Processing Accounting Information – Recording Economic Transactions | MBA 501, Study notes of Introduction to Business Management

Download Processing Accounting Information – Recording Economic Transactions | MBA 501 and more Study notes Introduction to Business Management in PDF only on Docsity! Introductory Financial Accounting Somna th Das Processing Accounting Information – Recording Economic Transactions DEFINITIONS: Asset: resource or right to expected (uncertain) future benefits which have been acquired by the firm. Liability: an obligation to produce and transfer a good or service to an outside party at some future time in return for benefits received currently or in the past. Income: the amount of resources a firm can consume or save during a period or at the end of a period, and be as well as of at the end as it was at the start or beginning. Revenue: the gross inflow of assets to the firm or reduction in its liabilities as a result of it selling its assets, goods or services to outside parties. Expense: outflow of assets consumed or increase in liabilities generated in a period by the production of revenue in that period., External and Internal Events Event: a happening of consequence to an entity - three characteristics -specific to economic entity -measurable in financial terms -results in two effects that CREATE or CHANGE the RIGHTS and OBLIGATIONS of the entity. Transaction: internal or external event recognized in financial statementscan be measured reliably Internal Event entirely within the company (entity) 1 External Event interaction between entity and outside environment A business or economic transaction is AN EXCHANGE of economic considerations between two parties. 2 2. Using a system that ensures that the accounting equation is preserved. Any transaction either increases or decreases the three components of the balance sheet Equation, the effect of which must be such that it still preserves the identity. Thus if we have a system of recording increases or decreases in these three components or accounts, that ensures the preservation of the identity then we have a good system. If there were only a few transactions to record then these three accounts and the balance sheet equation is sufficient to record transactions and aggregate them over a specified period of time. However, when the number of transaction is very large, it is not possible to just use the three primary accounts along with the balance sheet equation. The Double Entry System of debits and credits has to do with how we record increases and decreases to an account while preserving the accounting identity, and without using plusses and minuses. If debit only meant increase irrespective of the account, or credit simply meant decrease irrespective of the account, or vice versa, we would not be able to preserve the accounting identity at each transaction. T-account: is just a simplified form of general ledger account that shows left and right side entries to each individual account on a big "T" Left Right Debit(Dr) Credit(Cr) no bad or good connotation to either one, just left and right debit (charge is another verb for debit) and credit can also be used as verbs: we debit (make an entry to left side) or credit (make an entry to right side) an account do not necessarily mean "increase" and "decrease," only left and right 5 RULES OF DEBIT AND CREDIT: Asset Liability Owner's Equity Retained Earnings Debit(Dr) Credit(Cr) Debit(Dr) Credit(Cr) Debit(Dr) Credit(Cr) increase decrease decrease increase decrease increase normal balance normal balance normal balance Expense Revenue Debit(Dr) Credit(Cr) Debit(Dr) Credit(Cr) increase decrease decrease increase normal balance normal balance Normal Balance: is usually the entry to increase the account what we usually expect the account to have Double Entry Accounting every time we debit something, we have to credit something else; can be more than one of each type FIRST LAW of ACCOUNTING (a la Newton’s): For every DEBIT there is an Equal amount of CREDIT i.e TOTAL dollar amount of debits EQUALS TOTAL dollar amount of credits The above rule not only Preserves the Accounting Identity, it also permits us to add and subtract without actually using plusses and minuses. The four primary functions of accounting i.e.; (1) identification to (2) measurement to (3) aggregation to (4) communication are performed by the Accountant in THREE main phases:  Phase 1 Recording phase  Phase 2 Adjusting phase (to be discussed later)  Phase 3 Reporting phase. Phase 1 - There are Three steps to RECORD a transaction: A THINK!!!! What, if any, increases? What, if any, decreases. B. Recall the Debit and Credit Rules as they Apply to these Increases and Decreases. C. Record Using the Rules: Debit Something (S), Credit Something (S) 6 Source Document written evidence that an event has taken place: supplier invoice; cash register tape; time card; Sometimes the company must generate a document to establish that an event took place which was not initiated by a document Exhibit on Source Documents (TR12) Journal: book of original entry, kept in order of events rather than by account chronological record here first, then transfer - post to ledger- has three components:  The accounts affected  The direction of the effect.  The dollar value of the transaction. SO ASK THE FOLLOWING THREE QUESTIONS 1. What accounts are being affected by the transaction? 2. What is the direction of effect – increases or decrease- on each of the affected accounts? 3. What is the dollar value of the transaction? ACCOUNTS DIRECTION OF EFFECT ASSETS LIABILITIES & STOCKHOLDER’S EQUITY INCREASE LEFT RIGHT DECREASE RIGHT LEFT The Format for a Journal Entry Dr Cr Date Debit account $ Credit account name $ explanation of entry on last line Example: E3-14 Posting to the Ledger Accounts - transfers amounts from journal to proper ledger account The Trial Balance Trial balance lists each account and its balance at a specific point in time Proves That Total Dr = Total Cr Does Not Necessarily Mean Correct Accounts Were Used The Trial Balance Is Not the Balance Sheet. 7