Financial accounting 1.Chapter 4, Apuntes de Contabilidad Financiera

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CHAPTER 4:

Book-keeping

© Ediciones Pirámide BEYOND FIGURES: Introduction to Financial Accounting

CAMACHO-MIÑANO, M.M.; AKPINAR, M.; RIVERO- MENÉNDEZ, M.J.; URQUIA.GRANDE, E. and ESKOLA, A. (2012).

MOTIVATION OF THE CHAPTER 4

© Ediciones Pirámide BEYOND FIGURES: Introduction to Financial Accounting

THE ACCOUNTING PROCESS

Business

Transactions

Other

(internal)

events

Analyzing

economic

events

Recording

their effects

Financial

statements

and other

reports

presented

to

economic

decisions

makers

Economic events

*“Fundamental Accounting principles”, LARSON, K.D. and MILLER, P.B. 1993, PAG. 77.

Index

4.1. Accounting books.

4.2. How the accounts work.

4.3. Double-entry bookkeeping system: debit and credit rules.

4.4. Basic accounting logic.

4.5. Adjustments.

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Example of JOURNAL

The form of GENERAL JOURNAL or JOURNAL :

There is no single standard form of Journal. Each entry has to be organized according to its date (chronologically).

TRADITIONAL FORM: Date (Oct. 1)

AMERICAN FORM:

Date Accounting elements Debit Credit

Oct. 1 Wages 5, Cash 5,

D Amount D element C element C Amount

5,000 Wages Cash 5,

4.1. Accounting books (II)

• LEDGER : The ledger is prepared based on classification of Journal entries under their related accounts, called T-accounts. Thanks to such classification, one can easily track the changes in a particular account and prepare the financial statements (see below T-account for sales revenue). It is voluntary.

RULE: Each transaction generates two effects in the firm’s equity (double entry system book-keeping): an origin and a destination of resources that must record “at the same time” in the Journal and the Ledger of the firm.

There is another compulsory accounting book: INVENTORIES AND FINANCIAL STATEMENTS BOOKS with the initial balance sheet, Quarterly trial balance and the Financial Statements. © Ediciones Pirámide BEYOND FIGURES: Introduction to Financial Accounting

4.2. How the accounts work

• Each T-account has two sides. Debit entries are entered in the left side of the T- account, and credit entries are entered in the right side. Transactions can either increase the debit side or the credit side of the account depending on the nature of the entity and the transaction.
• If the sum of debit entries is more than the sum of credit entries, the account is said to have a debit balance. If the sum of credit entries is larger than the sum of debit entries, then the account is said to have a credit balance. If the two sums are the same, the account is said to have zero balance.

© Ediciones Pirámide BEYOND FIGURES: Introduction to Financial Accounting

DEBIT Name of an account CREDIT

entry on the left side of entry on the right side of any account any account to CHARGE to CREDIT Balance debit or credit

4.2. How the accounts work

• At the end of the accounting period, we need to close all accounts in order to create financial statements for the period and also prepare the accounts for the next period.
• Income statement accounts are temporary accounts. Their balances are not carried forward to the next accounting period.
• Balance sheet accounts are permanent accounts. Their balances are carried forward to the next accounting period.
• NOTICE CAREFULLY! The balance of an accounting is not an entry, it is a difference between total amounts

© Ediciones Pirámide BEYOND FIGURES: Introduction to Financial Accounting

4.3. Double-entry bookkeeping system: debit

and credit rules

• Revenue accounts are credited when we record additional revenues.
• Expense accounts are debited when we record additional expenses.
• Asset accounts are debited if the levels of company’s asset entities increase.
• Equity accounts are credited if the levels of company’s equity entities increase.
• Liability accounts are credited if the levels of company’s liability entities increase.

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AGREEMENT OF CREDIT AND DEBIT:

accounts of ASSETS

• It starts with a DEBIT registry
• It has a bilateral working: it can receive entries on the Debit and Credit

side

• Restriction: Debit ≥ Credit
• Final balance: debit or zero balance
• LEFT-SIDE BALANCE

Initial value Increases

Debit Account of Asset Credit

Decreases

AGREEMENT OF CREDIT AND DEBIT: accounts of EXPENSES and REVENUES

Remember!: EXPENSES of equity

It starts and increases by DEBIT registries Unilateral working. These accounts can’t have entries at the right side of the accounts.

Remember!: REVENUES of equity

It starts and increases by CREDIT registries Unilateral working. These accounts can’t have entries at the left side of the accounts

4.4. Basic accounting logic

When recording a transaction, in the Journal (to journalize) and Ledger (to post), we have to “imagine the answers” to 5 questions:

1. What accounting elements are involved in this transaction?
2. Where do those elements belong to? Assets? Liabilities? Equity?
3. What is the effect of this transaction? Increases or decreases? 4 Where do these elements start with? by Debit or Credit?
4. What is their value? Amount?

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Example B. Asset

• 1.- Sale of a car 20,000€ cash, at its cost value.

Elements Group Variation Annotation Amount

Cash, open account ASSET Debit 20, Vehicles ASSET Credit 20,

DEBIT JOURNAL CREDIT

20,000 Cash, open account Vehicles 20,

Example C. Equity

• 1.- A company was incorporated on June 1, 2009, when some stockholders invested 70,000€ in a bank. Elements Group Variation Anotation Amount

Cash, open account ASSET Debit 70, Capital EQUITY Credit 70,

DEBIT JOURNAL CREDIT

70,000 Cash, open account Capital 70,