1. Discuss the role of accounting records in an organization.
2. Descritie a ledger account and a ledger.
3. State the rules of debit and credit for balance sheet accounts .:
4. Explain the double-entry system of accounting.
5. Explain the purpose of a journal and its relationship to the ledger.
6. Explail1the nature of net income, revenue, and expenses.
7. Apply the realization and matching principles in recording revenue and expenses..
8. Explain why revenues are recorded with credits and expenses are recorded with debits.
9. Describe the steps in the accounting cycle.
10. Prepare a trial balance and explain its uses and limitations.
CAN GIANT BECOME A BIG WHEEL?
In’1997, Giant boosted its efforts to dominate the middle market and move into the high end as well. Besides sponsoring Rob Warner, it backs a Teur de France team In a bid to increase Giant’s exposure in Eu~ rope, where it is already strong. Profits jumped tc an estimated $9 million, with additional gains expected. This year, it will increase from 8 to 16 the number of models using aluminum dual-suspension frames, known for handling and durability. Giant says it can sell these decked-out bikes at a profit in the moderate, sub-$1,000 price range
Thanks to aggressive marketing that targets America’s savvy teen consumers and young adults, the company says U.S. sales jumped 30%’ in 1997. -Giant, with a 6% market share, says it is now one of the , ” “-t~p-fi~~- brand~-but still behind high-flier Trek and Schwinn, which has bounced back from bankruptcy. Independent data verifying Giant’s claim are hard to come by. But Ash Jaising, president of Boston’s Bicycle ch Institute, agrees that Giant has gained share in the strategic $1.1 . “There are hundreds of brands, and dozens of companies have gone bankrupt,” says Jaising. “To rank among the top five is an accomplishment.”
An accounting system includes a separIfe record for each item that appears in the’ financial statements. For example. a separate record is kept for the asset cash, showing all increases and decreases in cash resulting. from the many transactions in which cash is received or paid. A·record is kept for every other asset, for every liability, for owner’s equity, and for every revenue and expense account appearing in the income statement.
THE USE OF ACCOUNTS
An account isa means of accumulating in one place all the information about changes in specific financial statement items, such as a particular asset or liability. For example. the Cash account provides-a company’s current cash balance, a record of its cash receipts. arid a record of its cash disbursements
In its simplest form. an account has only three elements: (1) a title; (2) a left side, .which is called the debit side; and (3) a right side. which is called the credit side. This form of an account ••iIIustrated below and on the following page, is called a T account because of its resemblance to the letter “T.” In a computerized system, of course. the elements of each account are stored and formatted electronically. More complete forms.of accounts will be illustrated later
DEBIT AND CRED IT ENTRIES
An amount recorded on the left, or debit. side of an account is called a debit. or a debit entry; Likewise, any amount entered on the right. or credit, side is called a credi,t. or a credit entry. In simple terms, debits refer to the left side of an account, and credits refer to the right side of an,account.
To illustrate the recording of debits and credits in an account, let us go back to the seven cash transactions of Overnight Auto Service, described in Chapter 2. ~en these cash transactions are recorded in the Cash account. ‘the receipts are listed on the debit side, and the payments are listed on the credit ‘side. The dates of the transactions may also be listed, as shown in the following illustration:
RECORDING TRANSACTIONS IN LEDGER ACCOUNTS AN ILLUSTRATION
The use of debits: and credits for recording’ transactions in accounts now will be illustrated using selected November transactions of Overnight Auto Service. At this point, we will discuss only those transactions related to changes in the company’s financial position and reported directly in its balance sheet. The revenue and expense transactions that took place on November 30 will be addressed later in the .chapter, Each transaction from November I through November 26 will first be analyzed in terms of increases in assets, liabilities, and owner’s equity. Then we shall follow the debit and credit rules for entering these increases and decreases in specific accounts. Asset ac- , counts will be shown on the left side of the analysis; liability and owner’s equity accounts will be shown on the right side. For convenience in the following transactions, both the debit and credit entries for-the transaction under discussion are shown in red. Entries relating to earlier transactions appear in black.
