3-1

Chapter
THE ACCOUNTING
3 CYCLE: CAPTURING
ECONOMIC EVENTS

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-2

The
The Role
Role of
of Accounting
Accounting Records
Records
Establishes
Establishesaccountability
accountabilityfor
for
assets
assetsand
andtransactions.
transactions.
Keeps
Keepstrack
trackof
of routine
routine
business
businessactivities.
activities.
Obtains
Obtainsdetailed
detailedinformation
information
about
about aaparticular
particular transaction.
transaction.
Evaluates
Evaluatesefficiency
efficiencyand
and
performance
performancewithin
withincompany.
company.

Maintains
Maintainsevidence
evidenceof
ofaa
company’s
company’sbusiness
businessactivities.
activities.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-3

PEPSICO
PEPSICO
Wide variety of business: soft drinks, snacks,
juices, oats, etc.
Worldwide manufacturing facilities and thousands
of warehouses and distribution centers
143,000 employees
How PEPSICO accounts for all these transactions?
The use of sophisticated accounting and computer
systems

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 The Accounting Cycle
3-4

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Prepare after-closing Journalize and Prepare Prepare adjusted

trial balance. post closing financial trial balance.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
entries. statements.
 3-5

The
The Ledger
Ledger

Accounts
Accounts are
are
Cash individual
individual records
records
showing
showing increases
increases
Accounts
and
and decreases.
decreases.
Payable
The
The entire
entire group
group of
of
Capital accounts
accounts is is kept
kept
Stock together
together in in an
an
accounting
accounting record
record
called
called aa ledger.
ledger.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-6

The
The Use
Use of
of Accounts
Accounts

Increases are
Title of
recorded on one Account
side of the T- Left Right
account, and or or
decreases are Debit Credit
Side Side
recorded on the
other side.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-7

Let’s
Let’s see
see how
how
debits
debits and
and credits
credits
are
are recorded
recorded inin the
the
Cash
Cash account
account for
for
JJ’s
JJ’s Lawn
Lawn Care
Care
Service.
Service.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-8

Debit
Debit and
and Credit
Credit Entries
Entries
Cash
Cash
Receipts
5/1
5/1 8,000
8,000 5/2
5/2 2,500
2,500 Payments
are on 5/25
5/25 75
75 5/8
5/8 2,000
2,000 are on the
the debit 5/29 750
side.
5/29 750 5/28
5/28 150
150 credit
side.
5/31
5/31 50
50
5/31
5/31 4,125
4,125 The
Thebalance
balance is
isthe
the
Bal.
Bal. difference
differencebetween
between
the
thedebit
debitand
andcredit
credit
entries
entriesin
inthe
the
account.
account.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-9

Debit
Debit and
and Credit
Credit Rules
Rules
Debits
Debits and
and credits
credits affect
affect accounts
accounts as
as
follows:
follows:

A = L + OE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-10

Double
Double Entry
Entry AccountingThe
AccountingThe Equality
Equality of
of
Debits
Debits and
and Credits
Credits

A = L + OE
=
Debit Credit
balances balances

In
In the
the double-entry
double-entry accounting
accounting system,
system,
every
every transaction
transaction is
is recorded
recorded by
by equal
equal
dollar
dollar amounts
amounts of
of debits
debits and
and credits.
credits.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-11

HOUSEHOLD
HOUSEHOLD Accounting
Accounting
Do you use double entry in accounting your
household economic activities?
Do you think the double entry principle apply to
the household or personal financial accounting?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-12

Let’s record
selected
transactions for
JJ’s Lawn Care
Service in the
accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 
3-13

 May
May 1:
1: Jill
Jill Jones
Jones and
and her
her family
family invested
invested $8,000
$8,000
in
in JJ’s
JJ’s Lawn
Lawn CareCare Service
Service and
and received
received 800
800 shares
shares
of
of stock.
stock.

