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Chapter 3

Annual Report. Chapter 3. Processing Accounting Information. Key Concepts & Objectives. Where does financial statement input data come from? Analyzing transactions using: The Accounting Equation “T” Accounts including Debits and Credits Preparing financial statements

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Chapter 3

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  1. Annual Report Chapter 3 Processing Accounting Information

  2. Key Concepts & Objectives • Where does financial statement input data come from? • Analyzing transactions using: • The Accounting Equation • “T” Accounts including Debits and Credits • Preparing financial statements • Accounting “Books” – General Ledger (G/L) & General Journal (G/J)

  3. Internal events: interaction within company External vs. Internal Events External events: interaction between company and outside environment Both of these types of events may cause the recording of information in theFinancial Statements.

  4. Source Documents Sales Invoice Purchase Invoice Definition: Evidence needed in an accounting system to record transactions Checks Cash Register Receipt Receiving Document Shipping Document Payroll Records

  5. Transaction Analysis • Concept: Analyze the effect of external and internal transactions on the company’s financial statements • How? Interpret the impact on the Accounting Equation – What increases? What Decreases? • Identify: • ACCOUNTS  A, L, O/E, R or E • AMOUNTS  Given or Calculated • Approaches: • Accounting equation: Increases (+’s) & Decreases (-’s) • T Account analysis: Debits & Credits

  6. The T Account Account Name Debits are entered on left Credits are entered on right Increases/Decreases depend upon TYPE of account

  7. OWNERS’ EQUITY + ASSETS = LIABILITIES Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + Debits/Credits and the Accounting Equation Opposite sides of the accounting equation are increased/decreased in an opposite way

  8. Assets Expenses Dividends Liabilities Owners’ Equity Revenues “Normal” Account BalancesWhich accounts normally have a debit or credit balance? Credit Debit

  9. Dr. Cr. + - Dr. Cr. + - Dr. Cr. + - Dr. Cr. - + Dr. Cr. - + Dr. Cr. - + T Account Templateusing Expanded Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + ( Contributed Capital + Retained Earnings ) Assets = Liabilities + C/C + [ (Revenues – Expenses) – Dividends] Assets = Liabilities + C/C + [ (Revenues – Expenses) – Dividends]

  10. Effect of Revenue and Expenses on Retained Earnings Income Stmt. R/E Stmt. Revenue - Expenses Net income Beg. R/E + Revenues - Expenses - Dividends End. R/E Revenues & Expensesare part of Retained Earnings but are separated out during the period using the Time Period Assumption to measure Net Income.

  11. RETAINED EARNINGS Dr. Cr. - + REVENUES Dr. Cr. - + Link Between Revenues and Retained Earnings • Revenuesincrease • Retained Earnings • (part of Owners’ equity) • Both accounts are • increased with credits

  12. RETAINED EARNINGS DR. CR. - + EXPENSES AND DIVIDENDS DR. CR. + - Link Between Expenses and Dividends and Retained Earnings • Expenses and Dividends • decreaseRetainedEarnings • (part of Owners’ Equity) • RetainedEarnings is • decreased with debits • Use debits to record • (increase)Expenses and • Dividends

  13. Represents a 2nd economic event that has been recorded Reflects an economic event that has been recorded $ 400 $ 900 Debits & credits are “netted” to obtain balance in account $ 500 cr. The T AccountHow to get the Balance in an account Account Name What this ($500 cr.) means depends on what type of account it is! Debits Credits

  14. Transaction Analysis: January 2002 transactions • #1: Issue Common Stock for Cash • #2: Purchase Equipment on credit (Note Payable) • #3: Purchase Inventory on credit (Accts. Payable) • #4a: Sell product (Sales) for Cash • #4b: Record cost of goods exchanged during sale • #5: Pay employees their Wages in Cash • #6: Pay Rent for the month in Cash • #7: Pay (Cash) our vendor for goods purchased earlier on credit (Accts. Payable)

  15. 1/02 Sample Transactions for “T-Shirts R Us” (1) Issuance of common stock for cash $10,000 What accounts are effected in the Balance Sheet Equation? Assets = Liabilities + Owners’ Equity Cash + 10,000 = Common Stock + 10,000 What type of transaction is this Operating , Financing or Investing? FINANCING The Accounting Equation Must Always Remain in Balance!

  16. OWNERS’ EQUITY Cash Common Stock + ASSETS = LIABILITIES Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + Transactions and T Accounts (1) Issuance of common stock for cash $10,000 What 2 accounts are affected? How do they incr. or decr.? (1) 10,000 10,000 (1)

  17. 1/02 Sample Transactions for “T-Shirts R Us” (2)Purchase of equipment in exchange for N/P $3,500 What accounts are effected in the Balance Sheet Equation? Assets = Liabilities + Owners’ Equity Equipment + 3,500 = Note Payable + 3,500 What type of transaction is this Operating , Financing or Investing? INVESTING & FINANCING The Accounting Equation Must Always Remain in Balance!

