Unit 2 The Basic Accounting Cycle

1. Unit 2The Basic Accounting Cycle In Unit 1 we learned about the different accounting careers and three forms of business organizations. In Unit 2 we will analyze transactions and prepare financial records for a business

2. Effective Reading Skills • Needed even in accounting • Without these skills accountants wouldn’t be able to analyze important financial documents, make important financial recommendations or stay up-to-date on current events and changes in laws that affect the accounting field.

3. Chapter 3: Business Transactions and the Accounting Equation Big Idea • To understand the financial condition of any business, you must first understand the accounting equation. Main Idea • Any item of property has at least one financial claim against it. Accounts are used to analyze business transactions. Owner’s equity is changed by revenues, expenses and withdrawals.

4. Real World Connection • Hulu lets you watch TV shows, clips and movies online—anytime • Can use Hulu to embed video on your blog or Web page, or just email a clip to your friends • Hulu was founded in 2007 and have become very successful • Within the first year it was oneof the top five online video sites in the US • Hulu employs about 150 people, which is a much smaller staff that companies that generate similar revenues, and so is able to keep its payroll costs to a minimum. Lower operating cost is a big advantage in business because it helps increase profitability • Hulu’s main assets are virtual in the world of streaming online video, but producing its “product” requires technological equipment and real space in which staff develops Hulu’s innovative media distribution

5. 3-1 Property and Financial Claims • We will look at basic accounting and concepts and terminology • UPS (United Parcel Service), a corporation the provides global delivery services, uses accounting reports to communicate with its managers, employees and investors • Financial reports identify the property used in the business such as airplanes, trucks and computers. • They also show how the property was obtained, either from loans or from funds provided by investors

6. What is Property? • It is anything of value that a person or business owns and therefore controls • You have a legal right to that property • Businesses own property • Financial claim: a legal right to property • One of the purposes of accounting is to provide financial information about property and financial claims to that property • When you buy property with cash you acquire all the financial claims to that property and the time of the purchase

7. Example • For example, if you pay $600 for a mountain bike then you own that bike. Had you rented it for the weekend then you would pay less but only have it for a limited amount of time • Since you paid cash, you have ownership and a financial claim of $600

8. Buying On Credit • CREDIT - when you buy something and agree to pay for it later • CREDITOR - the business or person selling the item on credit, can be any person/business you owe money to • When buying on credit, you do not have the only financial claim to the property. You share the financial claim with the creditor

9. Example – Buying on Credit • If you purchase the bike by paying cash for $100 of it and sign agreement to pay the remaining $500 over the next 5 months then you share the financial claim • Two or more people/businesses can have financial claims to the same property, although only the owner has control of the property • If you don’t make payments the property can exercise its legal claim and take it back

10. Assets • ASSETS: property or items of value owned by a business • There are a variety of assets a business can have: • Cash • Office Equipment • Manufacturing Equipment • Buildings • The accounting term for the financial claims to assets is EQUITIES

11. Example • Zip Delivery Service purchases a delivery truck for $10,000 and puts a cash down payment of $3,000 and a local bank loans the remaining $7,000 • Both Zip Delivery and the bank have financial claim to the truck

12. Zip’s financial claim increases as the loan is repaid • Once the loan is paid in full Zip will have total financial claim and the bank will have none

13. Accounting Equation • In accounting there are separate terms for owner’s claims and creditor’s claims • Owner’s Equity is the owner’s claims to the assets of a business • Liabilities is the creditor’s claims to the assets of a business • Accounting Equation:

14. 3-2 Transactions That Affect Owner’s Investment, Cash, And Credit • Business transaction – an economic event that causes a change – either increase or decrease – in assets, liabilities or owner’s equity • When a business buys a computer with cash, its cash decreases, but its computer equipment increases • Account – a subdivision under assets, liabilities, or owner’s equity

15. Accounts • Each business sets up its accounts to meet its needs • The number of accounts needed varies • Every account must be classified as an asset, liability or owner’s equity • Accounts Receivable: the total amount of money owed to a business, an asset • Accounts Payable: the total amount of money owed to creditors, a liability

16. Transactions and the Accounting Equation • Analyzing a business transaction • Identify the accounts affected • Classify the account affected • Determine the amount of increase or decrease for each account affected • Make sure the accounting equation remains in balance • Every business transaction causes a change in assets, liabilities or owner’s equity • Analyzing each transaction to see how it affects the accounting equation keeps everything in balance

17. Types of Transactions • Investments by the owner – money or property paid out in order to produce profit • Cash transactions – any asset purchased for cash • Credit transactions – any asset purchased on account • Revenue transactions • Expense transactions • Withdrawals by the owner

25. 3-3 Transactions That Affect Revenue, Expense, and Withdrawals by the Owner UPS has thousands of shareholders who expect a return on their investment in the business. The most common way for a business to provide a return is by selling goods or providing services. UPS earns revenue by providing a global delivery service. To provide the delivery service, UPS incurs expenses like salaries, transportation, and insurance.

26. What are Revenues and Expenses? • Revenue is income earned from the sale of good or services • Revenue increases owner’s equity because it increase the assets of the business • To generate revenue most businesses must incur expenses by buying goods, materials and services • Expense is the cost of products or services used to operate a business • Expenses include: rent, utilities, advertising • Expenses decrease owner’s equity because they decrease the assets of the business or increase liabilities

27. Effects of Revenue and Expenses • Revenue increase assets and increase owner’s equity • Expenses decrease assets and decrease owner’s equity OR increase liabilities and decrease owner’s equity

28. Think About It…. • What is the difference between revenue and investments by the owner?

31. What is a Withdrawal? • Withdrawal: the owner takes cash or other assets from the business for personal use • A withdrawal decreases both assets and owner’s equity • Not the same as an expense

33. Review • Describe the relationship between property and financial claims:

34. Review • List and define each part of the accounting equation:

35. Review • Use the following steps to analyze a business transaction: