week 3 lecture notes (1 slide) (1)

8/18/2019 Week 3 Lecture Notes (1 Slide) (1)

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Week 3

The Double Entry System

Student Handout

Lecturer:Dr. Youngdeok Lim

School of AccountingUNSW

Business SchoolACCT1501 Accounting and Financial Management 1A

Session 1 2016


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WEEK 3: The Double Entry System

1. Introduction

Last week we discussed the importance of the balance sheet and income statement tomanagers. It is therefore critical that every manager understand the impact of transactionson these financial reports. This week covers those skills by extending transaction analysis,which considers the impact of specific transactions on the accounting equation. Thedouble entry system involving debits and credits, which forms the basis of modernaccounting, is then addressed.

Learning objectives

At the end of this topic you should be able to:

• Carry out transaction analysis and determine the impact of transactions on elementsof balance sheets and income statements

• Describe how debits and credits work in the double entry accounting system.

• Understand debits and credits in the context of transaction analysis

Required reading

Trotman, Gibbins & Carson Chapter 3

2. Tutorial Questions – Week 4

Students should attempt these questions before the tutorial.

Preparation Questions:

DQ3.1, 3.2, 3.4,


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3. Lecture example – P3.6

Find the unknowns given the following information

$m $m

Assets 1 July 2015 600 Assets 30 June 2016 ?

Liabilities 1 July 2015 ? Liabilities 30 June 2016 300

Share capital 1 July 2015 180 Share capital 30 June 2016 190

Retained profits 1 July 2015 200 Retained profits 30 June 2016 ?

Revenue for the year 800

Expense for the year 650

Dividends 50


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ACCT1501Semester 1, 2016

Week 3

The Double Entry System

Dr. Youngdeok LimQuad 3069

1


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Today’s lecture objectives:

Carry out transaction analysis and determine the impact oftransactions on elements of balance sheets (i.e. A, L, and SE) andincome statements (i.e. R and E)

o transaction 1-7.

o LRM ltd (transaction 8-14).

Hot: Describe how debits and credits work in the double entryaccounting system.

Understand debits and credits in the context of transaction analysis

2


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Revisit the definition of an asset

To be reported on a balance sheet, assets must

(1) Meet definition criteria

And THEN (2) Meet recognition criteria!

A resource that is controlled by an entity as a result of past events, andfrom which future economic benefits are expected to flow to the

entity.Assets recognition criteria:

(a) It is probable that any future economic benefit associatedwith the item will flow to the entity, and

(b) The item has a cost or value that can be measuredreliably

4


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Revisit balance sheet and income statement

5

A t-1L t-1

SE t-1

A tL t

SE t

RE

R – E = Profit for the period

Beginning period (t-1) Ending Period (t)

A t-1 = L t-1 + SE t-1 A t = L t + SE t

Incorporated into B/S

Capture of income

Retained profits: the sum of net profits earned over the life of a company less dividends

declared to shareholders


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Revisit the accounting equation expanded

6

Where:

SC = Share capitalRP = Retained profits

R = Reen!e

" = "#penses

$ = $iidend %declared&

t = time t %at the endin' period&

t(1 = time t(1 %at the )e'innin' period&


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Revision question 1 – Lecture example (P3.6)

7

Find the unknowns given the following information

$m $m

Assets 1 July 2015 600 Assets 30 June 2016 ?

Liabilities 1 July 2015 ? Liabilities 30 June 2016 300

Share capital 1 July 2015 180 Share capital 30 June 2016 190

Retained profits 1 July 2015 200 Retained profits 30 June 2016 ?

Revenue for the year 800

Expense for the year 650

Dividends 50


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Watch ICAA clip which provides an overview of

the financial statements

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Business Model

9

Company

(e.g. Woolworths)

Customers

(e.g. You)

Suppliers

(e.g. farmers)

Purchase of inventory Sale of inventory

Payment

(Cash/ Accounts

Payable)

Payment

(Cash/ Accounts

Receivable)

Investors (e.g. banks,

shareholders)Financing

Property Plant and Equipment,

financial securities etc

Investing


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Consolidated B/S –Woolworths Limited

Current Assets $7,661 M Current Liabilities $9,168 M

Noncurrent

Assets

$17,675 M Noncurrent Liabilities $5,036 M

Total Liabilities $14,204 M

Equities $11,132 M

Total Assets $25,336 M Total Liabilities andEquities

$25,336 M

As at 28 June 2015

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Revenue $60,968 M

- Cost of sales (Cost of goods sold) ($44,344 M)

Gross profit $16,524 M

+/- other revenue/expense ($14,387 M)

Net profit $2,137 M

For the 52 weeks ended on 28 June 2015

Consolidated I/S –Woolworths Limited

11

The fiscal year is the 52 or 53 week period that ends on the last Sunday of June.


