Chapter 2 Lecture Presentation PDF

Recording Business Transactions  Objective To provide financial information that is useful to existing investors, lenders, and other creditors in making decisions about providing resources to that entity Fundamental Qualitative...

Recording Business Transactions  Objective To provide financial information that is useful to existing investors, lenders, and other creditors in making decisions about providing resources to that entity Fundamental Qualitative Relevance Faithful representation Characteristics (includes materiality) Comparability Verifiability Timeliness Understandability Enhancing Qualitative Characteristics Constraints Cost Financial Reporting Standards Copyright © 2015 Pearson Canada Inc. Fundamental Qualitative Characteristics  Relevance- Can make a difference  Predictive Value  Confirmatory Value  Materiality  Faithful Representation- Reliability  Complete  Neutral  Free from Error Recognition and Measurement Criteria- Assumptions  Separate Entity assumption  A business is a separate economic unit  Continuity (going- concern) assumption  Entity will continue to exist indefinitely  Historical cost assumption  Assets recorded at purchase price  Stable monetary unit assumption  Dollar’s purchasing power is stable over time  Accounting Information System Inputs Processing Outputs Accounting IFRS Financial Reports Transactions Concepts Income Statement Renting (O) Principles Statement of RE Buying (I, O) Methods Balance Sheet Selling (I, O) Assumptions Statement of Cash Borrowing (F) Guidelines Flows Recognition Measurement Disclosure (Identification) (Valuation) (Reporting)  The Accounting Cycle Business Activities(Buying, Selling, Hiring, Firing, etc…) Has the financial position changed? Can we measure it in dollars? Yes, Proceed No, Stop Transaction Analysis Journalizing: Record the transactions in journal entries The Accounting Cycle- Cont. Journalizing Posting journal entries to the Ledger Trial Balance End of period adjusting entries Adjusted Trial Balance The Accounting Cycle- Cont. Preparing Financial Statements Closing Entries Post-Closing Trial Balance  Transaction Analysis: Business Transactions vs. Accounting Transactions  Business transactions that affect the accounting equation are accounting transactions. Are these Accounting Transactions:  Purchase of equipment for cash?  Hiring or firing employees?  Sale of merchandise on account?  Signing a sales contract?  Transaction Analysis Assets = Liabilities + Shareholders Equity Three steps 1. Determine affected accounts, and classify them (at least two accounts should be affected)  Revenues and gains affect RE positively  Expenses, losses, and dividends affect RE negatively 2. Determine the amount of change on each affected account 3. Determine the direction of the change for each account The accounting equation must be balanced after analyzing each transaction  Transaction Analysis: Examples  Purchase of equipment for $50,000 cash  Affected accounts Equipment - Assets  Increase $50,000 Cash - Assets  Decrease $50,000 Assets = Liabilities + Shareholders equity +50,000 – 50,000 = 0 + 0 0=0  Transaction Analysis: Examples  Provided services for $3,000. Customers paid $2,000 and the remaining balance is due in 30 days  Affected accounts Service revenue – RE  Shareholders’ equity  Increase $3,000 Cash - Assets  Increase $2,000 Accounts Receivable (A/R)- Assets  Increase $1,000 Assets = Liabilities + Shareholders equity + 2,000 + 1,000 = 0 + 3,000  Journalizing Transactions  Daily record of accounting transactions  Debit and credit rules  Debits reflect Increases in assets Recording expenses, losses and declared dividends Decreases in liabilities and shareholders equity  Credits reflect Decreases in assets Recording revenues and gains Increases in liabilities and shareholders equity  Understanding Debit and Credit Rules Assets = Liabilities + SE Assets = Liabilities + (Capital + RE) Assets = Liabilities + (Capital + Beg RE + NI - Dividends) Assets = Liabilities + (Capital + Beg RE + Rev – Exp. – Div.) Assets + Exp. + Div.