Chapter 3: Double-Entry Accounting Plus Accounting Cycle Flashcards
Double-entry accounting system
An accounting system that maintains the equality of the basic equation by requiring that each entry have amounts of debits and credits
Why is it called Double-entry accounting
One of the reasons it is called this is because it requires that each transaction be recorded in a way that affects at least two accounts, with the transaction amount recorded in each account.
What is a limitation to the template method?
The most significant limitation of the template method is the number of columns that can be manageably used.
The double-entry accounting system overcomes this limitation (of the template method) how?
By enabling companies to use hundreds or even thousands of accounts to capture information at the level of detail required to manage the business effectively.
Normal Balence
The balance (debit or credit) that an account is normally expected to have. Assets, expenses, and losses normally have debit balances. Liabilities, shareholder equity, revenues, and gains normally have credit balances.
It is also used to indicate how the account is increased in an journal entry. The oppose of an account’s normal balance is used to record a decrease in the account
Assets = (names for assets)
The Left SIde!
Debit
DR
Liabilities = shareholder equity = (names for this)
The right side
Credit
CR
EXAMPLE: To record cash (an asset) an increase would mean adding ____ and a decrease would mean to add ____
Add credit to increase
Add debit to decrease
EXAMPLE: To record accounts payable (a liability) an increase would mean adding ____ and a decrease would mean to add ____
Add debit to increase
Add credit to decrease
Liquidity
An organizations short-term ability to convert assets into cash to be able to meet its obligations and pay its liabilities
General Ledger (aka G/L)
The financial records containing details on a company’s assets, liability, and shareholders equity, revenue, and expense accounts
General ledger account
An account in the general ledger
Another key difference between the template method and the double-entry accounting system is that there are:
cards for revenue accounts, expense accounts, and the Dividends Declared account. (not recorded in retained earnings as in template method)
Retained earnings =
operating retained earnings + net income - dividends declared
Revenues and their effect on retained earnings
Revenues ultimately increase Retained Earnings because they increase net income, which increases retained earnings.
Expenses and their effect on retained earnings
Expenses ultimately decrease Retained Earnings because they decrease net income, and a lower net income means lower retained earnings.
Dividends declared and their effect on retained earnings
Dividends declared decrease Retained Earnings because they are a distribution of retained earnings.
Revenue accounts will normally have a credit balance. This is because revenue accounts increase Retained Earnings and Retained Earnings normally has a credit balance, so it must be credited to increase it.
Know this
Expense accounts will normally have a debit balance. This is because expense accounts decrease Retained Earnings and Retained Earnings normally has a credit balance, so it must be debited to decrease it.
Know this
Dividends Declared will normally have a debit balance. This is because Dividends Declared decreases Retained Earnings and Retained Earnings normally has a credit balance, so it must be debited to decrease it.
Know this
Helpful HInt
Asset accounts normally have debit balances; increases in assets are also recorded as debits.
Helpful HInt
Liability and shareholders’ equity accounts normally have credit balances; increases in liabilities and shareholders’ equity are also recorded as credits.
Helpful HInt
Revenue accounts normally have credit balances; increases in revenue are recorded as credits.
Helpful HInt
Expense and dividends declared accounts normally have debit balances; increases in expenses and dividends declared are recorded as debits.
Accounting cycle
The sequence of steps that occur in measuring, recording, summarizing, and reporting of events in the accounting system
Chart of accounts
A listing of the names of the accounts used in a particular accounting system
Can Companies Change Their Chart of Accounts and What Are the Implications If They Do?
Yes, companies can and do make changes to their chart of accounts. Companies can add new accounts when they enter into new types of operations, open new locations, wish to capture information at a different level of detail, and so on.
When a company begins operations,
None of its accounts will have an opening balance.
Permanent accounts
Accounts whose balances carry over from one period to the next. All statement of financial position accounts are permanent accounts
Temporary accounts
Accounts used to keep track of information temporarily during each accounting period. The balances in these accounts are eventually transferred to a permanent account (Retained Earnings) at the end of the period by making closing entries
Dividends Declared account is a _______
temporary account
Types of permanent accounts
Asset, liabilities, and shareholders’ equity accounts are permanent accounts.
Types of temporary accounts
Revenue, expense, and dividends declared accounts are temporary accounts.
transaction analysis
This involves identifying whether an event or transaction has occurred and, if so, determining its effects on the company’s accounts.
source document
a document that is received or created by the company indicating that a transaction has taken place that needs to be recorded.
Examples of source documents
include invoices, cheques, cash register tapes, bank deposit slips, time sheets, and shipping documents.
