Accounting: What the Numbers Mean

1
Accounting What the Numbers Mean

• Study Outlines and Overhead Masters
• Chapter 4

2
TRANSACTIONS AND THE FINANCIAL STATEMENTS

• KEY IDEAS
•  
• TRANSACTIONS AFFECT THE BALANCE SHEET AND/OR THE
  INCOME STATEMENT.
•  
• THE BALANCE SHEET MUST BE IN BALANCE AFTER EVERY
  TRANSACTION.
•  
• THE RETAINED EARNINGS ACCOUNT ON THE BALANCE
  SHEET INCLUDES NET INCOME FROM THE INCOME
  STATEMENT.
•  
• BALANCE SHEET ACCOUNTS MAY HAVE BALANCES AT THE
  END OF A FISCAL PERIOD, AND BEFORE TRANSACTIONS
  OF THE SUBSEQUENT PERIOD ARE RECORDED.
•  
• KEY TERMINOLOGY
• EACH INDIVIDUAL ASSET, LIABILITY, OWNERS' EQUITY,
  REVENUE, OR EXPENSE ACCOUNT MAY ADDITIONALLY BE
  DESCRIBED WITH ITS CATEGORY TITLE. EXAMPLES
• CASH ASSET ACCOUNT
• ACCOUNTS PAYABLE LIABILITY ACCOUNT
• COMMON STOCK OWNERS' EQUITY ACCOUNT
• SALES REVENUE ACCOUNT
• WAGES EXPENSE ACCOUNT

3
BOOKKEEPING PROCEDURES

• WHAT THE BOOKS ARE CALLED
•  
• THE JOURNAL IS A CHRONOLOGICAL RECORD OF EACH
  TRANSACTION.
•  
• THE LEDGER IS A BOOK OF ALL OF THE ACCOUNTS
  ACCOUNTS ARE USUALLY ARRANGED IN THE SEQUENCE
  FOUND ON THE BALANCE SHEET AND INCOME STATEMENT,
  RESPECTIVELY.
•  
• HOW TRANSACTIONS ARE RECORDED
• ACCOUNTS ARE FREQUENTLY IN THE SHAPE OF A T.
•  
• THE LEFT-HAND SIDE OF THE T ACCOUNT IS CALLED
  THE DEBIT SIDE.
•  
• THE RIGHT-HAND SIDE OF THE T ACCOUNT IS CALLED
  THE CREDIT SIDE.
•  
• AN INCREASE IN AN ASSET OR AN EXPENSE ACCOUNT IS
  RECORDED AS A DEBIT A DECREASE IN EITHER AN
  ASSET OR AN EXPENSE ACCOUNT IS RECORDED AS A
  CREDIT.
•  
• AN INCREASE IN A LIABILITY, OWNERS' EQUITY OR
  REVENUE ACCOUNT IS RECORDED AS A CREDIT A
  DECREASE IN EITHER A LIABILITY, OWNERS' EQUITY,
  OR REVENUE ACCOUNT IS RECORDED AS A DEBIT.

4
BOOKKEEPING PROCEDURES

• A TRANSACTION IS INITIALLY RECORDED IN A JOURNAL
  ENTRY.
•  
• THE JOURNAL ENTRY IS THEN POSTED TO THE LEDGER
  ACCOUNTS THAT HAVE BEEN AFFECTED BY THE
  TRANSACTION.
•  
• KEY IDEAS
•  
• A TRANSACTION WILL AFFECT AT LEAST TWO ACCOUNTS,
  AND CAN AFFECT MANY ACCOUNTS.
•  
• BECAUSE THE BALANCE SHEET MUST BALANCE AFTER
  EVERY TRANSACTION, THE DEBIT(S) AND CREDIT(S)
  AMOUNTS OF EACH JOURNAL ENTRY MUST BE EQUAL.
•  
• DEBITS CREDITS
•  
• KEY OBSERVATION
•  
• EACH ACCOUNT HAS A "NORMAL BALANCE" SIDE - DEBIT
  OR CREDIT - THAT IS CONSISTENT WITH THE KIND OF
  ENTRY THAT CAUSES THE ACCOUNT BALANCE TO
  INCREASE.
•  

5
TRANSACTION ANALYSIS METHODOLOGY

• FIVE QUESTIONS OF TRANSACTION ANALYSIS
•  
• KEY IDEA
•  
• TO UNDERSTAND EITHER THE BOOKKEEPING PROCEDURE
  FOR A TRANSACTION, OR THE EFFECT
• OF A TRANSACTION ON THE FINANCIAL
  STATEMENTS, THE FOLLOWING QUESTIONS MUST BE
  ANSWERED
•  
• 1. WHAT'S GOING ON?
• (WHAT IS THE NATURE OF THE TRANSACTION?)
•  
• 2. WHAT ACCOUNTS ARE AFFECTED?
• (WHAT IS THE FINANCIAL STATEMENT CATEGORY
  OF EACH ACCOUNT - ASSET, LIABILITY, OWNERS'
  EQUITY, REVENUE OR EXPENSE?)
•  
• 3. HOW IS EACH ACCOUNT AFFECTED?
• (IS THE BALANCE INCREASING OR DECREASING?)
•  
• 4. DOES THE BALANCE SHEET BALANCE? (DO THE
  DEBITS EQUAL THE CREDITS? IS THE BALANCE SHEET
  EQUATION STILL IN BALANCE AFTER RECORDING THE
  TRANSACTION?)
• DEBITS CREDITS?

6
ADJUSTING ENTRIES

• WHAT ARE THEY? WHY DO THEM?
•  
• ADJUSTING ENTRIES, OR ADJUSTMENTS, ARE UPDATES
  AND "CORRECTIONS" MADE TO INCREASE THE ACCURACY
  OF THE INFORMATION IN THE FINANCIAL STATEMENTS.
•  
• RECLASSIFICATIONS
• THE BOOKKEEPING FOR THE ORIGINAL
  TRANSACTION WAS APPROPRIATE WHEN IT WAS
  RECORDED, BUT THE PASSAGE OF TIME REQUIRES A
  RECLASSIFICATION OF THE ORIGINAL BOOKKEEPING TO
  REFLECT CORRECT ACCOUNT BALANCES AS OF THE DATE
  OF THE FINANCIAL STATEMENTS.
• ACCRUALS
• REVENUES WERE EARNED OR EXPENSES WERE
  INCURRED DURING THE PERIOD, BUT NO TRANSACTION
  WAS RECORDED, (BECAUSE NO CASH WAS RECEIVED OR
  PAID). THEREFORE, IT IS NECESSARY TO ACCRUE THE
  EFFECT OF THE TRANSACTION AS OF THE DATE OF THE
  FINANCIAL STATEMENTS.
•  
• KEY IDEAS
•  
• ACCRUAL ACCOUNTING MEANS THAT REVENUES ARE
  RECOGNIZED WHEN EARNED (NOT WHEN CASH IS
• RECEIVED) AND THAT EXPENSES ARE REFLECTED
  IN THE PERIOD IN WHICH THEY ARE INCURRED (NOT
  WHEN CASH IS PAID).
•  
• ADJUSTING ENTRIES RESULT IN MATCHING REVENUES AND
  EXPENSES, WHICH IS THE OBJECTIVE OF ACCRUAL
  ACCOUNTING.