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Transactions

Transactions are events that affect the operations orfinances of an organisation.

Analyze each transaction from the perspective of a company!

Accounting systems record transactions.

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Transaction analysis

Transaction analysis involves an examination of each

business transaction with the aim of understanding its effecton the accounting equation (i.e. A=L+SE).

Example: Borrow $10 000 from the bank.• A liability (source) has increased Loan

• An asset (resource) has increased Cash

After this transaction the accounting equation is in balance.

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Transaction analysis: The accounting equationextended

The equation you were introduced to earlier is asfollows:

Assets = Liabilities + Equity

This is extended to:

A = L + SE

CA + NCA = CL + NCL + SE

What is SE made up of?

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Expanding the accounting equation

A = L + SECA + NCA = CL + NCL + SEWhere SE:

SC + opening RP at the start of the period + RP for the period SC + opening RP + profit – dividends SC = Capital contributions by equity holders (share capital)

RP = Retained profits Op RP = Opening retained profits Profit = R – E R = Revenue E = Expenses

Dividends = Distributions to equity holders

CA + NCA = CL + NCL + SC + Op. RP + R – E – D

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Link between the balance sheet and the income

statement

Income statement

16

Balance sheet

CA + NCA = CL + NCL + SC + Op. RP + R – E – D

CA + NCA = CL + NCL + SE


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Let’s consider seven transactions.

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Transaction 1

Issued shares for $300 000 cash.

A = L + SE

Does the accounting equation balance?

YES! It must balance!

18

Share capitalCash


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Transaction 1

Issued shares for $300 000 cash.

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= Liabilities +

CashAccounts

Receivable Equipment Bank LoanShare

CapitalRetainedProfits

1 +300,000 +300,000

Assets Shareholders’ equity


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Transaction 2

Borrowed $50 000 cash from the bank.

A = L + SE



20

Bank LoanCash


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Transaction 2

Borrowed $50 000 cash from the bank.

21

= Liabilities +

Cash

Accounts

Receivable Equipment Bank Loan

Share

Capital

Retained

Profits1 +300,000 +300,000

2 +50,000 +50,000



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Transaction 3

Purchase equipment for $100 000 cash.

A = L + SE



22

Equipment

Cash


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Transaction 3

Purchase equipment for $100 000 cash.

23

= Liabilities +

Cash

Accounts


Share

Capital

Retained

Profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000



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Transaction 4

Signed six-month agreement to provide catering service for

a monthly fee of $2500 starting next month.

A = L + SE

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Transaction 4

Not a transaction:

no service provided.

no current right to receive.

no cash movement that needs to be recorded.

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Transaction 5

Catering services provided for an office function; billed

customer for $2500.

A = L + SE



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Accountsreceivable

Revenue


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Transaction 5

Catering services provided for an office function; billed

customer for $2500.

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= Liabilities +

Cash

Accounts


Share

Capital

Retained

Profits1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000

4

5 +2,500 +2,500

Assets Shareholders' equity

Revenue


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Transaction 6

Customer paid $2500 they owed on their account.

A = L + SE



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Accountsreceivable

Cash


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Transaction 6

Customer paid $2500 they owed on their account.

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Assets = Liabilities + Shareholders’ equity

Cash Accsrec.

Equipment Bank loan Sharecapital

Retainedprofits

1 !""#""" !""#"""

$ %"#""" %"#"""

! &1""#""" 1""#"""

'

% $#%"" $#%""

( $#%"" &$#%""

Revenue


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Transaction 7

Paid the bank $5000 as part repayment of the loan.

A = L + SE



30

Bank loanCash


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Transaction 7

Paid the bank $5000 as part repayment of the loan.

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Cash Accsrec.


Retainedprofits

1 !""#""" !""#"""

$ %"#""" %"#"""

! &1""#""" 1""#"""

'

% $#%"" $#%""

( $#%"" &$#%""

) &%#""" &%#"""

Revenue


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Transaction analysis complete


Cash Accsrec.


