ACCT 2310
Accounting Principles I Chapter 2
Dr. Robert R. Oliva
Professor and Chairperson
Department of Accounting
University of Arkansas at Little Rock
Questions:
• How do you find out the answer to the following
questions?
– Does the business have enough cash to buy a $5000
piece of equipment?
– Why was a $750 check written on March 28?
– How much have you spent on salaries so far this
month?
– How much did you spend for an ad placed in the
Arkansas Democrat Gazette during the first week in
July?
You need to have an appropriate
accounting system in place
• JOURNAL: Records daily transactions,
describing date, amount, brief explanation.
– Pages 62-64.
• LEDGER: Keeps a running balance showing
increases and decreases of each financial
statement item in a separate record, e.g.,
– Balance sheet: Cash, accounts receivable, etc.
– Income Statement: Revenues and expenses.
– Pages 65-68
Each business transaction must be
recorded
• Recording involves a 3-step approach:
– Determine which “accounts” are affected.
– As the Accounting Equation requires constant
balancing, one “account” increases while other
“account” decreases.
• Double-entry accounting
– Translate each increase and decrease into a debit or
a credit transaction.
• Initial recording done in a “Journal”
– The book of original entry
• Ledger: After all business transactions are recorded
(journalized) then they are posted in the “Ledger”
Flow of business transactions
• Exhibit 2, page 56
Will proper recording prevent
fraud?
• Bottom of page 54
But before we can record in a journal or
post to a ledger
• We need to know what to call each
business transaction
– We need to separate business transactions
into “Accounts”
Account classification
• Classification depends on the business
transaction and the type of business.
• Business transactions may be classified
as affecting
– Assets
– Liabilities
– Owners’ Equity
– Revenues
– Expenses
Chapter 1: Lawn Mowing example
• Many transactions were recorded in
Owner’s Equity
– Hard to separate and analyze
– OK for a very small business. But in reality not
very efficient.
• More efficient approach: Separate
“Owner’s Equity” into various accounts.
Owner’s Equity is separated into
four (4) separate “accounts”:
• Capital
– To record owner’s investments
• Drawing
– To record owner’s withdrawals
• Revenue
– To record revenues from customers
• Expense
– To record expenses incurred in business
Examples of other “accounts”:
• Cash
• Supplies
• Accounts Payable
Accounts Organization
Chart of Accounts
• Accounts can be classified/organized into 5
major groups/categories:
–
–
–
–
–
Assets
Liabilities
Owner’s Equity
Revenues
Expenses
• All business have these types, but names and/or
numbers given to them will vary.
– Unique: The Chart reflects the business transactions.
In-class exercise:
• Create a Chart of Accounts for Larry
Sharp, M.D.
• Consider Dr. Sharp’s practice and divide
business transactions among the following
– Assets
– Liabilities
– Owners’ Equity
– Revenues
– Expenses
Larry Sharp, M.D.
(a sole proprietorship)
• Dr. Sharp’s practice has a bank account, supplies, and
equipment.
• He buys supplies on credit and pays in 30 days
• His patients either pay same day or get bills
• He rents the office and pays for utilities
• He has malpractice insurance which he pays on on
1/1/xx
• He has 2 employees and buys them flowers on their
birthdays
• He attends medical seminars to keep current in his
practice.
Larry Sharp, M.D.
Chart of Accounts
•
Assets: # 1x
–
–
–
–
–
•
Liabilities: # 2x
–
•
41: Fees earned
Expenses; # 5x
–
–
–
–
–
–
•
31: Larry Sharp, Capital
32: Larry Sharp, Drawing
Revenues: # 4x
–
•
21: Accounts Payable
Owners’ Equity: # 3x
–
–
•
10: Cash
11: Accounts Receivable
12:Supplies
13: Prepaid Insurance
14: Medical equipment
51: Wage expenses
52: Rent expenses
53: Utilities expenses
54: Medical Seminars expenses
55: Supplies expenses
56: Miscellaneous expenses
Later we will consider two other accounts: Insurance expense; Depreciation
Recall: Why are we classifying the
accounts?
• To record the business transactions into a
journal
– Each business transaction requires at least 2
entries to keep the Accounting Equation on
balance.
What account increases and what
account decreases?
The hijacking receivable
• Page 53
Account Characteristics: pp. 4950
• Form: The “T’ account
• Two sides of the “T”
– Left side: The debit side
– Right side: The credit side
• Some accounts increase by “debit” entries
• Some account increase by “credit” entries
The top of the “T”
Describes type of account
• Based on the Accounting Equation:
Assets = Liabilities + Owner’s Equity
• The Accounting Equation determines the
recording of an account’s increases and
decreases, e.g., Debits and Credits
• Page 52
Assets’ Accounts:
• Assets increase with “debits”, e.g.,
increases recorded on the left side of the
“T”.
