CHAPTER 2

Accounting Methods for Measuring Performance

CASH BASIS OF ACCOUNTING VS

ACCRUAL BASIS OF ACCOUNTING

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Accounting Methods for Measuring Performance

(a) Cash basis of accounting
Revenues are recognized when cash is received and expenses are recognized when cash is paid

(b) Accrual basis of accounting

Revenues and expenses are recognized on an economic basis regardless of when cash is paid or received

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Success Service Corporation - Dry Cleaning Company

TL 3.000 bank loan in January 2007- loan due 30 June 2007- monthly interest expense of TL 100. Paid two months rent on 1 January 2007 total TL 200 Paid insurance premium of TL 120 to cover the whole year from January 1 to December 31 Purchased supplies of TL 90 to be used for 3 months and paid TL 75 of it; agreed to pay the rest in February In January-provided TL 750 worth of services and collected cash of TL 500 from customers; the rest would be collected next month Paid salaries of TL 500 at the end of January
Chapter 2 Mugan-Akman 2007 4-52

SUCCESS SERVICE CORPORATION Measurement of Performance on Cash Basis For the Period Ending 31 January 2007 Cash Receipts from Services Rendered Less: Cash Expenditures for Supplies Salaries Rent Insurance Total Cash Expenditures Excess of Cash Expenditures over Cash Receipts
Chapter 2 Mugan-Akman 2007

TL 500

75 500 200 120 895

TL -395
5-52

Accounting Methods for Measuring Performance

(a) Cash basis of accounting
Revenues are recognized when cash is received and expenses are recognized when cash is paid

(b) Accrual basis of accounting

Revenues and expenses are recognized on an economic basis regardless of when cash is paid or received

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SUCCESS SERVICE Income Statement For the Month Ended 31 January Revenues: Dry Cleaning Fees 750 Expenses: Salaries Interest Rent Expense Supplies Insurance Expenses Total Expenses Net Income Before Taxes
Chapter 2 Mugan-Akman 2007

500 100 100 30 10 740 TL 10

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Recognition of Revenues
Sales order 3 Ma Shipment of the goods 5 Ma

MILLENIUM CO.

Receipt of the computer 6 Ma

Receipt of the bill 7 Ma

Pa ment of the bill 20 Ma

CUSTOMER

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Recognition of Service Revenues

Accrual basis of accounting generally requires that revenues be recognized when both of the following conditions are met: A company has performed all (or the major part of) the services, or has delivered the goods; i.e., when there is little or no uncertainty regarding the exchange of goods or services, and The price of the services or goods has been accepted by both seller and buyer, and seller has received either cash or some other form of asset, enabling reasonable determination of the time of payment (such as accounts receivable, which is the buyers promise to pay)
Chapter 2 Mugan-Akman 2007 9-52

Recognition of Expenses
Expenses are recognized when they are incurred and helped to produce revenue, regardless of the cash payment date

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Generally Accepted Accounting Principles and Concepts

Entity - Every entity is a separate economic unit and should be kept distinct from the activities of its owners and other companies Monetary Unit - only economic events that have monetary transactions will be reported in the financial statements Cost Principle - assets are presented at their original (historical) cost Going Concern - companies are established with the goal that they will operate for an indefinitely long period of time Periodicity - economic activities of any firm can be divided into discrete time periods for reporting purposes Matching Principle -all revenues must be recorded in the accounting period in which the goods are sold or services are rendered and all expenses must be recorded in the accounting period in which they are incurred to produce such revenues
Chapter 2 Mugan-Akman 2007 11-52

Accounting Cycle
Post the transactions and prepare trial balance Adjust the accounts and prepare trial balance

Analyze and record the transactions

Prepare the financial statements

Chapter 2

Close the accounts and prepare trial balance

Mugan-Akman 2007 12-52

Analysis and Recording Business Transactions

Business transaction is an economic event that causes a change in the financial position Financial Position:
What we own How we own

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Fundamental Accounting Equation

ASSETS = EQUITIES

ASSETS = LIABILITIES + OWNERS' EQUITY

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How do we use the balance sheet equation?