Retainedprofits

1 !""#""" !""#"""

$ %"#""" %"#"""

! &1""#""" 1""#"""

'

% $#%"" $#%""

( $#%"" &$#%""

) &%#""" &%#"""

$')#%"" " 1""#""" = '%#""" + !""#""" $#%""

!')#%"" = '%#""" + !"$#%""

A = L + SE

Revenue

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Balance sheet

33

ASSETS LIABILITIES

Cash $') %"" Bank loan '% """

Equipment 1"" """

SHAREHOLDERS’ EQUITY

Share capital !"" """Retained profits $ %""

!') %"" !') %""


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Income statement

34

Re*enue $ %""

E+pense "

,et profits $ %""

Revision Question 2


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Inventory was purchased for cash, when:

1. an asset increased and another asset decreased

2. an asset decreased and an expense increased

3. an asset decreased and a liability decreased

4. a liability increased and an expense increased

Revision Question 2

35


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An illustrative example: Prepare transaction analysis

LRM Ltd: Balances as at 1 April 2016

Cash 140 000Inventory 55 000

Land and buildings 300 000

Equipment 90 000

Accounts payable 15 000Notes payable 70 000

Loans 300 000

Share capital 200 000

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Transactions for April 2016

8 Cash sales of $30 000; Cost of goods sold = $12 000.

9 Credit sales of $40 000; Cost of goods sold = $16 000.

10 $8000 payments to suppliers on the account.

11 $20 000 wages paid for first 2 weeks of April.

12 Received invoice for $2000 for an advertisement onApril 5.

13 Received $25 000 from accounts receivable.

14 At end of month: $18 000 wages is owing for last 2weeks of the month. Due to be paid on May 1.

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LRM Ltd: Exhibit 3.3, page 90

38

Transaction Cash

Accounts

receivable Inventory

Land and

building Equipment

Accounts

payable

Notes

payable

Wages

payable Loans

Share

Capital

Retained

profitsOpening

balance

140,000 0 55,000 300,000 90,000 15,000 70,000 0 300,000 200,000 0

8 30,000 30,000 Revenues

-12,000 -12,000 Expenses

9 40,000 40,000 Revenues

-16,000 -16,000 Expenses

10 -8,000 -8,000

11 -20,000 -20,000 Expenses

12 2,000 -2,000 Expenses

13 25,000 -25,000

14 18,000 -18,000 Expenses

Closingbalance 167,000 15,000 27,000 300,000 90,000 9,000 70,000 18,000 300,000 200,000 2,000

Assets 599,000 Liabilities 397,000

Stockholder's

equity 202,000

A=L+SE


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LRM Ltd

-ncome statement for the month ended !" April $"1(

. .

Sales )" """Cost of /oods sold $0 """

ross profit '$ """2peratin/ e+penses3a/es !0 """Ad*ertisin/ $ """ '" """

,et profit $ """

LR4 Ltd5 E+hibit !.'# pa/e 61

39

LR4 L d E hibi ! % 61


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LRM Ltd

Balance sheet as at !" April $"1(

Assets Liabilities and shareholders e!it"

. .#!rrent assets #!rrent liabilities

Cash 1() """ Accounts payable 6 """Accounts recei*able 1% """ ,otes payable )" """-n*entory $) """ 3a/es payable 10 """

$"6 """ 6) """

$on%&!rrent assets $on%&!rrent liabilities

Land and buildin/ atcost !"" """ Loans !"" """

2ffice equipment atcost

6" """ Total liabilities !6) """

!6" """Shareholders’ e!it" Share capital $"" """

Retained profit 7 $ """Total shareholders’

e!it" $"$ """

Total assets %66 """Total liabilities and

shareholders’ e!it" %66 """

7 Retained profit 8 openin/ retained profits 9": profit 9$""":; di*idends declared 9": 8 $"""

LR4 Ltd5 E+hibit !.%# pa/e 61

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Revision Question 3


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Additional credit sales of $2m (cost of sales $1.5m)

are made on credit. This transaction will:

1. increase net profit, increase cash, and increasetotal assets

2. increase net profit, increase total assets but not

affect cash3. increase net profit, and not affect cash or total

assets

4. increase net profit, increase cash.

Revision Question 3

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Double entry accounting

A = L + SE

42

The accounting equation ust al!a"s #alance

$t eans De#its = C%e&its.

The 'ol&en Rule(

$n accounting !e use &e#it )D%* an& c%e&it )C%* to &esc%i#e

changes in accounts


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Debit–credit convention

• Remember the equation:

Assets = Liabilities + Equity

• We define increases in Assets to be debits (DR) – decreases in Assets therefore must be credits (CR).

• DR = CR, therefore increases in Liabilities (and Equity)

must be credits, decreases must be debits.

