INTRODUCTION TO ACCOUNTING

INTRODUCTION TO ACCOUNTING UNIT 3: Accounting for Transactions TouchText • The Journal: Double Entry Bookkeeping • Examples: Accounting for Individual Transactions • The Ledger: Account Balances Accumulate Problems and Exercises Next

Transactions: Starting a Business The first accounting transaction of any business is for the owner(s) to insert cash into the business. Dictionary $$$$$ 10,000 Business Owner Example: The owner starts a business with $10,000 cash. If one were going to record this transaction from the business’s point of view, he/she would write: Date: ##/##/## “Owner invests $10,000 cash.” Back Next

Transactions: Two (2) Accounts (at least) are always affected Date: ##/##/## “Owner invests $10,000 cash.” Dictionary Notice that two (2) accounts are affected: Cash (Asset) + $10,000 Owner’s Capital (Owners’ Equity) + $10,000 Every transaction will involve two (2) or more accounts! Take Notes Back Next

Account Types Reminder: Every account is one of five (5) types. Revenues Income from sales, etc. Dictionary Liabilities Debts the business owes Assets Things of value that the business owns Expenses Costs of running the business Owners’ Equity Owners’ net investment in the business Take Notes Back

Transactions: Two (2) Accounts (at least) are always affected Even though …. Every transaction will involve two (2) or more accounts! Dictionary The transaction will maybe, but NOT necessarily involve … • Only the balance sheet. • Both sides of the balance sheet. • One plus (+) offset by one minus (-). Any one of these is possible….. • Two accounts increase. • One account increases, the other decreases. • Two accounts decrease. • A balance sheet and income statement item change. • Only one side of the balance sheet is affected. Take Notes Back Next

Accounts Going Up or Down An account will increase if the balance in the account goes up. An account will decrease if the balance in the account goes down. It does not matter if the transaction is “good” or “bad”. Dictionary Examples: More Cash >>> Cash (Asset Account) New Bank Loan >>> Loans (Liability Account) Another Sale >>> Sales (Revenue Account) Another Rent Payment >>> Rent (Expense Account) Take Notes Back Next

Recording Transactions: The Journal In accounting, the Journal is where transactions are recorded. The transactions are recorded in chronological order (by date/time) and, for each transaction, the (a) affected accounts are listed, with the (b) money amount, and (c) whether there is an increase or decrease to that account. The process is known as “journalizing”. Dictionary Example: Pay electricity bill of $124 Journal Date Acct. # Acct. Name Amount 5115 Electricity (Expense Account) + $124 1010 Cash (Asset Account) - $124 12/7/13 * In this unit, entries with green font are Balance Sheet (B/S) accounts; and entries withbrown font are Income Statement (P&L) accounts. Take Notes Back Next

What Is a Journal? Before computers and accounting software existed, an actual physical journal – a book!) was kept with such entries as above. Dictionary Cash (asset acct.) Electricity (expense acct.) Journal Now, with modern accounting software, the accountant or bookkeeper would simply create a dated check from its bank account to the recipient, noting what account the money is for. The accounting software would, at the same time, create the journal entry indirectly. Cash (asset acct.) Electricity (expense acct.) Create bank check (Cash – asset acct.) Journal Take Notes Back Next

Recording Transactions: Inventory Example: Buy $1,545 of inventory (things to sell). Journal Date Acct. # Acct. Name Amount Dictionary 1115 Inventory (Asset Account) + $1,545 1010 Cash (Asset Account) - $1,545 12/7/13 Why no “sale of inventory” example (yet)? *Note: Most beginning accounting textbooks start with selling services rather than selling inventory. Why? Because selling inventory (for cash, say) actually involves four (4) accounts: Sales (Revenue Acct.) Cash (Asset Acct.) Inventory (Asset Acct.) Cost of Goods Sold (Expense Acct.) Take Notes Back Next

Hint on Identifying Accounts: Do Cash First Most transactions (in this course) involve cash. If so, this solves one half of your problem. Dictionary Account #1 Was cash involved in the transaction? If “yes”, did cash go up, or did it go down? If cash went up, where did it come from? If cash went down, what was it used for? Account #2 Take Notes Back Next

