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CHAPTER 2 “THE RECORDING PROCESS”
It consists of 3 parts:
- The Account (Debits and Credits, Equity relationships, Summary of d/c rules)
- Steps in Recording Process (Journal, Ledger, Posting, The RP illustrated, Summery illustration of journalizing and posting)
- The trial Balance (limitations of a trial balance, locating errors, currency signs and underlining)
THE ACCOUNT
An account is an individual accounting record of increase and decreases in a specific asset, liability, equity, revenue or expense items. The account consists of 3 parts: a title, a left or debitd side, a right or credit side. An account can be illustrated in a T form. Title/Name Debit Credit Debits(Dr) and Credits(Cr) They do not mean increase or decrease. They are used in the accounting rocess to describe where entries are made in accounts. When comparing the totals of the 2 sides-> the account shows the belance :
- Debit balance if the total of the debit amount exceeds the credits If Debits are greater than Credits, the account has a debit balance.
- Credit balance if the total of the credit amount exceeds the debits If Credits are greater than Debits, the account has a credit balance Ex. Tabulary summary CASH DEBITS CREDITS 15000 7000 1200 1700 1500 250 600 1300 Balance 8050 Every positive item -> receipt f cash Every negative item-> payment of cash We record the increases in cash as debits and the decreases in cash as credits. The balance is determinated by retting the 2 sides.
CASH
Debit and credit procedure of double-entry system Each transaction must affect two or more accounts to keep the basic accounting equation in balance. For each transaction, debits must equal credits. This equality provides the basis for the double-entry system of recording transactions Recording is done by debiting at least one account and crediting at least one other account. If every transaction is recorded with equal debits and credits. The sum off all the DEBITS must equal CREDITS. The concept of “debits” and “credits” had its foundation over 500 years ago when the Italian mathematician Luca Pacioli codified the financial transaction recording system used by the Venetian merchants of that time. Pacioli observed that funders “entrusted” (credere hence credit) financial resources to a business which then created an obligation on the part of the business “to owe” (debere hence debit) that money back to the funders. Pacioli codified the concept that in a closed system like finance, monetary value is not created or destroyed but rather flows FROM a source TO a destination. Debere to owe Possession= Use of found Source of found Capital= Assets Liabilities + Equity Credere to entrust An increase in a possession (anything belonging to a business) is always a debit. An increase in capital (and anything not belonging to a business) is always a credit. When circumstances are the opposite, the opposite entry is made Every transaction affects: item exchanged, Form of settlement To identify the accounts to debit and credit, always focus on the Item exchanged The treatment of the Form of Settlement is always the opposite of the treatment of the Item exchanged 2- Double-entry accounting: example e.g. you pay an electricity bill for €120 by cash. The Item exchanged is electricity. The expense of electricity has increased, so it is a debit. Cash is the Form of settlement and it must be a credit. Summary of Debits and Credits rules Assets = Liabilities + Equity Assets = Liabilities + Share Capital Ord. + Retained Earnings + Revenues – Expenses – Dividends Assets + Expenses + Dividends = Liabilities + Share Capital Ord. + Retained Earnings + Revenues Debits = Credits
Retained Earnings is net income that is kept (retained) in the business. It is the portion of equity that the company has accumulated through the profitable operation of the business. Credits (net income) increase the Retained Earnings account, and debits (dividends or net losses) decrease it. Dividends A Dividendi s a company´s distribution to its shareholders. The most coomon form of a distribution is a cash dividend. Dividends reduce the shareholders´ claims on retained earnings. Debits increase the Dividends account, and credits decrease it. Normally has a debit balace Dividends Debit for increase Credit for decrease Normal balance 213weRevenues and Expenses The purpose of earning revenues is to benefit the shareholders. When a company recognized revenues, equity increases. Revenues are a subdivision of equity that provides information as to why equity increased. Credits increase revenue accounts and debits decrease them. The effect of debits and credits on revenue accounts is the same as their effect on equity. Expenses have the opposite effects: expenses decrease equity. Debits increase expense accounts, and credit decrease them. Retained Earnings Debit for decrease Credit for increase Normal balance Debits Credits Decrease revenues Increase expenses Increase revenues Decrease expenses Expenses Debit for increase Credit for decrease Normal Baalance Revenues Debits for decrease Credits for increase Normal balance
Equity Relationships Dividends, revenues and expenses are eventually transferred to retained earning at the end of the period. As result a chang in any one of these 3 items affects equity. Issuance of share capital and revenues increase equity (credit). Dividends and expenses decrease equity (debit). Summary of Debit/Credit Rules Slide 2.18 e 2.
date, journal page and credite amount shown in the journal. In the reference column of the journal, write the account number to which the credit amount was posted Posting should be performed in chronological order: the company should post all the debits and the credits of onejournal entry before proceeding to the next journal entry. The reference column of a ledger account indicates the journal page from which the transaction was postes. Chart of accounts The numbers of accounts are different from each company and depens on the amount of detail management desires. Most of company have a chart of accounts that lists the accounts and the account numbers that identify their location in the ledger. The numbering system that identifies the accounts usually starts with the statement of financial position accounts and follow with the income statement accounts. Account 101-199 -> asset accounts 200-299-> liabilities 300-399->equity 400-499->revenues 500-799->expenses 800-899->other revenues 900-999->other expenses The recording Process illustrated The purpose of transaction analysis is first to identify the type of account involved, and then to determine whether to make a debit or a credit to the account. Vedi libro pg 65 e seguenti THE TRIAL BALANCE A trial balance is a list of accounts an their balance at a given time. It is prepared at end of an accountin period, in the ordner in which they appear in the ledger. The trial balance proves the mathematical equality of debits and credits after posting and it may also uncover errors in journalizing and posting. It is useful in the preparation of financial statements. Steps for praparing a trial balance: list the account titles and their balances, total the debit and credit columns, prove the equality of the 2 columns. Limitation of a Trial Balance It can´t guarantee freedom from recording errors. For ex the trial balance may balance even when a transaction is not journalized, a correct journal entry is not posted, a journal entry is posted twice, incorrect accounts are used in journalizing or posting, or offsetting errors are made in recording the amount of a transaction. The trial Balance does not prove that the company has recorded all transactions or that the ledger is correct. Locating Errors Errors generalyy result from mathematical mistakes, incorrect postings or transcribing data incorrectly. What to do if the balance doesn´t balance? 1.determine the amount of the difference between the 2 columns; 2. If the error is $1, $10, $100 or $1000, re add the trial balance columns and recompute the account balances ; 3.if the error is divisible by 2, scan the trial balance to see whether a balance equal to half the error has been entered in the wrong column ; 4.if the error is divisible by 9, reversing the account
balance on the trial balance to see whether they are incorrectly copied from the ledger. ($21 instead of $ -> error $9) reversing the order of numbers is called “transposition error”; 5. If the error is not divisible by 2 or 9, scan the ledger to see whether an account balance in the amount of the error has been omitted from the trial balance, and scan the journal to see whether a posting of that amount has been omitted. Currency Signs and Underlining Currency signs are typically used only in the trial balance and the financial statements. Generally a currency sign is shown only for the first item in the column and for the total of that column. A single line (a totalin rule) is placed under the column to be added or subtracted. Total amounts are double underlined to indicate they are final sums.
