03


Investing activities include the purchase or sale of long-lived assets
used in operating the business, or the purchase or sale of investment
securities (like stocks and bonds of other companies).
Financing activities include borrowing money, issuing shares of stock
and paying dividends.
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