Example: Hint on Identifying Accounts: Do Cash First Example: Business pays $2,660 in salaries. Dictionary Account #1 Was cash involved in the transaction? If “yes”, did cash go up, or did it go down? If cash went up, where did it come from? If cash went down, what was it used for? Answer: Salaries (Expense Account) Account #2 Journal Salaries (Expense Acct.) + $2,660 Cash (Asset Acct.) - $2,660 Take Notes Back Next

Recording Transactions: Buying/Selling on Credit Example: Do work “on credit” for a customer, who now owes you $675. Journal Date Acct. # Acct. Name Amount Dictionary 1120 Acct.s Receivable (Asset Account) + $675 4100 Sales (Revenue Account) + $675 12/7/13 “On Credit” = buy now / pay later. Example: Buy $1,267 of inventory on credit. Journal Date Acct. # Acct. Name Amount 1010 Inventory (Asset Account) + $1,267 3150 Acct.s Payable (Liability Account) + $1,267 12/7/13 *Accounts Receivable (asset) = “A/R”; Accounts Payable (liability) = “A/P” Take Notes Back Next

When to Record A/R’s and A/P’s ? Almost all business-to-business transactions are done on credit. Normally, as soon as a non-cash transaction is “completed” – i.e. ownership is transferred - an A/R or A/P should be entered into the books. This must always be done if/when…. Dictionary • The amount of money is significant. • A/R’s and A/P’s need to be actively managed. • The time lag between transaction and payment is long. • The A/R’s and A/P’s carry over into another accounting cycle. However, as a practical matter, many (small) businesses will, for example, not enter bills due – which should be A/P’s – and just “sit on them” until they are paid. This is OK as long as none of the criteria above are met. Take Notes Back Next

Recording Transactions: Bank Loan Example: Borrow $16,500 from the bank. Journal Date Acct. # Acct. Name Amount Dictionary 1010 Cash (Asset Account) + $16,500 4455 Loans (Liability Account) + $16,500 12/7/13 Example: Pay back a loan from the bank of $16,500. Journal Date Acct. # Acct. Name Amount 1010 Cash (Asset Account) - $16,500 4455 Loans (Liability Account) - $16,500 12/7/13 Take Notes Back Next

Inventory and the Cost of Goods Sold Inventory (Asset Acct.) = Historical cost of purchasing or making things for sale to customers. Cost of Goods Sold (COGS – Expense Acct.) = Historical cost of things sold to customers. Dictionary Before something is sold, it is an inventory asset. After it is sold, it is no longer inventory. It becomes a cost of something already sold. (When sale is made) Take Notes Back Next

Selling Inventory: The Other Accounts • When inventory is sold to a customer, two other accounts are affected. • Cash (or A/R) (asset acct.) goes up by the price of the sale. • Sales (revenue acct.) goes up by the price of the sale. Dictionary Take Notes Back Next

Example: Selling Inventory Example: $64 of inventory is sold for $110. Dictionary Take Notes Back Next

Recording Transactions: Owner’s Draw Example: The owner takes $2,000 out of the business for personal use. Journal Date Acct. # Acct. Name Amount Dictionary 5050 Capital Draw (Equity Account) + $2,000 1100 Cash (Asset Account) - $2,000 12/7/13 Reminder: If the business is a corporation, owners’ equity will be in the form of common stock shares, and money paid to stockholders/owners will be in the form of cash dividends. Take Notes Back Next

Recording Transactions: Paying Off A/R’s and A/P’s Example: The business pays off a $169 Account Payable. Journal Date Acct. # Acct. Name Amount Dictionary 3220 A/P (Liability Account) - $169 1100 Cash (Asset Account) - $169 12/7/13 Example: A customer pays off his $67 bill to the business. Journal Date Acct. # Acct. Name Amount 1100 Cash (Asset Account) + $67 2220 A/R (Asset Account) - $67 12/7/13 Take Notes Back Next