Recall the Balance Sheet Equation: Assets = Liabilities + Shareholders Equity Implications: If assets increase : either Liabilities and/or Shareholders should also increase and vice versa For example: borrow cash, cash (asset) will increase and Liabilities will increase when it is paid back: cash (asset) will decrease and liabilities will decrease
Chapter 2 Mugan-Akman 2007 15-52

How do we record?
an ACCOUNT: accounting report of a specific asset, liability or owners equity item Has 3 elements: title, debit side and credit side (also called the T-Account) Changes in the accounts are entered manually into a book called a ledger computerized Basic forms of book ledgers: the two-column account format, and the four-column account format Chart of accounts
Chapter 2 Mugan-Akman 2007 16-52

Forms of Ledgers
Two-Column Account
Account Account No: Date Item t. Ref. * Debit Date Item ting Reference Credit

T-Account form that depicts the two-column account:

Account Name Account No:

Left-hand or
Debit Side

Right-hand or
Credit Side

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How do accounts behave?

Assets = Liabilities + Shareholders Equity + + + So Assets increase on the left hand or debit side then they decrease on the credit side Assets + debit credit
Chapter 2 Mugan-Akman 2007 18-52

Behavior of Accounts
Liabilities and Owners Equity accounts increase on the credit side, decrease on the debit side Liabilities or Owners Equity Accounts debit
Chapter 2 Mugan-Akman 2007

+ credit
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Transaction Analysis and The Duality Concept

if an asset account increases, because of duality concept there must be a corresponding 1. increase in a specific liability account 2. or a decrease in a another asset account 3. or an increase in owners' equity account.
Chapter 2 Mugan-Akman 2007 20-52

Illustration of Express Travel Agency

1. Ms. Fodor invested TL100.000 at the inception

Event Assets Liabilities Owners No Equity 1 +100.000 No change +100.000 Total 100.000 0 100.000
GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit 1 Jan 20 Cash Capital Investment by the shareholders
Chapter 2 Mugan-Akman 2007 21-52

Credit 100.000

100 100.000 500

2. On 1 January employed a full time secretary and a

sales representative.

Event No

Total

Assets Liabilities Owners Equity 1 +100.000 No change +100.000 2 No change No change No change 100.000 0 100.000

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3. On 1 January rented an office building and paid 3 months rent of TL 600.

Event ets 1 +100.000 2 No 3 +600 -600 . Liabilities Owners Equity No +100.000 No No No No No No .

Total

ENERAL OURNAL age ate Account Title and escription Acct.No. 1J 20 Prepaid Rent ash Payment of 3 months of rent in advance
Chapter 2 Mugan-Akman 2007

ebit 600

redit 600

180 100

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4. On 2 January office furniture and equipment is purchased for TL 15.000 , for which TL 5.000 is paid in cash and the rest would be paid later in January and February 2007.
Event o 1 2 3 4 otal ssets Lia ilities Owners Equit +100.000 No cha e +100.000 No cha e No cha e No cha e +600 No cha e No cha e 600 No cha e No cha e +15.000 +10.000 No cha e 5.000 110.000 10.000 100.000 Page 1 escription Acct.No 100 320 ebit redit 5.000 10000
24-52

GENERAL JOURNAL ate Account Title an 2 Ja 20 itu e a Fu Equipme t

255 15.000

Ca h Accou t Payab e Pu cha e of fu itu e a equipme t

Chapter 2 Mugan-Akman 2007

5. On 3 January insured the office building and the equipment effective from 1 January to 31 December 2007 and paid TL 120 for the whole period.
Event No 1 2 3 4 5 Total Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 110.000 10.000 100.000

