Chapter 2: The Recording Process
Chapter 2: The Recording Process 51499
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This 8 page Class Notes was uploaded by Stacy OK on Wednesday September 14, 2016. The Class Notes belongs to 51499 at Leeward Community College taught by Kamida in Fall 2016. Since its upload, it has received 9 views. For similar materials see Introduction to Financial Accounting in Accounting at Leeward Community College.
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Date Created: 09/14/16
I. Chapter 2: The Recording Process LO 1: Describe how accounts, debits and credits are used to record business transactions -Account - an individual accounting record of increases and decreases in a speciﬁc asset, liability, or stockholders’ equity item. (ex. separate accounts for Case, Accounts Receivable, Service Revenue, Salaries and Wages Expense, etc.) -Accounts consist of 3 parts: title, left/debit side, right/credit side. -T-account - Format of an account that resembles the letter T A. Debits and Credits -Debit (DR.) - indicates left side of an account -Credit (CR.) - indicates right side of an account -does not indicate increase or decrease -used in recording process to describe where entries are made in accounts. -Debit Balance - when comparing totals of two sides of an account, the total of the debit amounts exceeds the credits -Credit Balance - if credit amounts exceed the debits -Every positive item in the tabula summary represents a receipt of case -Every negative amount represents a payment of case. -In the account form, we record the increases of cash as debits and the decreases in cash as credits. -Increases on one side/decreases on the other side reduces recording errors and helps in determining the totals of each side of the account as well as the account balance -Balance is determined by netting the two sides (subtracting one amount from the other) 1. Debit and Credit Procedure * Debits MUST EQUAL credits: Each transaction must affect two or more accounts to keep the basic accounting equation in balance -Double-entry system - equality of debits and credits of recording transactions in appropriate accounts, helps ensure accuracy of of the recorded amounts as well as the detection of errors. 2. DR./CR. Procedures for Assets and Liabilities *Increases and decreases in liabilities will have to be recorded opposite from increases and decreases in assets. Debits Credits Increase assets Decrease assets Decrease liabilities Increase liabilities *Asset accounts normal show debit balances (asset account should exceed credits to that account *Liability accounts normally show credit balances (credits to a liability account should exceed debits to that account.) -Normal balance - the side where an increase in the account is recorded. -Knowing the normal balance in an account may help you trace errors Assets Liabilities Debit for Increase (+) Credit for decrease (-) Debit for decrease (-) Credit for increase (+) ^NORMAL BALANCE ^NORMAL BALANCE 3. Stockholders Equity -There are ﬁve subdivisions of stockholders’ equity: common stock, retained earnings, dividends, revenues and expenses. -Accounts kept for each of these subdivisions a) Common Stock -Common Stock - issued in exchange for the owners’ investment paid in to the corporation. *Credits increase the Common Stock account, debits decrease it. b) Retained Earnings -Retained Earnings - net income that is kept in the business, represents the portion of stockholders’ equity that the company has accumulated through the proﬁtable operation of the business. *Credits (net income) increase the Retained Earnings accountant debits (dividends or net losses) decrease it. c) Dividends -Dividend - a company’s distribution to its stockholders on a pro rata (equal) basis. -Cash Dividend - most common form of a distribution -Dividends reduce the stockholders’ claims on retained earnings *Debits increase the Dividends account and credits decrease it d) Revenues and Expenses -Purpose of earning revenues is to beneﬁt the stockholders of the business. *Credits increase revenue accounts and debits decrease them *The effect of debits and credits on revenue accounts is the same as their effect on stockholder’ equity. -Credits to revenue accounts should exceed debits (Credit balance) -Expenses decrease stockholders’ equity. *Expense accounts are increased by debits and decreased by credits. -Debits to expense accounts should exceed credits (Debit balance) B. Stockholders’ Equity Relationships -Common stock and retained earning is reported on stockholders’ equity section of balance sheet. -Dividends reported on retained earnings statement -Revenues and expenses reported on income statement -Dividends, revenues and expenses eventually transferred to retained earnings at end of period -Change in either dividends, revenues and expenses affect stockholders’ equity. C. Summary of Debit/Credit Rules Basic Equation Assets = Liabilities + Stockholders’ Equity + + Expanded Assets = Liabilities Common Retained + - - Equation Stock Earnings Revenues Expenses Dividends Debit/ Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Credit + - - + - + - + - + + - + - Effects D. Steps in the Recording Process LO2. Indicate how a journal is used in the recording process. Three basic steps in the recording process: 1. Analyze each transaction for its effects on the accounts through business documents - sales receipt, check or bill to provide evidence of transaction 2. Enter the transaction information in a Journal by determining transactions effect’s on speciﬁc accounts 3. Transfer the journal information to the appropriate accounts in a Ledger. E. The Journal -Journal - referred to as the book of original entry for records of transactions in chronological order. Shows debit and credit effects on speciﬁc accounts. -General Journal - the most basic form of journal, has spaces for dates, account titles and explanations, references and two amount columns. -Discloses in one place the complete effects of a transaction -Provides a chronological record of transactions -Helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared. 1. Journalizing -Journalizing - entering transaction data A complete entry consists of: -date of transaction -accounts and amounts to be debited and credited -brief explanation of the transaction Example: -Date of transaction is entered in Date column -Debit account title (Account to be debited, ex. Cash) is entered ﬁrst at the extreme left margin of the column headed “Account Titles and Explanation,” and the amount is recorded in the Debit column -Credit account title (ex. Common Stock) is indented and entered on the next line in the column headed “Account Titles and Explanation,” and the amount of the credit is recorded in the Credit column -Brief explanation of the transaction appears on the line below the credit account title. A space is left between journal entries to separate individual entries and make it easier to read. -The column titled Ref. (Reference) is left blank when the journal entry is made. It is ﬁlled when the journal entries are transferred to the ledger. *It is important to use correct and speciﬁc account titles in journalizing. 