The Accounting Cycle

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CHAPTER 2

• The Accounting Cycle

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Accounting Methods for Measuring Performance
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Accounting Methods for Measuring Performance

• (a) Cash basis of accounting
• Revenues are recognized when cash is received and
  expenses are recognized when cash is paid
• (b) Accrual basis of accounting
• Revenues and expenses are recognized on an
  economic basis regardless of when cash is paid or
  received

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• Success Service Corporation -Dry Cleaning Company
• TL 3 billion bank loan in January 2004- loan due
  June 2004- monthly interest expense of TL 100.
• Paid two months rent on 1 January 2004 total TL
  200
• Paid insurance premium of TL 120 to cover the
  whole year from January 1 to December 31
• Purchased supplies of TL 90 to be used for 3
  months and paid TL 75 of it agreed to pay the
  rest in February
• In January-provided TL 750 worth of services and
  collected cash of TL 500 from customers the rest
  would be collected next month
• Paid salaries of TL 500 at the end of January

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Accounting Methods for Measuring Performance

• (a) Cash basis of accounting
• Revenues are recognized when cash is received and
  expenses are recognized when cash is paid
• (b) Accrual basis of accounting
• Revenues and expenses are recognized on an
  economic basis regardless of when cash is paid or
  received

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Recognition of Revenues
Sales order 3 May
MILLENIUM CO.
 
Receipt of the computer 6 May
CUSTOMER
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Recognition of Service Revenues

• Accrual Basis of Accounting Recognizes Revenue
  When
• All or major parts of services are performed
• Cash or other form of assets are received to
  reasonably determine the value of the transaction

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Recognition of Expenses

• Expenses are recognized when they are incurred
  and helped to produce revenues

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Generally Accepted Accounting Principles and
Concepts

• Entity - Every entity is a separate economic unit
  and should be kept distinct from the activities
  of its owners and other companies
• Monetary Unit- only economic events that have
  monetary transactions will be reported in the
  financial statements
• Cost Principle- assets are presented at their
  original (historical) cost
• Going Concern- companies are established with the
  goal that they will operate for an indefinitely
  long period of time
• Periodicity - economic activities of any firm
  can be divided into discrete time periods for
  reporting purposes
• Matching Principle -all revenues must be recorded
  in the accounting period in which the goods are
  sold or services are rendered and all expenses
  must be recorded in the accounting period in
  which they are incurred to produce such revenues

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Accounting Cycle
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Fundamental Accounting Equation
ASSETS EQUITIES
ASSETS LIABILITIES OWNERS' EQUITY
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How do we use the balance sheet equation?

• Recall the Balance Sheet Equation
• Assets Liabilities Shareholders Equity
• Implications
• If assets increase either Liabilities and/or
  Shareholders should also increase and vice versa
• For example borrow cash, cash (asset) will
  increase and Liabilities will increase
• when it is paid back cash (asset) will decrease
  and liabilities will decrease

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How do we record?

• An account accounting report of a specific
  asset, liability or owners equity item
• Has 3 elements title, debit side and credit side
  (also called the T-Account)

Title
Debit
Credit
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Accounts

• Debiting (abbr Dr.) or Crediting (abbr Cr.)
  alone does not mean increasing or decreasing,
  these terms just show that an amount has been
  entered to the left or to the right hand side of
  the account, respectively

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Accounts

• The Double-entry (or Dual-entry) System
• Each transaction must be recorded with at least
  one debit and one credit, in such a way that the
  total amount of debits and the total amount of
  credits equal each other
• Hence, the system as a whole is always in
  balance. All accounting systems, no matter how
  sophisticated, are based on this principle of
  duality

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Accounts

• When we total the two sides of an account, if the
  debit side total is more than the credit side
  total, then the account has a debit balance
• Conversely, if the total of the credit entries
  exceeds the total of debit entries, than the
  account will have a credit balance

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Accounts

• Two types of accounts
• Temporary
• Permanent
• Temporary Accounts Opened at the beginning of
  each accounting period with a zero balance and
  closed at the end of the accounting period (e.g.
  Income st. accounts)

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Accounts

• Permanent Accounts Never closed, their balances
  at the end of an accounting period become the
  beginning balances of the next period. All
  balance sheet accounts are permanent accounts.

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How do accounts behave?

