McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
The Accounting Cycle:
The Accounting Cycle:
Capturing Economic Events Capturing Economic Events
Chapter 3
3-2
The Role of Accounting The Role of Accounting
Records Records
Establishes accountability for assets and transactions.
Establishes accountability for assets and transactions.
Keeps track of routine business activities.
Keeps track of routine business activities.
Obtains detailed information about a particular transaction.
Obtains detailed information about a particular transaction.
Evaluates efficiency and performance within company.
Evaluates efficiency and performance within company.
Maintains evidence of a company’s business activities.
Maintains evidence of a company’s business activities.
3-3
The Ledger The Ledger
The entire group of accounts is kept
together in an accounting record
called a ledger.
The entire group of accounts is kept
together in an accounting record
called a ledger.
Cash
Accounts Payable
Share Capital
Accounts are individual records showing increases
and decreases.
Accounts are individual records showing increases
and decreases.
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The Use of Accounts The Use of Accounts
Increases are recorded on one
side of the T account, and decreases are recorded on the
other side.
Left or Debit
Side
Right or Credit
Side Title of Account
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Cash
5/1 8,000 5/2 2,500 5/25 75 5/8 2,000 5/29 750 5/28 150 5/31 50 5/31 4,125
Bal.
Cash
5/1 8,000 5/2 2,500 5/25 75 5/8 2,000 5/29 750 5/28 150 5/31 50 5/31 4,125
Bal.
Receipts are on the debit
side.
Payments are on the credit
side.
The balance is the difference between the debit and credit entries
in the account.
The balance is the difference between the debit and credit entries
in the account.
Debit and Credit Entries
Debit and Credit Entries
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A = A L + L E E
ASSETS ASSETS Debit
for Increase
Credit for Decrease
EQUITIES EQUITIES Debit
for Decrease
Credit for Increase LIABILITIES
LIABILITIES Debit
for Decrease
Credit for Increase
Debits and credits affect accounts as follows:
Debits and credits affect accounts as follows:
Debit and Credit Entries
Debit and Credit Entries
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A = A L + L E E
Debit Debit balances balances
Credit Credit balances balances
=
In the double-entry accounting system, every transaction is recorded by equal
dollar amounts of debits and credits.
In the double-entry accounting system, every transaction is recorded by equal
dollar amounts of debits and credits.
Double Entry Accounting
Double Entry AccountingThe The Equality of Debits and Credits
Equality of Debits and Credits
3-8
Let’s record selected
transactions for JJ’s Lawn Care Service in
the accounts.
1 May: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.
1 May: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.
Will Cash increase or decrease?
Will Share Capital increase or
decrease?
Cash increases
$8,000 with a debit.
Share Capital increases $8,000
with a credit.
3-9
2 May: JJ’s purchased a riding lawn mower for $2,500 cash.
2 May: JJ’s purchased a riding lawn mower for $2,500 cash.
Will Cash increase or decrease?
Will Tools &
Equipment increase or decrease?
Cash decreases
$2,500 with a credit.
Tools & Equipment increases $2,500
with a debit.
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8 May: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000.
8 May: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000.
Will Truck increase or decrease?
Will Cash and Notes Payable
increase or decrease?
Truck increases
$15,000 with a debit.
3-11
11 May: JJ’s purchased some repair parts for $300 on account.
11 May: JJ’s purchased some repair parts for $300 on account.
Will Tools &
Equipment increase or decrease?
Will Accounts
Payable increase or decrease?
Tools & Equipment increases $300 with
a debit.
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18 May: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost.
ABC Lawns agrees to pay JJ’s within 30 days.
18 May: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost.
ABC Lawns agrees to pay JJ’s within 30 days.
Will Tools &
Equipment increase or decrease?
Will Accounts
Receivable increase or decrease?
Tools & Equipment decreases $150 with
a credit.
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3-14
In an actual accounting system,
transactions are initially recorded in the journal.
In an actual accounting system,
transactions are initially recorded in the journal.
The Journal
The Journal
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Posting Journal Entries to Posting Journal Entries to
the Ledger Accounts the Ledger Accounts
Posting simply
means updating the ledger accounts for
the effects of the transactions
recorded in the journal.
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Posting Journal Entries to Posting Journal Entries to
the Ledger Accounts
the Ledger Accounts
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Posting Journal Entries to Posting Journal Entries to
the Ledger Accounts
the Ledger Accounts
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Let’s see what the cash account looks like after posting the cash portion of this
transaction for JJ’s Lawn Care Service.
Let’s see what the cash account looks like after posting the cash portion of this
transaction for JJ’s Lawn Care Service.