  18. Transactions and T Accounts OWNERS’ EQUITY Equipment Notes Payable + ASSETS = LIABILITIES Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + (2) Purchase of equipment in exchange for N/P $3,500 What 2 accounts are affected? How are they incr. or decr.? (2) 3,500 3,500 (2)

  19. 1/02 Sample Transactions for “T-Shirts R Us” (3) Purchase of inventory of T-shirts on credit $3,000 What accounts are effected in the Balance Sheet Equation? Assets = Liabilities + Owners’ Equity Inventory +3,000 = Accounts Payable+ 3,000 What type of transaction is this Operating , Financing or Investing? OPERATING The Accounting Equation Must Always Remain in Balance!

  20. Transactions and T Accounts OWNERS’ EQUITY Inventory Accounts Payable + ASSETS = LIABILITIES Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + (3) Purchase of inventory of T-shirts on account $3,000 What 2 accounts are affected? How are they incr. or decr.? (3) 3,000 3,000 (3)

  21. 1/02 Sample Transactions for “T-Shirts R Us” (4a) Sell T-shirts during the month for cash $4,000 What accounts are effected in the Balance Sheet Equation? Assets = Liabilities + Owners’ Equity Retained Earnings + 4,000 Cash +4,000 = What does this amount Represent? Revenue REVENUE What type of transaction is this Operating , Financing or Investing? OPERATING The Accounting Equation Must Always Remain in Balance!

  22. Transactions and T Accounts OWNERS’ EQUITY Cash Sales + ASSETS = LIABILITIES Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + (4a) Sell T-shirts during the month for $4,000 cash. What 2 accounts are affected? How are they incr. or decr.? (1) 10,000 4,000 (4a) (4a) 4,000

  23. 1/02 Sample Transactions for “T-Shirts R Us” (4b) Cost of T-Shirts is 50% of selling price What accounts are effected in the Balance Sheet Equation? Assets = Liabilities + Owners’ Equity Cash +4,000 = Retained Earnings + 4,000 What does this amount Represent? Revenue Inventory -2,000 = Retained Earnings- 2,000 EXPENSE (COGS) Expense What type of transaction is this Operating , Financing or Investing? Illustrates MATCHING concept OPERATING

  24. Transactions and T Accounts OWNERS’ EQUITY Inventory Cost of Goods Sold + ASSETS = LIABILITIES Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + (4b) Cost is 50% of selling price $4,000 What 2 accounts are affected? How are they incr. or decr.? (3) 3,000 2,000 (4b) (4b) 2,000

  25. Cash Cost of Goods Sold (1) 10,000 (4a)4,000 (4b)2,000 Inventory (3) 3,000 (4b)2,000 Illustration of Matching Concept Sales (4a) 4,000 Revenues(4a) reflecting asset inflow (Cash is collected) are matched with Expenses(4b) reflecting asset outflow (Inventory is “used up”)

  26. 1/02 Sample Transactions for “T-Shirts R Us” (5) Pay employees $800 in wages for the month What accounts are effected in the Balance Sheet Equation? Assets = Liabilities + Owners’ Equity What does this amount Represent? Retained Earnings- 800 Cash -800 = Expense EXPENSE What type of transaction is this Operating , Financing or Investing? OPERATING The Accounting Equation Must Always Remain in Balance!

  27. Transactions and T Accounts OWNERS’ EQUITY Cash Wage Expense + ASSETS = LIABILITIES (1) 10,000 Dr. Cr. Dr. Cr. Dr. Cr. (4a) 4,000 + - - + - + (5) Pay employees wages for the month $800 What 2 accounts are affected? How are they incr. or decr.? (5) 800 (5) 800

  28. 1/02 Sample Transactions for “T-Shirts R Us” (6) Pay $1,000 rent for the month What accounts are effected in the Balance Sheet Equation? Assets = Liabilities + Owners’ Equity What does this amount Represent? Cash -1,000 = Retained Earnings-1,000 Expense EXPENSE What type of transaction is this Operating , Financing or Investing? OPERATING The Accounting Equation Must Always Remain in Balance!