Will Capital Stock

Will Cash increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 
3-14

 May
May 1:
1: Jill
Jill Jones
Jones and
and her
her family
family invested
invested $8,000
$8,000
in
in JJ’s
JJ’s Lawn
Lawn CareCare Service
Service and
and received
received 800
800 shares
shares
of
of stock.
stock.

Capital Stock
Cash increases
increases $8,000
$8,000 with a debit.
with a credit.

Cash Capital Stock

5/1 8,000 5/1 8,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

  May
May 2:
2: JJ’s
JJ’s purchased
purchased aa riding
riding lawn
lawn mower
mower
3-15

for
for $2,500
$2,500 cash.
cash.

Will Tools &

Will Cash increase
Equipment increase
or decrease?
or decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

  May
May 2:
2: JJ’s
JJ’s purchased
purchased aa riding
riding lawn
lawn mower
mower
3-16

for
for $2,500
$2,500 cash.
cash.

Tools & Equipment

Cash decreases
increases $2,500
$2,500 with a credit.
with a debit.

Cash Tools & Equipment

5/1 8,000 5/2 2,500 5/2 2,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

  May
May 8: 8: JJ’s
JJ’s purchased
purchased aa $15,000
$15,000 truck.
truck. JJ’s
JJ’s
3-17

paid
paid $2,000
$2,000 in
in cash
cash and
and issued
issued aa note
note payable
payable
for
for the
the remaining
remaining $13,000.
$13,000.

Will Cash and

Notes Payable
Will Truck increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

  May
May 8: 8: JJ’s
JJ’s purchased
purchased aa $15,000
$15,000 truck.
truck. JJ’s
JJ’s
3-18

paid
paid $2,000
$2,000 in
in cash
cash and
and issued
issued aa note
note payable
payable
for
for the
the remaining
remaining $13,000.
$13,000.

Cash decreases
$2,000 with a credit.
Truck increases
Notes Payable
$15,000 with a debit.
increases $13,000
with a credit.
Cash
5/1 8,000 5/2 2,500
Truck
5/8 2,000
5/8 15,000
Notes Payable
5/8 13,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
  May
May 11:
11: JJ’s
JJ’s purchased
purchased some
some repair
repair parts
parts
3-19

for
for $300
$300 on
on account.
account.

Will Tools & Will Accounts

Equipment increase Payable increase or
or decrease? decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

  May
May 11:
11: JJ’s
JJ’s purchased
purchased some
some repair
repair parts
parts
3-20

for
for $300
$300 on
on account.
account.

Tools & Equipment Accounts Payable

increases $300 with increases $300 with
a debit. a credit.

Tools & Equipment Accounts Payable

5/2 2,500 5/11 300
5/11 300

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 
 May
May 18:
18: JJ’s
JJ’s sold
sold half
half of
of the
the repair
repair parts
parts to
to
3-21

ABC
ABC Lawns
Lawns for
for $150,
$150, aa price
price equal
equal to
to JJ’s
JJ’s cost.
cost.
ABC
ABC Lawns
Lawns agrees
agrees to
to pay
pay JJ’s
JJ’s within
within 30
30 days.
days.

Will Tools & Will Accounts

Equipment increase Receivable increase
or decrease? or decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 
 May
May 18:
18: JJ’s
JJ’s sold
sold half
half of
of the
the repair
repair parts
parts to
to
3-22

ABC
ABC Lawns
Lawns for
for $150,
$150, aa price
price equal
equal to
to JJ’s
JJ’s cost.
cost.
ABC
ABC Lawns
Lawns agrees
agrees to
to pay
pay JJ’s
JJ’s within
within 30
30 days.
days.

Tools & Equipment Accounts Receivable

decreases $150 with increases $150 with
a credit. a debit.