Posting Journal Entries to Posting Journal Entries to
the Ledger Accounts
the Ledger Accounts
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This ledger format is referred to as a running balance.
This ledger format is referred to as a running balance.
Ledger Accounts After Ledger Accounts After
Posting
Posting
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T accounts are simplified versions of the ledger account that only show the
debit and credit columns.
T accounts are simplified versions of the ledger account that only show the
debit and credit columns.
Ledger Accounts After Ledger Accounts After
Posting
Posting
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Profit is not an asset it’s an increase in equity from profits of the business.
Profit is not an asset it’s an increase in equity from profits of the business.
A = A L + L E E
Increase Decrease
As income is earned, either an asset is
increased or a liability is decreased.
Increase
Profit always results in the
increase of Equity
What is Profit?
What is Profit?
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A = A L + L E E
Retained Earnings Retained Earnings
Share Capital
Retained Earnings
The balance in the Retained Earnings account represents the profit of the corporation over the
entire lifetime of the business, less all amounts which have been distributed to the shareholders as
dividends.
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The income statement summarizes the
profitability of a business for a specified period of time.
The income statement summarizes the
profitability of a business for a specified period of time.
The Income Statement: A The Income Statement: A
Preview
Preview
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Accounting Periods Accounting Periods
Time Period Principle To provide users of financial statements with timely information,
profit is measured for relatively short
accounting periods of equal length.
Time Period Principle To provide users of financial statements with timely information,
profit is measured for relatively short
accounting periods of equal length.
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Revenue and Expenses Revenue and Expenses
The price for goods sold and services
rendered during a given accounting period.
Increases equity.
The costs of goods and
services used up in the process of earning revenue.
Decreases equity.
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The Matching Principle:
The Matching Principle:
When To Record Revenue When To Record Revenue
Matching Principle Revenue should be
recognized at the time goods are sold
and services are rendered.
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The Matching Principle:
The Matching Principle:
When To Record Expenses When To Record Expenses
Matching Principle Expenses should be
recorded in the
period in which they are used up.
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The Accrual Basis of The Accrual Basis of
Accounting Accounting
Current
Accounting Period
Future
Accounting Period
1 Jan.
2009 1 Jan.
2009 1 Dec.
2009 1 Dec.
2009 1 Jan.
2010 1 Jan.
2010 1 Dec.
2010 1 Dec.
2010
Cash is received or paid here
Cash is received or paid here
The income
statement reports revenue or expense
here
The income
statement reports revenue or expense
here
The income
statement reports revenue or
expenses here The income
statement reports revenue or
expenses here
Cash is received or paid here
Cash is received or paid here
OROR
But . . .
But . . .
3-29
Debit and Credit Rules for Debit and Credit Rules for
Revenue and Expenses Revenue and Expenses
EQUITIES Debit
for Decrease
Credit for Increase
Expenses decrease
equity.
Revenues increase
equity.
EXPENSES
Credit for Decrease Debit
for Increase
REVENUES Debit
for Decrease
Credit for Increase
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EQUITIES Debit
for Decrease
Credit for Increase
Payments to owners
decrease equity.
Owners’
investments increase
equity.
DIVIDENDS
Credit for Decrease Debit
for Increase
Dividends Dividends
SHARE CAPITAL Debit
for Decrease
Credit for Increase
3-31
Let’s analyze the revenue and
expense
transactions for JJ’s Lawn Care
Service for the month of May.
We will also
analyze a dividend transaction.
Let’s analyze the revenue and
expense
transactions for JJ’s Lawn Care
Service for the month of May.
We will also
analyze a dividend transaction.
29 May: JJ’s provided lawn care services for a client and received $750 in cash.
29 May: JJ’s provided lawn care services for a client and received $750 in cash.
Will Cash increase or decrease?
Will Sales Revenue increase or
decrease?
Cash increases
$750 with a debit.
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31 May: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.
31 May: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.
Will Cash increase or decrease?
Will Gasoline
Expense increase or decrease?
Cash decreases $50 with a credit.
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31 May: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.
31 May: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.
Will Cash increase or decrease?
Will Dividends increase or
decrease?
Cash decreases
$200 with a credit.
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Now, let’s look at the Trial Balance
for JJ’s Lawn Care Service for the month of May.
Now, let’s look at the Trial Balance
for JJ’s Lawn Care Service for the month of May.
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All balances are taken from the ledger accounts on 31 May after considering all of JJ’s transactions for the
month.
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The Accounting Cycle in The Accounting Cycle in
Perspective Perspective
Accountants spend much of their time
focusing on the more analytical aspects of their
discipline.
3-38