2. Simple and Compounds Entries -Simple entry - involves only two accounts, one debit and one credit -Compound Entry - Entry that requires three or more accounts. (Ex. Making a purchase where you pay partially now and pay the rest later/accounts payable) -Compound Entry requires that all debits be listed before credits. F. The Ledger LO3. Explain how a ledger and posting help in the recording process -Ledger - Entire group of accounts maintained by a company, provides the balance in each of the accounts as well as keeps track of changes in these balances. -General Ledger -contains all the asset (cash, supplies, land, equiptment), liability (notes payable, accounts payable, salaries and wages payable, interest payable) and stockholders’ equity accounts (common stock, retained earnings, dividends, service revenue, salaries and wages expense). -Companies arrange the ledger in the sequence in which they preset the accounts in the ﬁnancial statements. In order: assets, liabilities, stockholders’ equity, revenues, and expenses. Each account is numbered. -The ledger provides the balances of each account. 1. Standard Form of Account -Three Column Form of Account- has three money columns — debit, credit, and balance. Balance in the account is determined after each transaction. G. Posting -Posting- Transferring journal entries to the ledger accounts, accumulates the effects of journalized transactions into the individual accounts. Steps: -In the ledger, in the appropriate columns of the accounts debited, enter the date, journal page and debit amount shown in the journal. -In the reference column of the journal, write the account number to which the debit amount was posted. -In the ledger, in the appropriate columns of the acount(s) credited, enter the date, journal page, and credit amount shown in the journal. -In the reference column of the journal, write the account number to which the credit amount was posted. *Adter the last entry has been posted, the account should scan the reference column in the journal, to conﬁrm that all posting have been made -Posting should be performed in chronological order (post all debits and credits of one journal entry before proceeding to the next journal entry) and should bee made on a timely basis to stay up-to-date. -The reference column of a ledger account indicates the journal page from which the transaction was posted -The explanation space of the ledger account is used infrequently because an explanation already appears in the journal. 1. Chart of Accounts -The number of accounts depends on the amount of detail management desires in a company (Ex. one “utility” expense account vs separate account for gas, electricity, water, etc.) -Chart of Accounts- lists the accounts a company has and the account numbers that identify their location in the ledger (Ex. Accounts 101-199 for asset accounts; 200-299 for liabilities; etc.) -Companies may leave gaps between numbers for accounts to permit the insertion of new accounts as needed during the life of the business. H. The Recording Process Illustrated -Increase in Cash increases Stockholders’ Equity -The purpose of transaction analysis is ﬁrst to identify the type of account involved, and then to determine whether to make a debit or a credit to the account I. Summary Illustration of Journalizing and Posting LO4. Prepare a trial balance. -Trial Balance - a list of accounts and their balances at a given time. -Proves the mathematical equality of debits and credits after posting. Debit = Credit -A trial balance may also uncover errors in journalizing and posting -Useful in the preparation of ﬁnancial statements Steps for preparing a trial balance: -List the account titles and their balance in the appropriate debit or credit column -Total the debit and credit columns -Proce the equality of the two columns J. Limitations of a Trial Balance -The trial balance does not prove that the company has recorded all transactions or that the ledger is correct. Trial balance may balance even when: -A transaction is not journalized -A correct journal entry is not posted -A journal entry is posted twice -Incorrect accounts are used in journalizing or posting -Offsetting errors are made in recording the amount of a transaction K. Locating Errors -Errors generally result from mathematical mistakes, incorrect postings or transcribing the data incorrectly. What to Do if Your Trial Balance Does Not Balance: -Determine the amount of difference between the two columns of the trial balance -If the error is $1, $10, $100, or $1000, re-add the trial balance columns and recompute the account balances -If the error is divisible by 2, scan the trial balance to see whether a balance equal to half the error has been entered in the wrong column. -If the error is divisible by 9, retrace the account balances on the trial balance to see whether they are incorrectly copied from the ledger for Transposition Errors (reversing the order of numbers) -If the error is not divisible by 2 or 9, scan the ledger to see whether an account balance in the amount of the error has been omitted from the trial balance, and scan the journal to see whether a posting of that amount has been omitted. L. Dollar Signs and Underlining -Dollar signs do not appear in journals or ledgers. -Dollar signs only appear in trial balance and the ﬁnancial statements (shown only for the ﬁrst item in the column and for the total.) -A single line (a totaling rule) is placed user the column of ﬁgures to be added or subtracted. -Total amounts are double underlined to indicate ﬁnal sums