Tools & Equipment Accounts Receivable

5/2 2,500 5/18 150 5/18 150
5/11 300

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-23

The
The Journal
Journal

In
In an
an actual
actual accounting
accounting system,
system, transactions
transactions
are
are initially
initially recorded
recorded in
in the
the journal.
journal.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2005
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-24

Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

Posting
involves
copying
information
from the
journal to the
ledger
accounts.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-25

Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2005
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest cash Ledger
in the business.
Cash
Date Debit Credit Balance
2005
May 1 8,000 8,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-26

Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2005
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest cash Ledger
in the business.
Capital Stock
Date Debit Credit Balance
2005
May 1 8,000 8,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-27

Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2005
May 2 Tools & Equipment 2,500
Cash 2,500
Purchased lawn mower.

Let’s
Let’s see
see what
what the
the cash
cash account
account looks
looks like
like after
after
posting
posting the
the cash
cash portion
portion of
of this
this transaction
transaction for
for
JJ’s
JJ’s Lawn
Lawn Care
Care Service.
Service.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-28

Ledger
Ledger Accounts
Accounts After
After Posting
Posting
General Ledger
Cash
Date Debit Credit Balance
2005
May 1 8,000 8,000
2 2,500 5,500

This
This ledger
ledger format
format is
is referred
referred to
to as
as aa
running
running balance.
balance.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-29

Ledger
Ledger Accounts
Accounts After
After Posting
Posting
General Ledger
Cash
Date Debit Credit Balance
2005
May 1 8,000 8,000
2 2,500 5,500

TT accounts
accounts areare simplified
simplified versions
versions of
of
the
the ledger
ledger account
account that
that only
only show
show the
the
debit
debit and
and credit
credit columns.
columns.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-30

What
What is
is Net
Net Income?
Income?

Net
Net income
income is
is not
not an asset it’s
an asset it’s an
an increase
increase in
in
owners’
owners’ equity
equity from
from profits
profits of
of the
the business.
business.

A = L + OE
Increase Decrease Increase

Either (or both) of these . . . but this is

effects occur as net income what “net income”
is earned . . . really means.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-31

Retained
Retained Earnings
Earnings

A = L + OE
Capital Retained
Stock Earnings

The balance in the Retained Earnings account represents

the total net income of the corporation over the entire
lifetime of the business, less all amounts which have
been distributed to the stockholders as dividends.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-32

Wal-Mart
Wal-Mart Inc.:
Inc.: aa discussion
discussion
Stockholders’ Equity US$ 39 billion. Originally
invested only US$ 1.8 billion ( < 5% of current
Equity)
It means around $37 billion has been added from
net income
How does the company you work for has
performed recently?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-33

The
The Income
Income Statement:
Statement: A
A Preview
Preview
JJ's Lawn Care Service
Income Statement
For the Month Ended May 31, 2005

Sales Revenue $ 750

Operating Expense:
Gasoline Expense 50
Net Income $ 700

The
Theincome
incomestatement
statement summarizes
summarizesthetheprofitability
profitability
of
of aabusiness
businessfor
foraa specified
specifiedperiod
periodof
of time.
time.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 3-34

Accounting
Accounting Periods
Periods

Time Period Principle

To provide users of financial
statements with timely
information, net income is
measured for relatively short
accounting periods of equal
length.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-35

J.
J. Paul
Paul Getty
Getty Income
Income only
only US$
US$ 11,000?
11,000?
One day he was interviewed by some business
students, on how much income he earns?
He says: about $ 11,000
But this was his average income per hour !!!

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Accounting
Accounting Periods:
Periods: December,
December, March,
March,
3-36

September?
September?
This is a choice as long as you are consistent.
 Walt Disney: September
 Walmart: January

 JC Penney: January

WHY? What is the reason?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-37

Revenue
Revenue and
and Expenses
Expenses
The price for
goods sold
and services Increases
rendered during a owner’s equity.
given accounting
period.