GENERAL JOURNAL 3 Jan 20 Prepai Insurance

Page 1 Credit 120

25-52

Date Account Title and Description Acct.No. Debit 180 100 120 Cash Purchase of insurance policy
Chapter 2 Mugan-Akman 2007

6. On 5 January the company agreed with Turkish Airlines to sell airline tickets of THY and receive commissions in return.
Even 1 2 3 4 5 6 Total A ets Li bilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change 110.000 10.000 100.000

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7. On 10 January Express Travel Agency borrowed TL 15.000 from the bank at an annual interest rate of 24% for six months. The principal and the interest of the loan will be paid together on 10 July 2007. Eve o 1 2 3 4 5 6 To al
Chapter 2

A e +100 000 o ha ge +600 600 +15 000 5 000 +120 120 No ha ge +15 000 125 000

Lia ili ie o ha ge No ha ge No ha ge No ha ge +10 000 No ha ge No ha ge +15 000 25 000

w er Equi y +100 000 No ha ge No ha ge No ha ge No ha ge No ha ge No ha ge No ha ge 100 000

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Mugan-Akman 2007

7. On 10 January Express Travel Agency borrowed TL 15.000 from the bank at an annual interest rate of 24% for six months. The principal and the interest of the loan will be paid together on 10 July 2007.

G N RA 10 Ja 20 Cash

OURNA

e Credi 15.000 100 15.000 00

D e Acc un

i le nd Descrip i n Acc N . Debi

Ba k Loa Borro ng from the ba k

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8. On 10 January purchased office supplies for TL 2.500 in cash.

Event 1 2 ets Li ilities Owners Equity +100.000 No a e +100.000 No a e No a e No a e +600 No a e No a e 600 No a e No a e +15.000 +10.000 No a e 5.000 +120 No a e No a e 120 No a e No a e No a e +15.000 +15.000 No a e No a e +2.500 No a e 2.500 5 5
Mugan-Akman 2007 29-52

5 6 7 8 Total
Chapter 2

8. On 10 January purchased office supplies for TL 2.500 in cash.

GENER L O RN L te cc t Title 10 Ja 20 Office Supplies Cas Purchase of office supplies

e e cri ti cct.N . 136 100 ebit 2.500 2.500 redit

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9. During the first half of January the agency sold tickets to various customers and on 16 January issued a commission invoice to THY amounting to TL 5.000 that will be collected later in January 2007. Event No A et iabilitie ner Equity 1 +100.000 No c +100.000 2 No c No c No c +600 No c No c 600 No c No c +15.000 +10.000 No c 5.000 5 +120 No c No c 120 6 No c No c No c +15.000 +15.000 No c +2.500 No c No c 2.500 9 +5.000 No c +5.000 otal 130.000 25.000 105.000
Chapter 2 Mugan-Akman 2007 31-52

9. During the first half of January the agency sold tickets to various customers and on 16 January issued a commission invoice to THY amounting to TL 5.000 that will be collected later in January 2007.
Revenue A unts et r e t S e ght r Cre t S e e rea e Incr

GENERAL JOURNAL 16 Jan 20 Account Recei able

Page 1 Credit 5.000 120 5.000

Date Account Title and Description Acct.No. Debit Commi ion Revenue 600 Recognition of commi ion on ticket sales

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10. On 20 January the company paid TL 5.000 for the furniture and equipment that were purchased on 2 January. Event N A et Li ilitie O ner Equit 1 +100.000 No change +100.000 2 No change No change No change +600 No change No change 600 No change No change +15.000 +10.000 No change 5.000 5 +120 No change No change 120 6 No change No change No change +15.000 +15.000 No change +2.500 No change No change 2.500 9 +5.000 No change +5.000 10 -5000 -5000 No change T t l 125. 20.000 105.000
Chapter 2 Mugan-Akman 2007 33-52