  29. Transactions and T Accounts OWNERS’ EQUITY Cash + ASSETS = LIABILITIES Rent Expense (1) 10,000 Dr. Cr. Dr. Cr. Dr. Cr. (5) 800 (4a) 4,000 + - - + - + (6) Pay rent for the month $1,000 What 2 accounts are affected? How are they incr. or decr.? (6) 1,000 (6) 1,000

  30. 1/02 Sample Transactions for “T-Shirts R Us” (7) Pay for 1/2 of the $3,000 of inventory purchased earlier this month on account. What accounts are effected in the Balance Sheet Equation? Assets = Liabilities + Owners’ Equity Cash - 1,500 = Accounts Payable - 1,500 What type of transaction is this Operating , Financing or Investing? OPERATING The Accounting Equation Must Always Remain in Balance!

  31. Transactions and T Accounts OWNERS’ EQUITY Cash + ASSETS = LIABILITIES Accounts Payable (5) 800 (1) 10,000 (3) 3,000 Dr. Cr. Dr. Cr. Dr. Cr. (6) 1,000 (4a) 4,000 + - - + - + (7) Pay for 1/2 of the inventory purchased earlier this month on account($1,500). (7) 1,500 (7) 1,500

  32. Calculate Balance for each T Account Inventory Cash (1) 10,000 (4a) 4,000 (3) 3,000 (5) 800 (6) 1,000 (7) 1,500 (4b) 2,000 1,000 FOUR STEPS: a. Add Drs. b. Add Crs. c. Calculate Difference d. Record Balance 10,700 Accounts Payable (7) 1,500 (3) 3,000 1,500

  33. + $15,200 = + $ 5,000 + $ 10,200 Cumulative Effect of Transactions for T-Shirts “R” Us Assets = Liabilities + O/E Sold stock +$10,000 = + $10,000 Bought equip. with N/P + 3,500 = + 3,500 Purchased inven- tory on credit + 3,000 = + 3,000 Sold inventory for cash + 4,000 = + 4,000 (Matching) - 2,000 = - 2,000 Paid wages - 800 = - 800 Paid rent - 1,000 = - 1,000 Paid A/P - 1,500 = - 1,500 Rev Exp Exp Exp

  34. T-Shirts “R” Us (who?) Income Statement (what?)for the Month of January 2002 (when?) Sales $ 4,000 Less: Cost of goods sold 2,000 Gross margin 2,000 Rent expense 1,000 Wage expense 800 Net Income $ 200

  35. Assets: Cash $ 10,700 Inventory 1,000 Equipment 3,500 Total assets $ 15,200 Liabilities: Accountspayable $ 1,500 Notes payable 3,500 5,000 Owners’ equity Capital stock 10,000 Retained earnings 200 10,200 Total liabilities & owners’ equity $15,200 T-Shirts “R” Us (who?)Balance Sheet (what?)as of January 31, 2002 (when?)

  36. Cash A/R +$400 - $100 (1) 10,000 (4a) 4,000 (5) 800 (6) 1,000 (7) 1,500 Cash +$100 -$50 10,700 General Ledger (G/L) DEFN: File or book that contains one page (or record) for each account(A, L, OE, R & E) Maintains the detail andtotal balanceofeach Account. (Some times referred to as “Book of final entry.”)

  37. 100 - 199 ASSETS 100 - 109: Cash 101: Checking Account 102: Savings Account 110 - 119: Accts Receivable : 120 - 129: Inventories 121: Raw materials 122: Work-in-process 123: Finished goods : : 150 Property, plant & equipment 200 - 299 LIABILITIES 201 - 219: Accts. Payable : : 300 - 399 OWNERS’ EQUITY 301 - 319 Capital Stock: : 320 Retained Earnings 330 Dividends Declared 400 - 499 REVENUES : 500 - 599 EXPENSES : Sample Chart of Accounts

  38. The General Journal ( via daily journal entries): Dr. Cr. Cash $10,000 Common Stock $10,000 (explanation) • G/L Accounts • Cash • Common Stock • Other accounts Posting from General Journal (G/J) Transactions are first entered in: And later posted (transferred) to: G/J is some times referred to as “Book of original entry” It’s like a diary.

  39. The Trial Balance is a T account summary of all G/L accounts after all journal entries have been posted. T-Shirts “R” Us Trial Balance at January 31, 2002 $ 19,000 $ 19,000 Trial Balance is an Error Check Debits Credits Cash Inventory Equipment Accounts Payable Notes Payable Common Stock Sales Revenue Cost of Goods Sold Wage Expense Rent Expense Total $ 10,700 1,000 3,500 $ 1,500 3,500 10,000 4,000 2,000 800 1,000

  40. Summary: Key Concepts & Objectives • External & internal sources of financial statement input data? • Analyzing transactions using: • The Accounting Equation • “T” Accounts including Debits and Credits • Preparing financial statements • Accounting “Books” – General Ledger (G/L) & General Journal (G/J)

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