Financial and
Managerial Accounting
WEEKS FOUR, FIVE, SIX, AND SEVEN
Readings
http://content.moneyinstructor.com/1435/accountingtransaction.html
Explanation of transaction analysis
http://www.keynotesupport.com/accounting/accounting-basicsdebits-credits.shtml
Explanation of debits and credits
http://www.keynotesupport.com/accounting/accountingtransactions.shtml
Transaction examples
Readings
http://www.slideshare.net/akhilkhanna7/generalledger-and-trial-balance
General ledger and trial balance
http://content.moneyinstructor.com/1499/trialbalan
ce.html
Preparing income statements from the trial balance
Where Do Financial Statements Come
From?
When we create a balance sheet and an income
statement, how do we know the account balances?
We analyze all of the transactions of a company
during the accounting period, using math to add and
subtract account activity to arrive at an account
balance for every account in the accounting system.
Transaction Analysis
Transaction: any business activity involving money
Account: a classification to identify similar activities
Journal: record of all transactions of a business
Journal entry: the process of recording a transaction
using accounts in the journal using a system called
“double entry accounting”
Double Entry Accounting
In double entry accounting, every transaction
balances using “debits” and “credits”, or “left-side”
and “right-side”. We increase and decrease account
balances using this system. To use the system
effectively, you need to know the rules for five types
of accounts: assets, liabilities, equity, revenues,
expenses.
Double Entry Accounting
Assets:
Expenses:
“debit” = increase, “credit” = decrease
“debit” = increase, “credit” = decrease
Liabilities:
Equity:
Revenues:
“debit” = decrease, “credit” = increase
“debit” = decrease, “credit” = increase
“debit” = decrease, “credit” = increase
Transaction Analysis Example One
Transaction: purchase inventory for cash, $800
Account: two accounts; Inventory and Cash
Journal: Inventory increases, Cash decreases
Now we decide: what is the debit, and what is the credit?
Journal entry:
DR Inventory
$800
CR Cash
$800
Transaction Analysis Example Two
Transaction: receive $4,000 from customers for services
Account: two accounts; Sales and Cash
Journal: Cash increases, Sales increases
Now we decide: what is the debit, and what is the credit?
Journal entry:
DR Cash
$4,000
CR Sales
$4,000
Transaction Analysis Example Three
Transaction: pay off bank loan, $200,000
Account: two accounts; Cash and Notes payable
Journal: Notes payable decreases, Cash decreases
Now we decide: what is the debit, and what is the credit?
Journal entry:
DR Notes payable
$200,000
CR Cash
$200,000
Transaction Analysis Example
In the first transaction, one account decreases and
one account increases, in the second transaction,
both accounts increase, and in the third transaction
both accounts decrease. But in all three transactions,
we have a debit and a credit, and the transactions
balance, that is:
Debits = Credits
Preparing Financial Statements
To calculate the total of individual accounts, we use
ledgers to record transactions for individual accounts.
Because ledgers look like a “T”, they are informally
called T-accounts.
So, we are actually recording all transactions in two
places; the journal (one journal for the company) and
the ledgers (one ledger for each account).
Preparing Financial Statements
Once we have recorded all transactions for a period,
we create a list of the balances of all accounts called
the “Trial Balance”.
From the Trial Balance, we select the revenue and
expense accounts to create the Income Statement,
and we select the asset, liability, and equity accounts
to create the Balance Sheet.
Balance Sheet/Income Statement
Relationship
Any income from the income statement increases
the equity account “Retained earnings”.
Any dividend payments reduce “Retained Earnings”.
Dividends are not an expense; rather they are a
return of invested capital to the investors.
Accounting Cycle Example
Fast Thinking Inc. - List of Accounts
Accounts payable
Furniture
Accounts receivable
Notes payable, long term
Accrued liabilities
Notes payable, short term
Advertising expense
Rent expense
Capital stock
Salaries expense
Cash
Sales
Dividends
Supplies
The Accounting Cycle…. Just Do It!
1
2
3
4
5
6
7
8
9
10
Equity investment of $50,000 to start business
Borrow $20,000 from bank, half due in 6 months and half due in 18 months
Pay office rent in cash, $8,000
Purchase office furniture for cash, $12,000
Pay $16,000 for advertising
Provide services for client, $30,000 cash and $20,000 on account
Purchase office supplies on account, $3,000
Receive $2,000 from client as payment towards account balance
Record salaries expense of $16,000 for the month, to be paid next month
Pay $2,500 dividend to shareholders
Journal (weeks 4, 5)
Ledgers (week 6)
Trial Balance (week 6)
Income Statement (week 7)
Balance Sheet (week 7)