Financial Accounting Lecture 2 1Chara Charalambous MBA CDA COLLEGE.

Chara Charalambous MBA CDA COLLEGE 1

Financial Accounting

Lecture 2


Learning Objectives• What are accounts and what is the ledger?• Understand the principles of double entry.• Understand the use of journal (book of prime

entry)• Be familiar with the recording of different

transactions• Balancing off the ledger accounts.• Be familiar with the trial balance• Understand what is the Financial Information

System


Accounts and Ledger

• ACCOUNT is a table in T- shape which records chronologically the changes caused by the trade transactions that a business proceeds in an item of the assets, liabilities or capital.

• All Accounts are kept in a book which is called GENERAL LEDGER (‘T’ accounts).

• There is a ledger account for each asset, liability, revenue and expense item. Ledger accounts are pages in the ledger book with a separate page reserved for each one in order to record transactions.


The duality concept and double entry bookkeeping

• Each account has two sides - the debit (Dr) and credit (Cr) sides.

Dr Name of Account Cr Date Description € Date Description €


The Account

• Basic summary device • Detailed record of all changes that have occurred

in a particular asset, liability, or stockholders’ equity

• Grouped in three broad categories :Assets Liabilities Stockholders’ Equity



• Each transaction that a business realize affects the financial statements in two ways.

• These two effects are equal and opposite so as the accounting equation will be always satisfied.

Assets = Liabilities + Capital• Double Entry Rule: For every debit there is a credit and for every credit

there is a debit.

• Each transaction will affect at least two accounts: ‘the one will be debited and the other will be credited’



• Whether an entry is to the debit or credit side of an account depends on the type of account and the transaction:

The Asset Accounts are debited when an increases of asset occurs and are credited when a diminish of asset occurs.

The Liability and Capital Accounts are credited when an increase of liability occurs and are debited when a reduce of liability occurs.

Debits are not good or bad Neither are credits

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ACCOUNTS INCREASES DECREASES

Asset Account Debited Credited

Liability Account Credited Debited

Capital Account Credited Debited

Also known as “bookkeeping cycle ”, is the process of recording and processing the accounting events of a company. The series of steps begin when a transaction occurs and end with its inclusion in the financial statements.

The main steps of the accounting cycle are:

Collecting and analyzing data from transactions and events.Posting entries to the general ledger.Adjusting entries appropriately.Preparing an adjusted trial balance.Organizing the accounts into the financial statements.Closing the books.Preparing a post-closing trial balance to check the accounts.

.


Accounting Cycle During Period


Post-Closing Trial Balance A post-closing trial balance is a list of permanent

accounts and their balances from the ledger after all closing entries have been journalized and posted. It lists the balances for all accounts not closed. These accounts comprise a company’s assets, liabilities and equity, which are identical to those in the balance sheet. The aim is to verify that (1) total debits equal total credits for permanent accounts, and (2) all temporary accounts have zero balances.


ACCOUNTING PROCESS AND RECORDS ▲ Accounting records are any listing or book which records the transactions of a business in a logical manner. This is achieved by the use of books of prime entry and the Ledger.

Journals ( Journal is one of the books of prime entry) is a detail diary in which the transactions of each day are recorded. They are used as an initial ‘store’ of information of the business transactions prior to storing the information in the ledger accounts.

journals

Ledgeraccounts

Trial BalanceTransactions

Step 1 Step 2

Financialstatements

Make Adjusting entries

Post Closing Trial Balance

Closing the Accounts


The Accounting Process• Transaction Journal General Ledger (T-

Accounts) Trial Balance Adjusting entries (adjust for the accruals , prepayments , not-earned revenue and prepaid

revenue) Closing and Balancing the Accounts Financial Statements (Income Statement and Balance Sheet) Post Closing Trial Balance

Documents verifying a transaction:• Bank deposit documentation• Invoices • Cheques• Stock certificates


ACCOUNTING RECORDS

▲ The journal is called a book of prime entry meaning the ‘first book’.

A Journal is prepared in a specific format as shown in the next slide.