Recording Transactions: Buying Supplies. Example: The business buys $69 of office supplies (paper, pens, etc.) with cash. Journal Date Acct. # Acct. Name Amount Dictionary (Option 1) 1430 Supplies (asset Account) + $69 1100 Cash (asset account) - $69 12/7/13 Journal Date Acct. # Acct. Name Amount (Option 2) 1100 Supplies (expense account) + $69 1100 Cash (asset account) - $69 12/7/13 Take Notes Back Next

Small Purchases: Capitalize or Expense? Small asset purchases (supplies, phones, etc.) are often “expensed”, i.e. placed directly on the income statement, not on the balance sheet. In some cases, expenses can be “capitalized”, i.e. placed on the balance sheet as an asset. Examples include capital leases and interest payments on construction projects. Dictionary Income Statement • Advantages to “expensing” • Easy bookkeeping • Less taxes to pay • Disadvantages • Less profit • Weaker balance sheet Sales (less) Expenses = Net Income “Expense” Purchase Expense Balance Sheet Assets Liabilities Equity “Capitalize” Take Notes Back Next

Middle of Unit 3 Questions and Problems Directions:Create Journal entries for the following transactions. Do not enter a date, but specify which accounts will change, and by how much they go up or down. Use standard account names where appropriate, and create your own account names when necessary. State what kind of account it is (i.e. asset, liability, etc.). Dictionary The owner invests $25,000 cash into a new business. The business rents an office, paying $850 refundable deposit, plus $850 for the first month’s rent. A secretary is hired, who will be paid $1,200 per month, at the end of each month. Office furniture is purchased for $682 cash. Internet service is subscribed to. It requires $69 per month paid in advance of each month. So the first month’s service is paid with cash. The business opens a bank account, and pays the bank $25 for fees. (Continued …….) * Cash (asset acct.) includes $$$ in the bank. Take Notes Back Next

Middle of Unit 3 Questions and Problems (Continued) A first client (customer) comes into the office, and pays a $1,500 retainer (deposit) for future services. The business gets a bank loan of $20,000. The loan is credited to the business’s checking account balance. Two computers and other computing equipment is purchased for $3,640. The electricity bill of $46 arrives and is paid immediately. A bill for a local business tax of $280 is received. It is entered into the books but not paid (yet). A second client (customer) pays $275 for services provided at the time.. The owner takes $1,500 out of the business for personal use. The secretary is paid her first month’s salary of $1,200. $600 of work is performed for the first client (Q.7) and entered into the journal. Dictionary Take Notes Back Next

Transactions Amounts vs. Account Balances In recording transactions in the Journal, we are recording the changein the balance of an account, not the actual account balance. Dictionary Example: ATM cash withdrawal Account Balance Before: $2,350 After: $2,200 Δ = - $150 $ 150 Transaction = change Δ in account balance. Take Notes Back Next

All Accounts Accumulate Until The End of the Accounting Cycle Current Balance: Electricity Expense Account = $342. Dictionary Accounting Cycle Going Concern……. Forever ∞ Take Notes Back Next

The (General) Ledger In addition to the Journal, which lists transactions, there is a (general) Ledger which keeps records of the balances of individual accounts. Before computers, periodically, transactions entered into the Journal were “posted” to the various accounts in the Ledger. Now, with modern computer softer, posting to the journal is done instantaneously and automatically. Dictionary Ledger (update account balances) Journal (enter transactions) Post to Ledger Take Notes Back Next

Journal vs. Ledger Post Journal (enter transactions) Ledger (update account balances) The owner invests $25,000 cash into a new business. The business rents an office, paying $850 refundable deposit, plus $850 for the first month’s rent. A secretary is hired, who will be paid $1,200 per month, at the end of each month. Office furniture is purchased for $682 cash. Cash (A) $25,000 Owner’s Capital (OE) $25,000 Rent Expense (E) $850 Refundable Deposit (A) $850 Cash (A) $1,700 Furniture (A) $682 Cash (A) $682 Dictionary Cash (asset) + $25,000 - $1,700 - $682 $22,618 Balance Furniture (asset) + $682 $682 Balance * Account balances are always positive (or zero). Take Notes Back Next

End of Unit 3 Questions and Problems Directions: Record only the transactions. Create an end-of-cycle Income Statement and Balance Sheet (only). Dictionary Take Notes Back Next

INTRODUCTION TO ACCOUNTING