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Assets (+A) Liabilities (+L)

Capital (+SE)

Expenses (+E) Revenues (+R)

Uses of Funds Sources of Funds Always record on the

right-hand side

Always record on the

left-hand side

Simultaneous

recording of the use of

funds and the source of

funds

Basic orientation of the “double-entry bookkeeping system”

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Double entry system: Debit and Credit

Debit Credit

+A +L+SE

+E +R

-L -A

-SE

-R -E

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Remembering debits/credits

Type Normal Incr. Decr.

Assets Debit Debit Credit

Liabilities Credit Credit Debit

Shareholder’s equity Credit Credit Debit

Revenues Credit Credit Debit

Expenses Debit Debit Credit

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Debit and credit (Critical thinking)

Company record v.s. Bank statement

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Journal entries

• Journal entries are, essentially, a shorthand version ontransaction analysis.

• They are prepared using the rules of debit and credit.• Debits must always equal credits.

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Journal entries

Example

Machinery is purchased for $10 000 cash.

Journal entry:

Dr Machinery 10 000

Cr Cash 10 000

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Revision Question 4


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Which of the following accounts does NOT normally have a creditbalance?

1. accounts payable

2. retained profits

3. tax payable4. prepaid expenses.

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Revision Question 5


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Identify the journal entry required to correctly record the followingtransactions.

Cash received from accounts receivable

1. Dr Accounts Receivable Cr Cash

2. Dr Cash Cr Accounts Payable

3. Dr Cash Cr Accounts Receivable

4. none of the above

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Revision Question 6


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Identify the journal entry required to correctly record the followingtransactions.

Cash dividends of $20,000 declared and paid.

1. Dr Retained profits 20,000 Cr Dividends payable 20,000

2. Dr Cash 20,000 Cr Retained profits 20,000

3. Dr Retained profits 20,000 Cr Cash 20,000

4. none of the above

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Appendix Dividends


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Appendix- Dividends

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The dividends recommended by directors are authorised by shareholders at an

annual meeting: (Declaration)

Dr Retained profits 20,000 (-SE)

Cr Dividends payable 20,000 (+L)

When the final dividends are paid: (Payment)

Dr Dividends payable 20,000 (-L)

Cr Cash 20,000 (-A)

Revision Question 7


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Which of the following are debits?

1. contributions of capital

2. increases in revenues

3. increases in liabilities

4. decreases in owners’ equity.

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Link transaction analysis and journal entries


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Link transaction analysis and journal entries

Back to the previous transactions.

Prepare journal entries for transaction 1-7. Prepare journal entries for LRM ltd.

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Transaction 1 7


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Transaction 1-7

1: Issued shares for $300 000 cash.

2: Borrowed $50 000 cash from the bank.

3: Purchase equipment for $100 000 cash.

4: Signed six-month agreement to provide cateringservice for a monthly fee of $2500 starting next month.

5: Catering services provided for an office function; billedcustomer for $2500.

6: Customer paid $2500 they owed on their account.

7: Paid the bank $5000 as part repayment of the loan.

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Solution: Transaction 1 7


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Solution: Transaction 1-7

1.

2.

3.

4.

5.

6.

7.

57



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8 Cash sales of $30 000; Cost of goods sold = $12 000.

9 Credit sales of $40 000; Cost of goods sold = $16 000.

10 $8000 payments to suppliers on the account.

11 $20 000 wages paid for first 2 weeks of April.

12 Received invoice for $2000 for an advertisement on

April 5.

13 Received $25 000 from accounts receivable.

14 At end of month: $18 000 wages is owing for last 2

weeks of the month. Due to be paid on May 1.

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Solution: LRM ltd case 8.

9.

10.

11. 12.

13.

14.

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Application of journal entries


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Application of journal entries

Depreciation: The more details will be covered

in week 8 (noncurrent assets)

Dr Depreciation expense xxx (+E)Cr Accumulated depreciation xxx (-A)

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Wrap-Up


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• Double entry system: Debits and Credits – Debits Credits

+A +L

+SE+E +R

-L -A

-SE

-R -E

Relationship between transaction analysis and journal

entries Negative values in transaction analysis mean theabnormal side in journal entries.

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Next Lecture…


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62

Record-Keeping

Please bring comprehensive class example fromthe moodle.

Appendix


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pp

Accounts payable (AP)

Accounts payable are dollar amounts owed to othersfor goods, supplies, and services purchased on openaccount.

Notes payable (NP)

Notes payable is evidenced by a promissory note orbill of exchange. (e.g. credit purchase of equipment)

The interest-bearing characteristic and the writtendocumentation distinguish NP from AP.

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