Journal

Four parts: • a)Date of transaction • b)Title of account debited with dollar amount • c)Title of account credited with dollar amount • d)Brief explanation of transaction


To sum up: the Journal and the Ledger

Journal • Chronological record of transactions • Organized by date Ledger • The book holding all the accounts and their

balances • Organized by account

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Book of Prime Entry Transaction type

Sales Day Book Credit Sales

Purchases Day Book Credit Purchases

Sales Returns day Book Returns of goods sold on credit

Purchases returns day book Returns of goods bought on credit

Cash Book All bank transactions

Petty Cash Book All small cash transactions

Other Books of Prime Entry


TRADE TRANSACTIONS 1. Recording Cash Transactions

• Cash transactions are those where payment is made or received immediately.

• Double Entry in the bank ledger is as follow:

– A debit entry is where funds are received.– A credit entry is where funds are paid out.


• Credit sales and purchases are transactions where goods or services change hands immediately, however payment is not made right away but in some time in the future.

• Money that a business is owned is recorded in the receivables or Debtor ledger account.

• Money that a business owes is recorded in the payables or Creditor ledger account.

TRADE TRANSACTIONS 2. Recording Credit Sales and Purchases

Chara Charalambous MBA CDA COLLEGE20

TRADE TRANSACTIONS 3. Recording Sales and Purchases Returns

• It is normal for customers and a business to return unwanted goods to a business or the supplier respectively.

• The double entries arising will depend upon whether the returned goods were initially

purchased on credit or cash.

Originally a credit transactions

Originally a cash transactions

Sales Returns (returns inwards)

Dr Sales (Returns) Cr Receivables/ Debtors

Dr Sales (Returns)Cr Cash

Purchases Returns(returns outwards)

Dr Payables/ CreditorsCr Purchases (Returns)

Dr CashCr Purchases (Returns)


TRADE TRANSACTIONS 4. Recording Discounts

• Discounts may be given in the case of credit transactions in order to encourage quick payment. For example a cash discount of 3% is offered to any customers who pay within 14 days.

– A business may give its customer a discount - known as Discount Allowed.

– A business may receive a discount from a supplier – known as Discount Received.


Recording DiscountsDiscount Allowed• Dr Discount Allowed (expense) X• Cr Debtors / Receivables X

Discount allowed is treated as all other expenses in Income Statement

Discount Received• Creditors / Payables X• Discount Received (income) X

The income is shown beneath gross profit in the IncomeStatement.


Balancing off a statement of financial position ledger account

cashCapital 10000 Purchases 200Sales 250 Rent 150 B/ce c/d 9900 10250 10250B/ce b/d 9900

1.Total both sides of the T account and find the larger total. In the example the larger total is in debit side.

2.Put the larger in the total box on the debit and credit side.

3.Calculate the difference between the large side and the small side and set the figure in the small side naming it Balance c/d (carried down)

4.Carry the balance down diagonally and call it “balance b/f” (brought forward)

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ADJUSTMENTS

Accrued expenses

– The expenses which have been used up in the current year, but have not yet been paid.

Prepaid expenses

– those to be used in the following period but have been paid in advance this period.

added in the total expenses and goes in the Profit and Loss account also goes to Balance sheet in the Current liabilities side and is called Accrued Expenses.

we deduct it from the total expense so in Profit and Loss account goes the expense which is related to this year.Also goes in the Balance Sheet in the side of Current assets named Prepaid expenses.


ADJUSTMENTS - INCOME

• Accrued income

– The income which has been earned in the current period but has not yet been received.

• Prepaid income

– The income to be earned in the following period but has been received in advance.

We record the whole (paid + unpaid) income in the Profit and Loss Account. also goes in the Balance sheet in the side of current assets and is called accrued income.

we deduct the prepaid income from the total amount of the income which goes in the Profit and Loss account (because is not related to the year) And also this amount goes to Balance sheet in the side of current liabilities and is called prepaid income.

In this case we mean the income from other sources than the clients for e.g. the bank interest, rents e.t.c)

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Classes of Accounts• Personal Accounts: The accounts which represent persons,

organizations, claims and liabilities examples are debtors, creditors, loans, prepayments, accruals, drawings, capital.

• Real Accounts: The accounts which represent assets examples are cash , bank, stock, fixed assets.

• Nominal Accounts: The accounts which represent expenses, losses, incomes, profits examples are purchases, sales, expenses. Also called Temporary Accounts because the are related to one year only and they are closed at the end of the year and next year they will not have balance they start from zero.

