Accounting Chapter 2

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Accounting Chapter 2
2011-02-13 23:17:09
Accounting Chapter

Accounting Chapter 2
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  1. Source Documents
    • source of information for accounting entries that can be in
    • either paper or electronic form
  2. Account
    • record of increases and decreases in a specific asset,
    • liability, or equity item
  3. Asset Accounts-

    resources owned or controlled by a company and
    that have expected future benefits. Common asset accounts are
    • Cash – includes currency, coins, and amounts on
    • deposit in bank checking or savings accounts

    • Accounts Receivable – amounts due from customers
    • for credit sales (backed by the customer’s general credit standing). Customers
    • and others who owe a company are called its debtors

    • Notes Receivable – a written promise of another
    • entity to pay a definite sum of money on a specified future date to the holder
    • of the note

    • Prepaid Accounts (Prepaid Expenses) – represent
    • prepayments of future expenses (not current expenses) by a company; when
    • expenses are later incurred, the amounts in Prepaid Accounts are
    • transferred to expense accounts

    • Supplies – recorded as assets until they are
    • used, then amounts used-up are transferred to expense accounts

    • Equipment – may be office or store equipment; as
    • equipment wears-out, its cost is gradually transferred to expense accounts (called
    • depreciation)

    • Buildings – stores, offices, warehouses, and
    • factories; also depreciated

    • Land – not depreciated because land does not
    • generally wear-out (lose its value)
  4. Liability Accounts
    – claims by creditors against a company’s assets
    – obligations to transfer assets (usually money) or provide products or
    services. Individuals and organizations that own the right to receive payments
    from a company are called creditors. Common liability accounts are:
    • Accounts Payable – created by buying goods or
    • services on credit (backed by the buyer’s general credit standing)

    • Note Payable – a written promise to pay a
    • definite sum of money on a specified future date to the holder of the note

    • Unearned Revenues – represent receipts of future
    • revenues (not current revenues) from customers (when customers pay in advance
    • for products or services); when revenues are later earned, the amounts
    • in Unearned Revenues are transferred to revenue accounts

    • Accrued Liabilities – amounts owed that are not
    • yet paid (e.g. wages, taxes, interest, etc., that do not relate to the purchase
    • of goods or services)
  5. Equity Accounts – claims by the owner
    against the company’s assets. Common equity accounts are:
    • Owner, Capital – all investments by owner are
    • recorded here

    • Owner, Withdrawals – all distributions to the
    • owner for personal use
    • Revenues – variety of accounts depending on the
    • type of revenue earned

    • Expenses – variety of accounts depending on the
    • type of expenses incurred
  6. Chart of Accounts
    • a list of all accounts used by a company and includes an
    • identification number assigned to each account; usually in the following order:
    • Assets, Liabilities, Capital, Withdrawals, Revenues, and Expenses.
  7. T-account – tool used to show the effects of
    transactions and events on individual accounts
    • T-accounts are used for two purposes:
    • 1.To quickly see how a transaction affects one or more
    • accounts (real business world use)

    • 2.To serve as a representation of an account for
    • beginning Accounting students. T-accounts can be quickly drawn on the board or
    • on a piece of paper (drawing a regular account is more awkward and time
    • consuming). Also T-accounts are used to explain the concept of Debits and
    • Credits.
  8. A Debit is the left-hand side of a T-account; a
    Credit is the right-hand side of a T-account
    • T-accounts show increases and decreases in an
    • account. A Debit can be either an increase or a decrease, depending on the
    • account (same is true with Credits).
  9. Double-Entry Accounting
    • Each transaction affects at least two accounts
    • and has at least one debit and one credit (transaction level)

    • The total debits and total credits of a
    • transaction must be equal (transaction level)

    • The sum of all debit balance accounts must equal
    • the sum of all credit balance accounts (ledger level)
  10. Normal Balance
    • the side of a T-account that makes the account
    • increase (the expected balance that an account will have due to its type, e.g.
    • Asset, Liability, etc.)
  11. Journal (Book of Original Entry)
    • a complete record of each transaction in one place
    • (all transactions are recorded here), including debits and credits; can be a
    • book or a computerized Accounting System
  12. General Journal
    • a type of journal that can be used to record any type of
    • transaction; although companies may have different types of journals, all
    • of them will have, at a minimum, a General Journal.
  13. Contents of a Journal Page:
    • v
    • Date of transaction

    • v
    • Titles of affected accounts (note that debits
    • are flush with the left column and credits are indented)

    • v
    • Dollar amount of each debit and credit

    • v
    • Explanation of the transaction
  14. Compound Journal Entry
    • a journal entry that affects more than two accounts (note
    • that one journal entry can affect many accounts – most seen in class will
    • affect only two)
  15. General Ledger/Ledger (Book of Final Entry)
    • – a collection of all accounts of a
    • company listed in order; can be a book or a computerized Accounting System

    • Periodically (daily, weekly), transactions recorded in the
    • General Journal are transferred to the General Ledger
  16. Trial Balance
    • a list of accounts and their balances at the end of a month
    • (prepared from the General Ledger)
    • v
    • Purpose: used to identify errors that
    • have been made in the Accounting Process

    • o
    • Determine that total debits equals total credits

    • o
    • Determine that each account has the correct Normal balance

    • o
    • Perform an analytical review to identify any unusual
    • balances

    • Note: errors can still exist
    • even if the three bullet points above look ok
  18. Trial Balance
    • A Trial Balance is not a Financial Statement but an internal
    • document – Financial Statements do not have debit and credit columns.
  19. v
    Financial Statements (if put together manually) are
    prepared in the following order (information from the Income Statement flows to
    the Statement of Owner’s Equity, which in turn flows to the Balance
    Covers a period of time


    Income Statement

    Covers a period of time


    Statement of Owner’s Equity

    A snapshot at end of month


    Balance Sheet
  20. Financial Statement Analysis
    • v
    • Debt ratio – solvency ratio that
    • determines the degree of financial leverage (higher financial leverage involves
    • greater risk since a company has financed more of its assets with debt.

    debt ratio= total liabilities/total assets