The costs of
goods and Decreases
services used up owner’s equity.
in the process of
earning revenue.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 The
The Realization
Realization Principle:
Principle: When
When To
To
3-38

Record
Record Revenue
Revenue

Realization Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.
Check: CASH Effects p. 101
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 The
The Matching
Matching Principle:
Principle: When
When To
To
3-39

Record
Record Expenses
Expenses

Matching Principle
Expenses should be
recorded in the
period in which they
are used up.
Check: CASH Effects p. 101

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Debits
Debits and
and Credits
Credits for
for Revenue
Revenue and
and
3-40

Expense
Expense

Expenses EQUITIES Revenues

decrease Debit Credit increase
owner’s for for owner’s
equity. Decrease Increase equity.

EXPENSES REVENUES
Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-41

Investments
Investments by
by and
and Payments
Payments to
to Owners
Owners
Payments to Owners’
EQUITIES
owners investments
decrease Debit Credit increase
for for
owners’ Decrease Increase owners’
equity. equity.

DIVIDENDS CAPITAL STOCK

Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-42

Let’s
Let’s analyze
analyze thethe
revenue
revenue and
and
expense
expense
transactions
transactions forfor
JJ’s
JJ’s Lawn
Lawn Care
Care
Service
Service for
for the
the
month
month of
of May.
May.
We
We will
will also
also
analyze
analyze aa dividend
dividend
transaction.
transaction.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
  May
May 29:
29: JJ’s
JJ’s provided
provided lawn
lawn care
care services
services for
for
3-43

aa client
client and
and received
received $750
$750 in
in cash.
cash.

Will Sales Revenue

Will Cash increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

  May
May 29:
29: JJ’s
JJ’s provided
provided lawn
lawn care
care services
services for
for
3-44

aa client
client and
and received
received $750
$750 in
in cash.
cash.

Sales Revenue
Cash increases
increases $750 with
$750 with a debit.
a credit.

Cash Sales Revenue

5/1 8,000 5/2 2,500 5/29 750
5/29 750 5/8 2,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 
 May
May 31:
31: JJ’s
JJ’s purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
3-45

mower
mower and
and the
the truck
truck for
for $50
$50 cash.
cash.

Will Gasoline
Will Cash increase
Expense increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 
 May
May 31:
31: JJ’s
JJ’s purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
3-46

mower
mower and
and the
the truck
truck for
for $50
$50 cash.
cash.

Gasoline Expense
Cash decreases $50
increases $50 with a
with a credit.
debit.

Cash Gasoline Expense

5/1 8,000 5/2 2,500 5/31 50
5/29 750 5/8 2,000
5/31 50

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 
 May
May 31:
31: JJ’s
JJ’s Lawn
Lawn Care
Care paid
paid Jill
Jill Jones
Jones and
and
3-47

her
her family
family aa $200
$200 dividend.
dividend.

Will Dividends
Will Cash increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 
 May
May 31:
31: JJ’s
JJ’s Lawn
Lawn Care
Care paid
paid Jill
Jill Jones
Jones and
and
3-48

her
her family
family aa $200
$200 dividend.
dividend.

Cash decreases Dividends increase

$200 with a credit. $200 with a debit.

Cash Dividends
5/1 8,000 5/2 2,500 5/31 200
5/29 750 5/8 2,000
5/31 50
5/31 200

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-49

Now,
Now, let’s
let’s look
look at
at
the
the Trial
Trial Balance
Balance
for
for JJ’s
JJ’s Lawn
Lawn CareCare
Service
Service for
for the
the
month
month ofof May.
May.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 3-50

All balances
JJ's Lawn Care Service
are taken from
Unadjusted Trial Balance
May 31, 2005
the ledger
Cash $ 3,925 accounts on
Accounts receivable 75 May 31 after
Tools & equipment 2,650 considering all
Truck 15,000 of JJ’s
Notes payable $ 13,000 transactions
Accounts payable 150 for the month.
Capital stock 8,000
Dividends 200 Proves equality
Sales revenue 750 of debits and
Gasoline expense 50 credits.
Total $ 21,900 $ 21,900
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 The Accounting Cycle
3-51

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Prepare after-closing Journalize and Prepare Prepare adjusted

trial balance. post closing financial trial balance.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
entries. statements.