10. On 20 January the company paid TL 5.000 for the furniture and equipment that were purchased on 2 January.

GENERAL JOURNAL 20 J 20 Accounts Payable

1 Credit 5.000 320 00 5.000

Date Account Title and Description Acct.No. Debit Cas Payment for an accounts payable

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11. On 22 January received TL 7.500 from a customer for organizing the accounting conference that will be held on February 2, 2007. sse s Eve o ia ili ies ners Eq i
1 2 3 4 5 6 +100.000 o cha ge +600 600 +15.000 5.000 +120 120 No cha ge +15.000 +2.500 2.500 +5.000 -5.000 +7.500 132.500 o cha ge No cha ge No cha ge No cha ge +10.000 No cha ge No cha ge +15.000 No cha ge No cha ge -5.000 +7.500 27.500 +100.000 No cha ge No cha ge No cha ge No cha ge No cha ge No cha ge No cha ge No cha ge +5.000 No cha ge No cha ge 105.000
35-52

9 10 11 T al
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Mugan-Akman 2007

11. On 22 January the company received TL 7.500 from a customer for organizing the accounting conference that will be held on 2 February 2007.

GENERAL 22 Jan 20 Cas

RNAL nd cri tion Acct.No. 00 ma 0 stome it 7. 00 7. 00 redit

Account itl

Unea ned Reven es Re e t advan e ayment

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12. The company received the full payment of commission charged to THY of TL 5.000 on 23 January.
Event No 1 Assets Liabilities Owners Equity +100.000 No No No No change change change change +100.000 No change No change No change No change +10.000 No change No change +15.000 No change No change -5.000 +7.500 No change 27.500

Total
Chapter 2

2 No change +600 3 -600 4 +15.000 -5.000 5 +120 -120 6 No change 7 +15.000 8 +2.500 -2.500 9 +5.000 10 -5.000 11 +7.500 12 +5.000 -5.000 132.500

No change No change No change No change +5.000 No change No change No change 105.000

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Mugan-Akman 2007

12. The company received the full payment of commission charged to THY of TL 5.000 on 23 January.

GENER L O RN L te cc t Title 23 Ja 20 Cash

e cct.N . 100 120 ebit 5.000 5.000 redit

d e cri ti

Accou ts ecei able eceipt of payme t from a customer

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13. On 24 January paid salaries of TL 9.000 employees in cash.

Eve t 7

ssets +15.000 +2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 -9.000 1 3 00

Lia ilities +15.000 No c a e No c a e -5.000 +7.500 No c a e No c a e 7 00

ers Eq it No c a No c a e e

9 10 11 12 13 T tal
Chapter 2

+5.000 No c a e No c a e No c a e -9.000 9 000

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Mugan-Akman 2007

13. On 24 January paid salaries of TL 9.000 employees in cash.

pen e Account Le t or eb t de ght or Cred t I c ease De ea e

de

GENER Dat 24 J

J URNAL

Pag D bit 9.000 9.000 Credit 770 100

Account itl and D scription Acct.No. 20 l ry Exp S P y sh t of s l ri s

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14. During the second half of January the agency sold tickets to various customers and on 31 January issued a commission invoice to THY amounting to TL 7.500 which will be collected in February 2007.

Event No Assets 8 9 10 11 12 13 14 Total

Liabilities Owners Equity No change No change -5.000 +7.500 No change No change No change 27.500 No change

+2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 -9.000 +7.500 131.000

+5.000 No change No change No change -9.000 +7.500 103.500

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Chapter 2

Mugan-Akman 2007

14. During the second half of January the agency sold tickets to various customers and on 31 January issued a commission invoice to THY amounting to TL 7.500 which will be collected in February 2007.
GENERAL JO RNAL ate Acco nt Title an 31 Ja 20 Accou ts Recei able age 1 escri tion Acct N Debit 120 7.500 7.500 Cre it

600 Commission Re enues Recognition of commission on ticket sales

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15. Ms. Fodor withdrew TL 3.000 on 31 January for personal use.