– AID
• Assets decrease with “credits”, e.g.,
decreases recorded on the left side of the
“T”
– ADC
Liabilities’ Accounts
• Liabilities and Owner’s Equity increase with
“credits”, e.g., increases recorded on the left
side of the “T”.
– LIC
• Liabilities and Owners’ Equity decrease with
“debits”, e.g., decreases recorded on the left
side of the “T”
– LDD
• Note: Rules mirror each other
– Memorize only one
A different approach
• After eating dinner, let’s read the comics
• Using the “T”:
– Left: After Eating Dinner: Accounts increasing with
debits:
• Assets
• Expenses
• Drawings
– Right: Let’s Read the Comics: Accounts increasing
with credits:
• Liabilities
• Revenues
• Capital
In-class Exercise:
Posting entries into “T” accounts
•
•
•
•
•
•
•
•
•
•
(a) Dr. Sharp deposits $7000 cash in business account
(b) Buys $5700 in medical equipment on account.
(c) Pays $500 cash for ad in newspaper
(d) Pays $75 for supplies.
(e) Receives $1000 from patients
(f) Pays for the $5700 in equipment.
(g) Patients are billed $300
(h) Paid employee $150
(i) Patients in (g) send $300 check in payment.
(j) Dr. Sharp withdraws $575 for personal use
Solution
• Left: After Eating Dinner: Accounts increasing
with debits:
– Assets
– Expenses
– Drawings
• Right: Let’s Read the Comics: Accounts
increasing with credits:
– Liabilities
– Revenues
– Capital
Solution: Assets:
• Cash account
– Debit: (a), (e); and (i)
– Credit: (c); (d); (f); (h); (j)
• Account receivable
– Debit: (g)
– Credit: (i)
• Supplies:
– Debit: (d)
• Equipment:
– Debit: (b)
Solution: Liabilities
• Accounts Payable
– Credit: (b)
– Debit: (f)
Solution: Capital, Revenues,
Expenses
• Capital Account
– M. Gordon, Capital:
• Credit: (a)
– M. Gordon, Drawing:
• Debit: (j)
• Revenues
– Fees earned:
• Credit: (e); (g)
• Expenses:
– Wages
• Debit: (h)
– Advertising
• Debit; (c)
But many times proper recoding
requires through analysis
• Payments in advance
Pre-payments paid
• Difference between paying for 2-year in
advance v. 1-month in advance:
– Page 56: Pre-payment of a 2-year policy on
December 1st.
• Credit cash
• Debit an asset
– Page 58: Pre-payment of 1-month rent on
December 1st.
• Credit cash
• Debit an expense
Pre-payments received
• Receiving $360 for prepaid rent 3-months
in advance
– Page 58
– Debit receipt of $360 cash
– Credit a liability: Unearned Revenue
• Each month
– Debit the liability
– Credit revenues
Answers to Earlier Questions:
• How do you know whether the business has enough
cash to buy the equipment?
– Ledger: Current balance in the CASH ACCOUNT.
• Why was a $750 check written on March 28?
– Journal: The journal will show a brief description as to why the
check was written.
• How much have you spent on salaries so far this month?
– Ledger: WAGE EXPENSE ACCOUNT shows balance to date.
• How much did you spend for an ad placed in the
Arkansas Democrat Gazette during the first week in
July?
– Journal: Look for entries during the first week in July and look for
description indicating the Arkansas Democrat Gazette.
TRIAL BALANCE
• Reports the balance of each ledger
account
• Aim: TO show that Debits = Credits
In-Class Exercise
• Trial balance for Dr. Sharp
Dr. Larry Sharp, M.D.
Trail Balance
May 31, 20xx
•
•
•
•
•
•
•
•
•
•
Cash…………
1300
Supplies……..
75
Equipment….
5700
Dr. L Sharp, Capital
Dr. L. Sharp, Drawing 575
Fees earned
Wages Expense
150
Advertising Expense 500
_______
8300
7000
1300
______
8300
Possible errors
Exhibit 6
• Transposition
• Slide
Error Correction
• Exhibit 7
Errors undetected by a Trial
Balance
• Failing to record or post a transaction
• Recording the same erroneous amounts as
debits and credits
• Recording the same transaction more than once
• Correct debit accompanied by crediting wrong
account
– Would the trial balance be off if you record a $500
sale on account as follows?
• Debited Cash for $500
• Credited Fees earned for $500
– Answer: No!
FINANCIAL ANALYSIS
• Horizontal analysis
– Comparing time periods
• Exhibit 8