Personal Accounts and Real Accounts are Permanent accounts are not closed at the end of the year, they will have balance next year and all these accounts are Balance Sheet Accounts.


• At the year end, the ledger accounts must be closed off (concerns accounts that closes – temporary accounts) or balanced (concerns accounts that their balance is transferred to next year- permanent accounts) and transfer the balances in the next accounting period.

• Balancing the account will result in:– A balance c/f (being the asset / liability at the

end of the accounting period). equals – A balance b/f (being the asset / liability at the

start of the next accounting period).

Balance c/d = Balance b/d


The following accounts are closing off and they are not transferring a balance to the next accounting period:

1. Expenses accounts and Purchases account 2. Income accounts (e.g. sales, discounts received)

Instead they are transferring the balancing figure on thesmallest side at the Income statement (depending if it goes to trading a/c or profit & loss a/c)

LEDGER ACCOUNTS THAT ARE TRANSFERING AT THE INCOME STATEMENT DO NOT HAVE AN OPENING BALANCE


CAPITAL ACCOUNT

• At the start of the next accounting period the capital account will have an opening balance, i.e. A balance b/f equal to the amount that is owed to the owner at the start of that period.

• This amount is equal to what was owed to the owner at the start of the previous period, plus any capital that the owner introduced in the period, plus any profits earned in the period less any drawings taken out in the period.

• Therefore we transfer the balance of the Income Statement -profit or loss- and the balance on the drawings account to the capital account at the end of the period so that it will have the correct opening balance at the start of the next.


Capital AccountLoss for the year x B/ce b/d xDrawings x Net Profit xB/ce c/d x Cash injections x x x B/ce b/d x


Chart of Accounts: List of all accounts used by a company


Example of Journal: Ned Brown opened a medical practice in San Diego, California. 1 Record the preceding transactions in the journal of Ned Brown, M.D., P.C. Include an explanation.

• Jan 1: The business received $29,000 cash and issued common stock.

• Jan 2 Purchased medical supplies on account, $14,000. • Jan 2 Paid monthly office rent of $2,600. • Jan 3 Recorded $8,000 revenue for service rendered to patients

on account.


DATE DESCRIPTION DEBIT CREDIT

JAN 1 Cash 29000

Common Stock 29000

Issued stock

Jan. 2: Purchased medical supplies on credit, $14,000. Medical Supplies, an asset, is increasing .Assets increase with debits. On credit increases accounts payable, a liability Increase liabilities with credits


JAN 2 Medical supplies 14000

Accounts payable 14000

Purchased supplies on account

Jan 1: The business received $29,000 cash and issued common stock Cash received indicates cash increases Cash is an Asset; Assets increase with debits .Issued common stock; indicates equity is increasing Increase equity with credits


Jan. 2: Paid monthly office rent of $2,600 .Paid rent, an expense, expense is increasing .Expenses increase with debits .Paid cash, cash is an asset ,decrease assets with credits


JAN 2 Rent Expense 2600

Cash 2600

Paid Office Rent

Jan. 3: Recorded $8,000 revenue for service rendered to patients on credit. On credit indicates Accounts receivable increase .Accounts receivable is an Asset, Assets increase with debits .Rendered services, services are revenues, indicates revenues are increasing Increase revenues with credits


JAN 3 Accounts receivable 8000

Service Revenue 8000

Performed service on account


Copying amounts from the journal to the ledger


Prepare the Trial Balance

Trial Balance of Ned Brown, M.D., P.C.

DR CR

Cash 26400

Accounts receivable 8000

Medical supplies 14000

Accounts payable 14000

Common stock 29000

Service revenue 8000

Rent expense 2600

Total 51000 51000


THE TRIAL BALANCE

• Once all ledger accounts have been balanced off a trial balance is prepared.

• A trial balance is a list of the “balance b/f” of the ledger accounts according to whether they are on the debit or credit side.


The purpose of a trial balance is:

– To check that for every debit entry made, an equal credit entry has been made since the total amount of the two columns must be equal.

– As a first step in preparing the financial statements.

Note that a number of adjustments will be made after the trial balance is extracted. These adjustments do not therefore appear in the trial balance.

Financial Accounting Lecture 2 1Chara Charalambous MBA CDA COLLEGE.

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