General journal
A chronological listing of all the events that are recorded in a company’s accounting system
Journal entry
An entry made in the general journal to record a transaction or event
When making journal entries
The customary practice is to list the accounts that are being debited before the accounts that are being credited, and to indent the accounts that are being credited.
Key points to recording journal entries
- The total dollar value of debits must be equal to the total dollar value of credits within each journal entry.
- Record debits before credits.
- Indent all credit entries.
Compound journal entry
A journal entry with more than two parts (that is, multiple debits or credits) that affects more than two accounts. As with any journal entry, the total amount debited must equal the total amount credited
Why Are Transactions Also Recorded in the General Ledger?
While the general journal provides an important chronological record of the effects of each transaction, companies require summarized information.
General journal contains what?
The general journal contains detailed information on each transaction.
General ledger contains what?
The general ledger contains summary information for each account.
Posting
The process of transferring the debit or credit information from the journal entries to the general ledger accounts
Trial balance
A listing of all the general ledger accounts and their balances. Used to check weather the total of the debit balances is equal to the total of the credit balances
Trial balance vs Balance sheet
Do not confuse a trial balance with a statement of financial position (also known as a balance sheet). A trial balance lists the balances in all the accounts, while a statement of financial position includes only the asset, liability, and shareholders’ equity accounts.
If you prepare a trial balance that does not balance, here are some tips for finding your error:
First, calculate the difference between the total debits and the total credits, and look for a transaction for this amount that may have been recorded or posted incorrectly.
Divide the difference from the first step by 2, and check to see whether a debit for this amount has been recorded as a credit, or vice versa.
Divide the difference from the first step by 9. If it divides evenly—with no decimals—check for a transposition error: two digits that have been reversed.
Adjusting entries
Journal entries made at the end of the accounting period to record an event or transaction that was not recorded during the period. Events or transactions that are not signalled in any other way are recorded through adjusting entries. The entries do not involve the Cash account
Two types of adjusting entries
Accruals
Deferrals
Accruals
Adjusting journal entries required when a company needs to recognize a revenue before the receipt of cash or an expense prior to the payment of cash
Deferrals
Adjusting journal entries required when a company needs to recognize a revenue in an accounting period after the cash has been received or an expense in an accounting period after the cash has been paid
Accrual entries are required when
Accrual entries are required when a revenue or expense needs to be recognized before cash is received or paid.
Deferral entries are required when
a revenue or expense needs to be recorded after it has been received or paid.
Adjusting journal entries:
never involve cash
are made at the end of each accounting period (such as each month, quarter, or year end)
Accumulated depreciation account
A contra-asset account whose normal balance is a credit
Contra-asset account
An account used to record record reductions is a related asset account
-But its normal balance is contrary or opposite to what an asset account would normally have. As such, a contra-asset account normally has a credit balance rather than a debit balance.
Carrying amount
The full value of all of a company’s accounts receivable less the allowance for doubtful accounts. In the context of long-term assets, carrying amount or carrying value s equal to the asset’s cost, less accumulated depreciation, less accumulated impairment losses. It represents the portion of the asset’s cost that has yet to expensed.
Adjusted trial balance
A listing of the accounts and their balances after the adjusting entries have been made, but before the closing entries have been made
Closing entries
Entries made at the end of the accounting period to transfer the balances from temporary revenue, expense, and dividend declared accounts into retained earnings accounts. Resets the balance of all temporary accounts to zero
On the statement of changes in equity, a company’s ending retained earnings balance is equal to:
= Beginning Retained Earnings + Net Income − Dividends Declared
four closing entries
- Close all revenue accounts to the Income Summary account.
- Close all expense accounts to the Income Summary account.
- Close the Income Summary account to Retained Earnings.
- Close the Dividends Declared account to Retained Earnings.
Income summary account
is a temporary account that is opened and closed on the last day of a company’s fiscal year. It is used to determine the amount of the company’s net income, which is then transferred to Retained Earnings.
The closing entry process has achieved two key objectives
The balance in the Retained Earnings account has been brought up to date by adding the net income for the period and deducting the dividends declared during the period.
The balances in all of the temporary accounts have been reset to zero, so that the accounts are ready to use at the start of the next accounting period.
Closing entries:
-transfer the balances in all temporary accounts to Retained Earnings
-reset all temporary account balances to zero
are made at the end of each year
Accounting cycle
1) Transaction analysis
2) Summarize + post to G/C accounts
3) Trial balance (DR=CR)
4) Adjusting entries
5) Adjusting T/B
6) Prepare financial statements
7) Closing entries
Which of the following accounts normally have a debit balance?
Dividend accounts
Asset account
Expenses
