Principle of Accounting Chapter 4 double entry recording process CLC

Slide 1 Principle of Accounting Chapter 4 The double entry Recording Process BA in International Business Foreign Trade University Outline An introduction to double entry accounting Footing and balancing ledger accounts The role of trial balance Detecting errors through a trial balance Chart of account Three column ledger accounts Accounting for drawings The Account Accounting’s main summary device is the account, the record of changes Accounts are grouped in three broad categories, according to.

Principle of Accounting

Chapter 4

The double-entry Recording Process

BA in International BusinessForeign Trade University

• An introduction to double-entry accounting

• Footing and balancing ledger accounts

• The role of trial balance

• Detecting errors through a trial balance

• Chart of account

• Three-column ledger accounts

• Accounting for drawings

The Account

Cash

Accounting’s main summary device

is the account, the record of changes

Accounts are grouped in three broad categories,

according to the accounting equation:

(for expenses incurred but not paid)

Long-term liabilities (bonds)

The Account

Stockholders’ (owners’) equity is the

owners’ claims to the assets of a corporation

A proprietorship uses a single account.

A partnership uses separate accounts for each

owner’s capital balance and withdrawals

A corporation uses separate capital

accounts for each source of capital.

The Account

Transactions are economic events that require recording in the financial statements

May be external or internal.

Not all activities represent transactions.

Each transaction has a dual effect on the accounting equation.

Accounting Transactions

Accounting Transactions

Double-Entry Accounting

Double-entry bookkeeping means to recordthe dual effects of each business transaction

The T-Account

Account TitleDebit

Credit

Three parts :

Double-entry accounting system

Each transaction must affect two or more

accounts to keep the basic accounting equation

in balance.

Recording done by debiting at least one

account and crediting another.

DEBITS must equal must equal CREDITS.

SO 3 Define debits and credits and explain their use in recording business transactions.

Debit and Credit Procedures

Debit and Credit Procedures

Account Name

If Debits are greater than Credits, the account

will have a debit balance.

$15,000

8,000 Transaction #3

Balance

Transaction #1

SO 3 Define debits and credits and explain their use in recording business transactions.

Debit and Credit Procedures

Debit and Credit Procedures

Account Name

If Credits are greater than Debits, the account

will have a credit balance.

SO 3 Define debits and credits and explain their use in recording business transactions.

Debit and Credit Procedures

Debit and Credit Procedures

Debits and Credits

• Debit (dr.) - an entry or balance on the left side of an account

• Credit (cr.) - an entry or balance on the right side of an account

• Remember:

– Debit is always the left side!

– Credit is always the right side!

Recording entries in ledger

accounts

Identify the transaction and state two ledger accounts

affected by the transaction

Determine whether each account is

increased or decreased by the transaction

State whether the accounts will have

a debit or a credit entry Classify the ledger accounts according to

their report classification

Recording entries in ledger

50,000

Credit for Increase, 50,000

Recording entries in ledger

accounts

Air & Sea purchased land for $40,000 cash.

Common Stock Bal 50,000

Cash

Credit for Decrease, 40,000

Bal 50,000

Land Debit

for Increase,

40,000

Assets = Liabilities +

Stockholders’

Equity

General Journal

Template

Journalize the April

Events

Journalize the April

Events

Posting from Journal to

Ledger

The ledger is a grouping of all the accounts; it shows their balances Data must be copied to the ledger –

a process called posting.

The journal is a chronological record

of all transactions listed by date.

Accounts Payable

Accounts Payable

Individual liability accounts Ledger

Ledger

All individual accounts combined make up the ledger.

Individual stockholders’ equity accounts

Cash Individual asset accounts

Posting from Journal to

Ledger

Flow of Accounting Data

Transaction

Occurs

Transaction Analyzed

Transaction Entered in the Journal

Amounts Posted to the Ledger

– The ledger is a company’s “books.”

• General ledger - the collection of accounts that accumulates the amounts reported in the major financial statements

Ledger

The General Ledger

Analysis chart

• An analysis chart provides an analysis of a

financial transaction to determine the entry to be recorded in ledger accounts

double-• An analysis chart helps to ensure that the

double-entry for each transaction is correctly determined

• Example

Transaction A/c names

Classifica-tion Increase/Decrease Debit/Credit

Bought vehicle for

$18,000 by cash at

bank

Vehicle Cash at bank

Asset Asset

Increase Decrease

Dr Cr

Mar 1 Cash at bank 18,000

Mar 4 Cash at bank 400

Revenue and Expense

Transactions

• Retained Income is merely accumulated revenues less expenses, but we cannot just increase or decrease the Retained

Income account directly

–This would make preparing the income statement very difficult

• By accumulating revenues and expenses separately, a more meaningful income

statement can be easily prepared

Revenue and Expense

Credit Increase

Revenue and Expense

Transactions

• Summary of revenue and expense transactions: – A credit to a revenue increases the revenue and increases Retained Income.

– A debit to a revenue decreases the revenue and decreases Retained Income.

– A credit to an expense decreases the expense and increases Retained Income.

– A debit to an expense increases the expense and decreases Retained Income.