Event o 7 8 9 10 11 12 13 14 15 otal
Chapter 2

et +15. +2.500 -2.500 +5. -5. +7.500 +5. -5. -9. +7.500 -3. 128.

ia ilities Owners Equity +15. No ang ang -5. +7.500 No ang No No No No ang ang ang 27. o No ang ang +5. ang ang ang -9. +7.500 -3. 100. 00
43-52

No No No

Mugan-Akman 2007

15. Ms. Fodor withdrew TL 3.000 on 31 January for personal use.

ner ' Withdrawal or Di idend Le t or Deb t de ght or Cred t de I c ease Decrea e

GENER at 31 J n 20 Wit Wit

J URNAL w l C w l by t

Pag 1 scri tio Acct.No. XXX 600 owner it 3.000 3.000 redit

Acco t itl a

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Summary
1. determine the effects of transactions on three components of the accounting equation, 2. determine which specific accounts are affected, and 3. assure that total of the increases should be equal to either increases on the other side of the equation or to decreases on the same side, or a combination there of.
Chapter 2 Mugan-Akman 2007 45-52

Behavior Summary
Assets = + Dr Cr Liabilities + + Dr Cr Owners Equity + Dr Cr Expense Revenue + + Dr Cr Dr Cr Withdrawals/Dividends + Dr Cr
Chapter 2 Mugan-Akman 2007 46-52

Accounting Cycle
Analyze and record the transactions Adjust the accounts and prepare trial balance

Post the transactions and prepare trial balance

Prepare the financial statements

Close the accounts and prepare trial balance

Mugan-Akman 2007 47-52

Chapter 2

Posting to The Ledger

GE ER L O R il 1 it l Invest ent
LED ER - C h Date Desc ption 1 an Invest ent 0
LED ER - Capital Date Desc iption 1 an Invest ent 0
Chapter 2

P s i i

. 00

i 100.000

100 100.000 t e shareholders

cc. Ref Debit .

C edit Debit C edit Balance Balance the shareholders P 1 100.000 100.000

cc. Ref Debit o. 5 C edit 100.000 Debit C edit Balance Balance 100.000
48-52

the shareholders P 1
Mugan-Akman 2007

LED E - Cash Da 1 Jan 1 Jan 2 Jan 3 Jan 10 Jan 10 Jan 20 Jan 22 Jan 23 Jan 24 Jan 31 Jan D s ip i

. 100 f D bi P 1 100.000 P1 P1 P1 P 1 15.000 P1 P1 P1 7.500 P1 5.000 P1 P1 C i D bi Bala 100.000 600 99.400 5.000 94.400 120 94.280 109.280 2.500 106.780 5.000 101.780 109.280 114.280 9.000 105.280 3.000 102.280

Investment by the shareholders Payment of off e rent P rchase of off ce f rniture and equipment Payment of insurance Borrowing from the bank Purchase of office supplies Payment for an accounts payable Receipt of advance payment from a customer Receipt of payment from a customer Payment of salaries Withdrawal by the owner

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Trial Balance
Express Travel Agency Trial Balance 31 January 2007 in TL Accounts Debit Credit Cash 102.280 Accounts Receivable 7.500 Office Supplies 2.500 Prepaid Rent 600 Prepaid Insurance 120 Office Furniture and Equipment 15.000 Bank Loan 15.000 Accounts Payable 5.000 Unearned Revenues 7.500 Capital 100.000 Withdrawal 3.000 Commission Revenues 12.500 Salary Expenses 9.000 Total 140.000 140.000
Chapter 2 Mugan-Akman 2007 50-52

Normal Balances of Accounts

Category of the Account Increase Recorded By Debits Credits Normal Balance Assets Liabilities Shareholders Equity Capital Dividends or Withdrawals Revenues Expenses Credits Debits Credits Debits Credit Debit Credit Debit Debit Credit

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Chapter 2

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