Chapter 2

Posting Transaction Effects

Posting involves the moving of the accounting information from the general journal to the general ledger. Remember that the general ledger shows the balance for each account in the chart of accounts. In the manual accounting system used by some small organizations, the ledger is often a three-ring binder with a separate page for each account. In a computerized system, accounts are stored on a disk. The posting process was tedious when done by hand, but is very quickly completed when done with the aid of a computer.

Principes of Transactional Analysis

1. Every transaction affects at least 2 accounts (duality of effects) 2. The accounting equation must remain in balance after each transaction

Nature of Business Transactions (exchange of goods and services)

1. External events- exchanges between entity and one of more parties (purchase of a machine from a supplier) 2. Internal events- events that are not exchanges between parties but have a direct and measurable effect on that entity (using up insurance paid in advance) ADJUSTING ENTRIES. IT AFFECTS THE INCOME STATEMENT AND BALANCE SHEET

To understand amounts appearing on a company's balance sheet we need to ask:

1. What business activities caused changes in the balance sheet? 2. How do specific activities affect each balance? 3. How do companies keep track of balance sheet amounts?

Trial Balance

A listing of all accounts in the general ledger. The purpose is to make sure the debits and credits are equal before we prepare the balance sheet.

Accounts

An organized format used by companies to accumulate the dollar effects of transactions

Classified Balance Sheet

Assets and liabilities are classified into two categories - current and noncurrent. Current assets are those to be used or turned into cash within the upcoming year (cash and accounts receivable, listed the top), whereas noncurrent assets are those that will last longer than one year (property, plant, & equipment). Current liabilities are those obligations to be paid or settled within the next 12 months with current assets. (unearned fees) Mortgage Payable is partially a current liability, partially a concurrent liability

Recognition and Measurement Concepts

Assumptions: 1. Separate-entity assumption- states that each business's activities must be accounted for separately from the activities of its owners, all other persons, and other entities. 2. Continuity assumption (sometimes called the going-concern assumption )- unless there is evidence to the contrary, we assume that the business will continue operating into the foreseeable future, long enough to meet its contractual commitments and plans. 3. Stable monetary unit assumption- each business entity accounts for and reports its financial results primarily in terms of the national monetary unit without any adjustment for changes in purchasing power (e.g., inflation).

Qualitative Characteristics of Useful Information

For accounting information to be useful, it must be relevant and be a faithful representation. Relevant information is capable of influencing decisions by allowing users to assess past activities and/or predict future activities. To be reported, the information should also be material in amount depending on the nature of the item and company. Key Factors that influence the usefulness of information that is relevant and faithful representation: 1. Comparability 2. Verifiability 3. Timeliness

Journal Entries

For the typical general journal entries the debited accounts are written first with the amounts placed in the column labeled "Debit". The credited accounts are written below the debits and are usually indented in a manual system and the amounts placed in the column labeled "Credit". It is useful to include a date or some form of reference for each transaction.

Nature of Business Transactions Continued

Most transactions with external parties involve exchanges where the business entity gives up something and receives something in return. Accounting focuses on certain events that have an economic impact on the entity. Those events that are recorded as part of the accounting process are called transactions. AS THE DEFINITIONS OF ASSETS AND LIABILITIES INDICATE, ONLY ECONOMIC RESOURCES AND DEBTS RESULTING FROM PAST TRANSACTIONS ARE RECORDED ON THE BALANCE SHEET.

Focus on Cash Flows

Companies report cash inflows and outflows over a period in their statement of cash flows. This statement categorizes all transactions that affect cash into three categories: operating, investing, and financing activities. Operating activities are covered in Chapter 3. Investing activities include buying and selling noncurrent assets and investments. Financing activities include borrowing and repaying debt including short-term bank loans, issuing and repurchasing stock, and paying dividends. When cash is involved, these activities are reported on the Statement of Cash Flows. (When cash is not included in the transaction, such as when a building is acquired with a long-term mortgage note payable, there is no cash effect to include on the statement of cash flows. You must see cash in the transaction for it to affect the Statement of Cash Flows.)