Debit / Dr Credit / Cr

Normal Balance

Expense

Chapter 3-24

Liabilities

Debit / Dr Credit / Cr

Normal Balance

Chapter 3-25

Debit / Dr Credit / Cr

Normal Balance

Stockholders’ Equity

Chapter 3-26

Debit / Dr Credit / Cr

Normal Balance

Revenue

Normal Balance

Credit

Normal Balance

Credit

Normal Balance

Debit

Normal Balance

Debit

Debits and Credits Summary

Debits and Credits Summary

SO 3 Define debits and credits and explain their use in recording business transactions.

a.increase both assets and liabilities.

b.decrease both assets and liabilities.

c. increase assets and decrease

liabilities.

d.decrease assets and increase

liabilities.

Review Question

Debits and Credits Summary

Debits and Credits Summary

SO 3 Define debits and credits and explain their use in recording business transactions.

Accounts that normally have debit

balances are:

a.assets, expenses, and revenues.

b.assets, expenses, and equity.

c. assets, liabilities, and dividends.

d.assets, dividends, and expenses.

Review Question

Debits and Credits Summary

Debits and Credits Summary

SO 3 Define debits and credits and explain their use in recording business transactions.

Examples – Exercise 4.3

names Classifi-cation Increase/Decrease Debit/Credit

Banked $60,000 cash

to start business Cash at bankCapital AOE Increase DrCr

Paid the 1 st month

rent $4,000 Expensecash

Bought shop fittings

for cash $12,000 Shop fittingCash

Purchased CDs for

$4,300 on credit Stock controlCredit

Sold CDs

Cost $2,000

Example – Exercise 4.3

(Cont’d)

names Classifi-cation Increase/Decrease Debit/Credit

Sold CDs for cash $4,300

Paid 1 month’s advertising

(Record Cost of sale)

Sold CDs on credit for $1,200

(Record revenue)

Purchased stock for cash

$3,600

Example – Exercise 4.3

(Cont’d)

names Classifi-cation Increase/Decrease Debit/Credit

Repaid the National Bank

$2,000

Paid wages $800

Cash sales of stock at cost

$1,200 (record cost of sale)

Cash sales of stock for

Footing & balancing ledger

accounts

• To foot an account: (informal procedures)

 Calculate total debits and credits.

 The difference is noted as the balance on the larger side (normally done by pencil).

• To balance an account: (formal procedures)

 Total the two sides of ledger account, larger amount is written on both sides of the account.

 The difference is entered as balance and

written on the side with the lower amount.

Closing the Accounts

• Once the financial statements are prepared, the ledger accounts must be prepared to

record the next period’s transactions This

– The balances in all “temporary” stockholders’

equity accounts are transferred to a

“permanent” stockholders’ equity account.

– The revenue and expense accounts are “reset”

to zero and the current net income is

transferred to Retained Income.

Closing the Accounts

• The Closing Process:

– The revenue accounts are closed to Income Summary

in the first entry.

– The expense accounts are closed to Income Summary

in the second entry – The amount of Net Income (revenues -

expenses) is then transferred from Income Summary to Retained Income.

Preparing the Trial Balance

• Once all transactions have been posted

to the ledger, a trial balance is

prepared.

accounts with their balances – assets

first, followed by liabilities, and then

stockholders’ equity It is prepared as a test or check before continuing the

recording process.

Preparing the Trial Balance

• The purposes of the trial balance:

– To help check on accuracy of posting by proving whether the total debits equal the total credits

– To detect errors in double-entry recording – To establish a convenient summary of

balances in all accounts for the

preparation of formal financial statements

Trial balance – An example

Trial balance (Cont’d)Some errors may not be detected by a trial balance:

• Entering an incorrect amount for both the debit and credit.

• Entering a debit or credit in the wrong

account.

• The debit and credit entries are reversed.

• Omitting a transaction completely.

• Compensating errors.

Detecting errors through

a trial balance

• Debit or credit omitted

• Duplication of a debit or credit

• Transposing error

Search the records for a missing amount.

Divide the out-of-balance amount by 2 (a debit treated as a credit or vice versa).

Divide the out-of-balance amount

by 9, which may indicate a slide

or a transposition.

Chart of accounts

• An organized index to the ledger

accounts

• Groups the account together according

to their accounting report classifications

• Facilitate report preparation

Three-column ledger accounts

debit entry, credit entry and the balance of

account

readily available

Eg: Three-column ledger – Cash at bank account

Date Account Dr Cr Balance

1 Capital 25,000 25,000 Dr

2 Loan 10,000 35,000 Dr

5 Stock control 600 33,900 Dr

Accounting for Drawings

• Drawings: withdrawals of assets by the owner for personal use

• The balance of drawings is accounted for

as a deduction against the owners’ equity

Profit earned for the year: $20,000

Drawings for the year: $10,000

Requirement: Record the transaction and prepare an

extract of the statement of financial position, owners’ equity section.

Accounting for Drawings

(Cont’d)

Dr Drawings a/c $500

Cr Cash at bank a/c $500

Extract statement of financial position

The Recording Process

• The sequence of steps in recording transactions:

Financial Statements

Trial

Practice questions

Exercise 4.4

Exercise 4.10

Exercise 4.5

Exercise 4.9

Exercise 4.11