• Assets liabilities Shareholders
  Equity
• 
  
• So Assets increase on the left hand or debit
  side then they decrease on the credit side
• Assets
• -
• debit credit

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Behavior of Accounts

• Liabilities and Owners Equity accounts increase
  on the credit side, decrease on the debit side
• Liabilities or Owners Equity Accounts
• -
• debit credit

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Transaction Analysis and The Duality Concept

• if an asset account increases, because of duality
  concept there must be a corresponding
• 1.      increase in a specific liability account
• 2.      or a decrease in a another asset account
• 3.      or an increase in owners' equity account.

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Illustration of Express Travel Agency

• 1. Ms. Fodor invested TL100.000 at the inception

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• 2. On 1 January employed a full time secretary
  and a sales representative.

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• 3. On 1 January rented an office building and
  paid 3 months rent of TL 600.

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• 4. On 2 January office furniture and equipment is
  purchased for TL 15.000 , for which TL 5.000 is
  paid in cash and the rest would be paid later in
  January and February 2004.

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• 5. On 3 January insured the office building and
  the equipment effective from 1 January to 31
  December 2004 and paid TL 120 for the whole
  period.

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• 6. On 5 January the company agreed with Turkish
  Airlines to sold airline tickets of THY and
  receive commissions in return.

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• 7. On 10 January Express Travel Agency borrowed
  TL 15.000 from the bank at an annual interest
  rate of 24 for six months. The principal and the
  interest of the loan will be paid together on 10
  July 2004.

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• 7. On 10 January Express Travel Agency borrowed
  TL 15.000 from the bank at an annual interest
  rate of 24 for six months. The principal and the
  interest of the loan will be paid together on 10
  July 2004.

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• 8. On 10 January purchased office supplies for TL
  2.500 in cash.

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• 8. On 10 January purchased office supplies for TL
  2.500 in cash.

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• 9. During the first half of January the agency
  sold tickets to various customers and on 16
  January issued a commission invoice to THY
  amounting to TL 5.000 that will be collected
  later in January 2004.

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• 9. During the first half of January the agency
  sold tickets to various customers and on 16
  January issued a commission invoice to THY
  amounting to TL 5.000 that will be collected
  later in January 2004.

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• 10. On 20 January the company paid TL 5.000 for
  the furniture and equipment that were purchased
  on 2 January.

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• 10. On 20 January the company paid TL 5.000 for
  the furniture and equipment that were purchased
  on 2 January.

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• 11. On 22 January received TL 7.500 from a
  customer for organizing the accounting conference
  that will be held on February 2, 2004.

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• 11. On 22 January received TL 7.500 from a
  customer for organizing the accounting conference
  that will be held on February 2, 2004.

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• 12. The company received the full payment of
  commission charged to THY of TL 5.000 on 23
  January.

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• 12. The company received the full payment of
  commission charged to THY of TL 5.000 on 23
  January.

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• 13. On 24 January paid salaries of TL 9.000
  employees in cash.

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• 13. On 24 January paid salaries of TL 9.000
  employees in cash.

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• 14. During the second half of January the agency
  sold tickets to various customers and on 31
  January issued a commission invoice to THY
  amounting to TL 7.500 which will be collected in
  February 2004.

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• 14. During the second half of January the agency
  sold tickets to various customers and on 31
  January issued a commission invoice to THY
  amounting to TL 7.500 which will be collected in
  February 2004.

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• 15. Ms. Fodor withdrew TL 3.000 on 31 January for
  personal use.

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• 15. Ms. Fodor withdrew TL 3.000 on 31 January for
  personal use.

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Summary

• 1.      determine the effects of transactions on
  three components of the accounting equation,
• 2.      determine which specific accounts are
  affected, and
• 3.      assure that total of the increases should
  be equal to either increases on the other side of
  the equation or to decreases on the same side, or
  a combination there of.

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Behavior Summary

• Assets Liabilities Owners
  Equity
• - -
  -
• Dr Cr Dr Cr Dr
  Cr
• 
  Expense Revenue
• 
  - -
• Dr
  Cr Dr Cr
• 
  Withdrawal/Dividends
• 
  -
• 
  Dr Cr

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Accounting Cycle
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Posting to The Ledger
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NORMAL BALANCES OF ACCOUNTS
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TRIAL BALANCE