Current Ratio

Current assets/current liabilities Users of financial information compute a number of ratios in analyzing a company's past performance and financial condition as input in predicting its future potential. How ratios change over time and how they compare to the ratios of the company's competitors or industry averages provide valuable information about a company's strategies for its operating, investing, and financing activities. Creditors and security analysts use the current ratio to measure the ability of the company to pay its short-term obligations with short-term assets. Generally, the higher the ratio, the more cushion a company has to pay its current obligations if future economic conditions take a downturn. However, a company with a high current ratio might still have liquidity problems if the majority of its current assets consist of slow-moving inventory. The primary causes for the overall decrease were a decrease in inventories (a current asset) and an increase in debt due in the current period (a current liability) for stock repurchases and restaurant acquisitions as part of its growth strategy. In some cases, analysts would be concerned about both the level and trend, but the situation is understandable when considering the nature of the business.

The Accounting Cycle

During the Period: 1. Analyze transactions 2. Record journal entries in the general journal 3. Post amounts to the general ledger

How do companies keep track of account balances?

During the accounting period, transactions that result in exchanges between the company and other external parties are analyzed and recorded in the general journal in chronological order, and the related accounts are updated in the general ledger. These formal records are based on two very important tools used by accountants: journal entries and T-accounts. From the standpoint of accounting systems design, these analytical tools are a more efficient way to reflect the effects of transactions, determine account balances, and prepare financial statements.

Balance Sheet

The balance sheet is a "snap shot" at any given point in time of the company's assets, liabilities, and stockholders' equity. Balance sheets may be prepared monthly, quarterly, or annually. Most companies list assets in order of liquidity, or how soon an asset is expected by management to be turned into cash or used. Note that inventory is always considered a current asset, regardless of how long it takes to produce and sell the inventory. Just as assets are reported in order of liquidity, liabilities are usually listed on the balance sheet in order of maturity (how soon an obligation is to be paid). Current liabilities are obligations that will be settled by providing cash, goods, or services within the coming year. Owner-provided cash (and sometimes other assets) is referred to as contributed capital. Contributed capital (financing provided by owners) is usually composed of Common Stock and Additional Paid-in Capital. Owners who invest (or buy stock) in a company hope to benefit from their investment in two ways: receipts of dividends, which are a distribution of a company's earnings (a return on the shareholders' investment), and gains from selling the stock for more than they paid (known as capital gains). Earnings that are not distributed to the owners but instead are reinvested in the business by management are called retained earnings.

Transactional Analysis

The process of studying a transaction to determine its economic effect on the entity in terms of the accounting equation (also known as the fundamental accounting model).

Transactional Analysis Model

The three parts of a T- Account are title, debit, and credit Throughout this course we are going to use the T-account as a tool to represent a ledger account. "T-account" is merely a shorthand term for the entire ledger account. The T-account has a left side, called the debit side, and a right side, called the credit side. As we saw earlier, transaction effects increase and decrease assets, liabilities, and stockholders' equity. To reflect the direction of these effects efficiently, we need to structure the transaction analysis model. The increase symbol + is located on the left side of the T for accounts on the left side of the accounting equation (assets) and on the right side of the T for accounts on the right side of the equation (liabilities and stockholders' equity). From this transaction analysis model, we can observe the following: Asset accounts increase on the left (debit) side; they have debit balances. It would be highly unusual for an asset account, such as Inventory, to have a negative (credit) balance. Liability and stockholders' equity accounts increase on the right (credit) side, creating credit balances. The words debit and credit have no specific meaning other than that they represent a left and right side of the ledger account.

Chart of Accounts

To facilitate the recording of transactions, each company establishes a chart of accounts, a list of all account titles and their unique numbers. The accounts are usually organized by financial statement element, with asset accounts listed first, followed by liability, stockholders' equity, revenue, and expense accounts in that order. Every company creates its own chart of accounts to fit the nature of its business activities.