ACCT 2310 Accounting Principles I Chapter 2

1
ACCT 2310 Accounting
Principles I Chapter 2

• Dr. Robert R. Oliva
• Professor and Chairperson
• Department of Accounting
• University of Arkansas at Little Rock

2
Questions

• How do you find out the answer to the following
  questions?
• Does the business have enough cash to buy a 5000
  piece of equipment?
• Why was a 750 check written on March 28?
• How much have you spent on salaries so far this
  month?
• How much did you spend for an ad placed in the
  Arkansas Democrat Gazette during the first week
  in July?

3
You need to have an appropriate accounting system
in place

• JOURNAL Records daily transactions, describing
  date, amount, brief explanation.
• Pages 62-64.
• LEDGER Keeps a running balance showing increases
  and decreases of each financial statement item in
  a separate record, e.g.,
• Balance sheet Cash, accounts receivable, etc.
• Income Statement Revenues and expenses.
• Pages 65-68

4
Each business transaction must be recorded

• Recording involves a 3-step approach
• Determine which accounts are affected.
• As the Accounting Equation requires constant
  balancing, one account increases while other
  account decreases.
• Double-entry accounting
• Translate each increase and decrease into a debit
  or a credit transaction.
• Initial recording done in a Journal
• The book of original entry
• Ledger After all business transactions are
  recorded (journalized) then they are posted in
  the Ledger

5
Flow of business transactions

• Exhibit 2, page 56

6
Will proper recording prevent fraud?

• Bottom of page 54

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But before we can record in a journal or post to
a ledger

• We need to know what to call each business
  transaction
• We need to separate business transactions into
  Accounts

8
Account classification

• Classification depends on the business
  transaction and the type of business.
• Business transactions may be classified as
  affecting
• Assets
• Liabilities
• Owners Equity
• Revenues
• Expenses

9
Chapter 1 Lawn Mowing example

• Many transactions were recorded in Owners Equity
• Hard to separate and analyze
• OK for a very small business. But in reality not
  very efficient.
• More efficient approach Separate Owners
  Equity into various accounts.

10
Owners Equity is separated into four (4)
separate accounts

• Capital
• To record owners investments
• Drawing
• To record owners withdrawals
• Revenue
• To record revenues from customers
• Expense
• To record expenses incurred in business

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Examples of other accounts

• Cash
• Supplies
• Accounts Payable

12
Accounts Organization Chart of
Accounts

• Accounts can be classified/organized into 5 major
  groups/categories
• Assets
• Liabilities
• Owners Equity
• Revenues
• Expenses
• All business have these types, but names and/or
  numbers given to them will vary.
• Unique The Chart reflects the business
  transactions.

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In-class exercise

• Create a Chart of Accounts for Larry Sharp, M.D.
• Consider Dr. Sharps practice and divide business
  transactions among the following
• Assets
• Liabilities
• Owners Equity
• Revenues
• Expenses

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Larry Sharp, M.D. (a
sole proprietorship)

• Dr. Sharps practice has a bank account,
  supplies, and equipment.
• He buys supplies on credit and pays in 30 days
• His patients either pay same day or get bills
• He rents the office and pays for utilities
• He has malpractice insurance which he pays on on
  1/1/xx
• He has 2 employees and buys them flowers on their
  birthdays
• He attends medical seminars to keep current in
  his practice.

15
Larry Sharp, M.D. Chart of
Accounts

• Assets 1x
• 10 Cash
• 11 Accounts Receivable
• 12Supplies
• 13 Prepaid Insurance
• 14 Medical equipment
• Liabilities 2x
• 21 Accounts Payable
• Owners Equity 3x
• 31 Larry Sharp, Capital
• 32 Larry Sharp, Drawing
• Revenues 4x
• 41 Fees earned
• Expenses 5x
• 51 Wage expenses
• 52 Rent expenses
• 53 Utilities expenses
• 54 Medical Seminars expenses
• 55 Supplies expenses

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Recall Why are we classifying the accounts?

• To record the business transactions into a
  journal
• Each business transaction requires at least 2
  entries to keep the Accounting Equation on
  balance.