Nov. 1 Michael McBryan, the owner, i’nvested $80,000 cash in the business
Nov. 3 Representing Overnight, Mclsryan negotiated with both the City of Santa Teresa.and Metropolitan Transit Authority (MTA) to purchase an abandoned bus garage. (The city owned the land, but the MTA owned the building.) On November 3, Overnight Auto Service purchased the land from the city for $52,000 cash.
Nov. 5 Overnight completed the acquisition of its business location by purchasing the abandoned building from the MTA. The purchase price was $36,000; Overnight made a $6,000 cash down payment and issued a’ 90-day, noninterest- bearing note payable for the remaining $30,000
In the preceding discussion, we recorded Overnight Auto- Service’s transactions in the company’s ledger accounts. We did this to stress the effects of business transactions on the individual asset, liability, and owner’s equity accounts. In an actual accounting system, however, the information about each business transaction is initially recorded in an accounting record called the journal.
The journal is a chronological (day-by-day) record of business transactions. At convenient intervals, the debit and credit amounts recorded in the journal are transferred , (posted) to the accounts in the ledger. The updated ledger accounts, in turn, serve as the basis for preparing the company’s financial statements.
The simplest type of journal is called a general journal and is shown at the top of . the following page. Note the way in which transactions are recorded in the general journI.
1.The name of the account to be debited is written first, and the dollar amount to be . debited appears in the left-hand money column.
2.:The name of the account credited appears below the account debited and is indented to the right. The dollar amount credited appears in the right-hand money column.
3. A brief description of each transaction appears immediately below each journal entry.
Notice that no new information is recorded’ during the posting process., Posting involves copying into the ledger accounts information that recorded ill the journal. In manual accounting systems, this can’ be a time-consuming, process; but in computer-based systems, it is done instantly and automatically, In ,addition, computerized posting greatly reduces the risk of errors
Ledger Accounts After Ppsting
After all the transactions through November 26 have been posted, Overnight’s ledger accounts appear as shown below and on the next pa~e. The accounts are arranged in the same order as in the balance sheet-that is, assets first, ‘ followed by liabilities and owner’s equity. Each ledger ‘account is presented in what .is,. referred to as a running balance format ,(asopposeq to simple T accounts). ,YO\l will notice that the running balance format does not indicate specifically whether a particular account has a debit or credit balance. This -causes’ no difficulty, however, because we know that asset accounts normally have debit balances, and liability and owner’s equity accounts normally have credit balances.
In the ledger accounts that follow we have not yet included ‘any of Overnight’s revenue and expense transactions discussed in Chapter 2. AiJ of tpe company’s .revenue and expense transactions took place on November 30. Before we can discuss the debit and credit rules for revenue and expense accounts, a more in-depth discussion of net income is warranted.
WHAT IS NET INCOME?
As previously noted, net income is em increase in owner’s equity resulting from the profitable operation ‘of the business. Net incoine does not consist of any cash or any other “specific assets. Rather. net income is a computation of the overall effects of many business
transactions on owner’s equity. The effects on the basic accounting equation’ are illustrated as follows
Our point is that net income represents an increase in owner’s equity and has no direct relationship to the types or amounts of assets on hand. Even a business operating at . a profit may run short of cash and become insolvent.
In the balance sheet, the changes in owner’s equity resulting from profitable or unprofitable operations are reflected in the balance of the owner’s capital accoum. The assets and liabilities of the business enterprise appear separately in their respective sections of the balance sheet.
An income statement is a financial statement that summarizes the profitability of the business entity for a specified period oftime, In this statement, net income is determined by comparing sales prices of goods or services sold during the period’ with the costs”incurred by the business in delivering these goods or services. The technical accounting .terms for these components of-net income are revenue and expenses. “Therefore, accountants say that net income is equal to’ revenue minus expenses. A sample income statement for Ovemight Auto Service is shown below. Later in this chapter we will show how this income statement was developed from the company’s accouriting records. For the moment, however, this income illustration will assist us in discussing ‘some of the basic concepts involved in measuring net income