= Liabilities + (Capital + Beg RE + Rev) Left is Debit and Right is Credit (By Definition!!), Thus Accounts on the left: Increase is Debit and Decrease is Credit Accounts on the right: Increase is Credit and Decrease is Debit  Journalizing- An example  Purchase of equipment for $50,000 cash  Affected accounts Equipment - Assets  Increase $50,000 Cash - Assets  Decrease $50,000  Equipment is an asset that increased  Debit  Cash is an asset that decreased  Credit Journal Entry Dr. Equipment 50,000 Cr. Cash 50,000  Journalizing- An example  Provided services for $3,000. Customers paid $2,000 and the remaining balance is due in 30 days  Affected accounts Service revenue – RE  Shareholders’ equity  Increase $3,000 Cash - Assets  Increase $2,000 Accounts Receivable (A/R)- Assets  Increase $1,000  Service revenue  Credit  Cash is an asset that increased  Debit  A/R in an asset that increased  Debit Journal Entry Dr. Cash 2,000 Dr. A/R 1,000 Cr. Service Revenue 3,000  Posting to the Ledger  Ledger: A book that has a separate page for each account. Each account has a debit and a credit side  The ledger keeps the balances of all the accounts  T-Accounts Dr. Account Cr.  Posting to Ledger- Example Post the following entry: March 31 Dr. Equipment 50,000 Cr. Cash 50,000 Dr. Cash Cr. Dr. Equipment Cr. 3/31 50,000 3/31 50,000  Trial Balance  Trial balance is a list of all accounts and their balances at a given time (typically at the end of the accounting period).  The only guarantee of a balanced trial balance is that debits equal credits  Error detection techniques  Trial Balance- Example Account Debit Credit Cash 13,950 A/R 4,500 Office Supplies 2,200 Equipment 7,500 A/P 7,500 Common Shares 20,000 Revenue 7,800 Utilities Expense 350 Advertising Expense 400 Wages Expense 6,400 Total 35,300 35,300  Income Statement  Measures the results of operations  Net income = revenues – expenses  Net income is an estimate. True income can be measured only when business is liquidated  Investors cannot wait for business liquidation to learn about true income  Conceptual Framework and Income Statement  The following assumption apply  Going-concern  Time period (periodicity)  The following principles apply  Revenue recognition  Matching  Cash basis vs. Accrual basis  Cash basis recognizes revenues and expenses when cash is either received or paid  Accrual basis recognizes the impact of revenue generating activities on the financial statements in the time periods when revenues and expenses accrue.  Cash basis vs. Accrual basis  Cash basis violates the Revenue Recognition and Matching Principles  Only accrual basis is accepted in accounting.  The Revenue Recognition Principle Recognize revenues when...  The service has been performed or the title of the goods have been transferred to the buyer.  Risk and reward has been transferred to the buyer.  The amount is known.  Collection is reasonably assured.  The Matching Principle Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid. Expenses are recognized when incurred, not when paid.  Revenue and Matching Principles Illustrated Green is for Seller, Red is for Buyer Services Provided or Received? Yes No Cash Cash received or paid in advance? Cash Service Revenue Unearned Revenue Yes Expense Prepaid Expense Cash Cash (Not an Accrual or Prepayment) (Prepayments or Deferrals) Accounts Receivable (A/R) Service Revenue Expense No Not a transaction Accounts Payable (A/P) (or another liability) (Accruals)  Revenue and Matching Principles Illustrated Green is for Seller, Red is for Buyer Services Provided or Received? Yes No Cash Asset inc Cash received or paid in advance? Cash Asset inc Service Revenue SE inc Unearned Revenue Yes Liability inc Expense SE dec Prepaid Expense Asset inc Cash Asset dec Cash Asset dec (Not an Accrual or Prepayment) (Prepayments or Deferrals) Accounts Receivable (A/R) Asset inc Service Revenue SE inc Expense SE dec No Not a transaction Accounts Payable (A/P) (or another liability) Liability Inc (Accruals) End Chapter 2