The Accounting Cycle: Capturing Economic

EventsLecture 2

Entity Principle

A business entity is an economic unit that engages in identifiable business activities

Separate from the personal affairs of its owner

The Concept of Business Entity

Current Assets◦ Cash and cash equivalents◦ Accounts receivables, trade receivables◦ Prepaids and advances◦ Inventory◦ Financial assets such as trading securities, investment

securities

Non-Current/Fixed Assets◦ Property, Plant and Equipment◦ Investment property◦ Intangible assets (patents, trademarks, licenses, copyright,

goodwill)◦ Loans receivables

Assets

The Cost Principle◦ The Going Concern Assumption◦ The Objectivity Principle◦ The Stable-Dollar Assumption

Asset Valuation

Short Term/Current Liabilities◦ Accounts payable – Generally payable to suppliers/vendors◦ Notes Payable – Interest bearing loan, less than a year maturity◦ Provisions or accrued liabilities◦ Unearned revenue◦ Interest payable◦ Notes Payable – Short term, interest bearing loan

Long Term/Non-Current Liabilities◦ Debt payable/Long term loan◦ Bonds/Debentures◦ Notes Payable – Interest bearing loan, more than a year

maturity

Liabilities

Increases through◦ Investments of cash or other assets by the owner◦ Earnings from profitable operation of the business

Decreases through◦ Withdrawals of cash or other assets by the owner◦ Losses from unprofitable operation of the business

Owner’s Equity

Sole Proprietorship

Partnership

Corporation

Owner’s Equity

Statement of Financial Position – Balance Sheet

Exercise 2.3 Exercise 2.8

Practice Questions

Assets = Liabilities + Owner’s Equity

The effects of Business Transactions◦ Exercise 2.6

The Accounting Equation

Revenues◦ Revenue, sales◦ Gains◦ Investment income (e.g., interest and dividends)

Expenses◦ Cost of Goods Sold◦ Selling, general, and administrative expenses (‘SG&A’) ◦ Rent, utilities, salaries and advertising expenses◦ Depreciation and amortization◦ Interest expense◦ Tax expense◦ Losses

Net Income

Net income is an increase in owners’ equity resulting from the profitable operation of the business

Net Income always results in the increase of Owner’s Equity

Net Income

Income Statement

Net Income is reported to the Owner’s Equity Section of the Balance Sheet

How is Income Statement related to Balance Sheet

The sequence of accounting procedures used to record, classify, and summarize accounting information in financial reports at regular intervals is often termed the accounting cycle

The Accounting Cycle

Analyzing and recording transactions via journal entries

Posting journal entries to ledger accounts Preparing unadjusted trial balance Preparing adjusting entries at the end of the

period Preparing adjusted trial balance Preparing financial statements Closing temporary accounts via closing entries Preparing post-closing trial balance

The Accounting Cycle

An account is a means of accumulating in one place all the information about changes in specific financial statement items, such as a particular asset or liability e.g. Cash, Notes Payable

The Use of Accounts

Debits refer to the left side of an account, and credits refer to the right side of an account

Debit and Credit Entries

Debit/Credit Relationships

Account Debit (Dr.) Credit (Cr.)Assets Increase Decrease

Contra Assets Decrease Increase

Liabilities Decrease Increase

Equity Decrease Increase

Revenue Decrease Increase

Expenses Increase Decrease

Distributions Increase Decrease

The information about each business transaction is initially recorded in an accounting record called the journal

This information is later transferred to the appropriate accounts in the general ledger

The journal is a chronological (day-by-day) record of business transactions

Example

The Journal

Basic characteristics of the general journal entry:

1. The name of the account debited is written first, and the dollar amount to be debited appears in the left-hand money column.

2. The name of the account credited appears below the account debited and is indented to the right. The dollar amount appears in the right-hand money column.

3. A brief description of the transaction appears immediately below the journal entry.

General Journal

The entire group of accounts is kept together in an accounting record called a ledger

The transactions from the journal are posted in separate accounts and are accumulated to form a ledger

Example

The Ledger

If the debit total exceeds the credit total, the account has a debit balance; if the credit total exceeds the debit total, the account has a credit balance

Debit Balances in Asset Accounts

Credit Balances in Liability and Owners’ Equity Accounts

Determining the Balance of a T-Account

Every transaction is recorded by equal dollar amounts of debits and credits

DOUBLE-ENTRY ACCOUNTING—THE EQUALITY OF DEBITS AND CREDITS