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What account increases and what account decreases?
18
The hijacking receivable

• Page 53

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Account Characteristics pp. 49-50

• Form The T account
• Two sides of the T
• Left side The debit side
• Right side The credit side
• Some accounts increase by debit entries
• Some account increase by credit entries

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The top of the T Describes type
of account

• Based on the Accounting Equation
  Assets Liabilities Owners Equity
• The Accounting Equation determines the recording
  of an accounts increases and decreases, e.g.,
  Debits and Credits
• Page 52

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Assets Accounts

• Assets increase with debits, e.g., increases
  recorded on the left side of the T.
• AID
• Assets decrease with credits, e.g., decreases
  recorded on the left side of the T
• ADC

22
Liabilities Accounts

• Liabilities and Owners Equity increase with
  credits, e.g., increases recorded on the left
  side of the T.
• LIC
• Liabilities and Owners Equity decrease with
  debits, e.g., decreases recorded on the left
  side of the T
• LDD
• Note Rules mirror each other
• Memorize only one

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A different approach

• After eating dinner, lets read the comics
• Using the T
• Left After Eating Dinner Accounts increasing
  with debits
• Assets
• Expenses
• Drawings
• Right Lets Read the Comics Accounts increasing
  with credits
• Liabilities
• Revenues
• Capital

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In-class Exercise Posting
entries into T accounts

• (a) Dr. Sharp deposits 7000 cash in business
  account
• (b) Buys 5700 in medical equipment on account.
• (c) Pays 500 cash for ad in newspaper
• (d) Pays 75 for supplies.
• (e) Receives 1000 from patients
• (f) Pays for the 5700 in equipment.
• (g) Patients are billed 300
• (h) Paid employee 150
• (i) Patients in (g) send 300 check in payment.
• (j) Dr. Sharp withdraws 575 for personal use

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Solution

• Left After Eating Dinner Accounts increasing
  with debits
• Assets
• Expenses
• Drawings
• Right Lets Read the Comics Accounts increasing
  with credits
• Liabilities
• Revenues
• Capital

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Solution Assets

• Cash account
• Debit (a), (e) and (i)
• Credit (c) (d) (f) (h) (j)
• Account receivable
• Debit (g)
• Credit (i)
• Supplies
• Debit (d)
• Equipment
• Debit (b)

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Solution Liabilities

• Accounts Payable
• Credit (b)
• Debit (f)

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Solution Capital, Revenues, Expenses

• Capital Account
• M. Gordon, Capital
• Credit (a)
• M. Gordon, Drawing
• Debit (j)
• Revenues
• Fees earned
• Credit (e) (g)
• Expenses
• Wages
• Debit (h)
• Advertising
• Debit (c)

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But many times proper recoding requires through
analysis

• Payments in advance

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Pre-payments paid

• Difference between paying for 2-year in advance
  v. 1-month in advance
• Page 56 Pre-payment of a 2-year policy on
  December 1st.
• Credit cash
• Debit an asset
• Page 58 Pre-payment of 1-month rent on December
  1st.
• Credit cash
• Debit an expense

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Pre-payments received

• Receiving 360 for prepaid rent 3-months in
  advance
• Page 58
• Debit receipt of 360 cash
• Credit a liability Unearned Revenue
• Each month
• Debit the liability
• Credit revenues

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Answers to Earlier Questions

• How do you know whether the business has enough
  cash to buy the equipment?
• Ledger Current balance in the CASH ACCOUNT.
• Why was a 750 check written on March 28?
• Journal The journal will show a brief
  description as to why the check was written.
• How much have you spent on salaries so far this
  month?
• Ledger WAGE EXPENSE ACCOUNT shows balance to
  date.
• How much did you spend for an ad placed in the
  Arkansas Democrat Gazette during the first week
  in July?
• Journal Look for entries during the first week
  in July and look for description indicating the
  Arkansas Democrat Gazette.

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TRIAL BALANCE

• Reports the balance of each ledger account
• Aim TO show that Debits Credits

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In-Class Exercise

• Trial balance for Dr. Sharp

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Dr. Larry Sharp, M.D. Trail
Balance May 31, 20xx

• Cash 1300
• Supplies.. 75
• Equipment. 5700
• Dr. L Sharp, Capital 7000
• Dr. L. Sharp, Drawing 575
• Fees earned 1300
• Wages Expense 150
• Advertising Expense 500
• _______
  ______
• 8300
  8300

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Possible errors Exhibit 6

• Transposition
• Slide

37
Error Correction

• Exhibit 7

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Errors undetected by a Trial Balance

• Failing to record or post a transaction
• Recording the same erroneous amounts as debits
  and credits
• Recording the same transaction more than once
• Correct debit accompanied by crediting wrong
  account
• Would the trial balance be off if you record a
  500 sale on account as follows?
• Debited Cash for 500
• Credited Fees earned for 500
• Answer No!

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FINANCIAL ANALYSIS

• Horizontal analysis
• Comparing time periods
• Exhibit 8