ch02-191207003518 (1).pdf principle of a

Sure, let's go through the main concepts of financial statements, their advantages and disadvantages, and provide examples and relevant ratio calculations.
Main Financial Statements
1. Income Statement
2. Balance Sheet
3. Cash Flow Statement
4. Statement of Changes in Equity
1. Income Statement
Concept:
• Shows the company's revenues, expenses, and profits or losses over a specific period.
• Key components include revenues, cost of goods sold (COGS), gross profit, operating expenses, operating income, interest, taxes, and net income.
Advantages:
• Provides a clear picture of profitability.
• Helps in assessing operational efficiency.
• Useful for trend analysis over different periods.
Disadvantages:
• Can be manipulated through accounting practices.
• Does not provide a complete financial health picture (e.g., cash flow).
Example:
Sure, let's go through the main concepts of financial statements, their advantages and disadvantages, and provide examples and relevant ratio calculations.
Main Financial Statements
1. Income Statement
2. Balance Sheet
3. Cash Flow Statement
4. Statement of Changes in Equity
1. Income Statement
Concept:
• Shows the company's revenues, expenses, and profits or losses over a specific period.
• Key components include revenues, cost of goods sold (COGS), gross profit, operating expenses, operating income, interest, taxes, and net income.
Advantages:
• Provides a clear picture of profitability.
• Helps in assessing operational efficiency.
• Useful for trend analysis over different periods.
Disadvantages:
• Can be manipulated through accounting practices.
• Does not provide a complete financial health picture (e.g., cash flow).
Example:

1. 2-1
The Recording Process2
Learning Objectives
Describe how accounts, debits, and credits are used to record
business transactions.
Indicate how a journal is used in the recording process.
Explain how a ledger and posting help in the recording process.3
Prepare a trial balance.
2
1
4

2. 2-2Account Name
Debit / Dr. Credit / Cr.
Record of increases and decreases
in a specific asset, liability, owners’
equity, revenue, or expense item.
Debit = “Left”
Credit = “Right”
The
Account
An account can be
illustrated in a T-
account form.
LEARNING
OBJECTIVE
Describe how accounts, debits, and credits are
used to record business transactions.
1
LO 1

3. 2-3
Double-entry system
Each transaction must affect two or more accounts to
keep the basic accounting equation in balance.
Recording done by debiting at least one account and
crediting at least one other account.
DEBITS must equal CREDITS.
DEBIT AND CREDIT PROCEDURES
The Account
LO 1

4. 2-4Account Name
Debit / Dr. Credit / Cr.
$10,000 Transaction #2$3,000
8,000
Balance
Transaction #1
Transaction #3
If the sum of Debit entries are greater thanthe sum of
Credit entries, the account will have a debit balance.
$15,000
Debits and Credits
LO 1

5. 2-5Account Name
Debit / Dr. Credit / Cr.
If the sum of Credit entries are greater thanthe sum of
Debit entries, the account will have a credit balance.
$10,000 Transaction #2$3,000
8,000 Transaction #3
Balance
Transaction #1
$1,000
Debits and Credits
LO 1

6. 2-6
Assets-Debits should exceed
credits.
Liabilities–Credits should
exceed debits.
Normal balanceis on the
increase side.Chapter
3-23
AssetsAssets
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance Chapter
3-24
LiabilitiesLiabilities
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
Debits and Credits
LO 1

7. 2-7
Owner’s investmentsand revenues
increase owner’s equity (credit).
Owner’s drawingsand expenses
decrease owner’s equity (debit).Chapter
3-25
Debit / Dr. Credit / Cr.
Normal Balance
Owner’s Capital Chapter
3-23
Owner’s Drawing
Debit / Dr. Credit / Cr.
Normal Balance Chapter
3-25
Debit / Dr. Credit / Cr.
Normal Balance
Owner’s Equity
Debits and Credits
Helpful Hint Because
revenues increase owner’s
equity, a revenue account
has the same debit/credit
rules as the Owner’s
Capital account. Expenses
have the opposite effect.
LO 1

8. 2-8Chapter
3-27
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
ExpenseExpense Chapter
3-26
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
RevenueRevenue
Debits and Credits
The purpose of earning revenues
is to benefit the owner(s).
The effect of debits and credits on
revenue accounts is the same as
their effect on Owner’s Capital.
Expenseshave the opposite effect:
expenses decrease owner’s equity.
LO 1

9. 2-9Chapter
3-23
AssetsAssets
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance Chapter
3-27
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
ExpenseExpense
Normal
Balance
Credit
Normal
Balance
Debit
Debits/Credits RulesChapter
3-24
LiabilitiesLiabilities
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance Chapter
3-25
Debit / Dr. Credit / Cr.
Normal Balance
Owner’s Equity Chapter
3-26
Debit / Dr. Credit / Cr.
Normal BalanceNormal Balance
RevenueRevenue
LO 1

10. 2-10
Balance Sheet Income Statement
= + -Asset LiabilityEquityRevenueExpense
Debit
Credit
Debits/Credits Rules
LO 1

11. 2-11
Debits:
a.increase both assets and liabilities.
b.decrease both assets and liabilities.
c.increase assets and decrease liabilities.
d.decrease assets and increase liabilities.
Debits/Credits Rules
Question
LO 1

12. 2-12
Accounts that normally have debit balances are:
a.assets, expenses, and revenues.
b.assets, expenses, and equity.
c.assets, liabilities, and owner’s drawing.
d.assets, owner’s drawing, and expenses.
Debits/Credits Rules
Question
LO 1

13. 2-13
Illustration 2-11
Assets = Liabilities +
Basic
Equation
Expanded
Equation
Debit/Credit
Effects
Summary of Debit/Credit Rules
Relationship among the assets, liabilities and owner’s equity
of a business:
The equation must be in balance after every transaction. Total
Debitsmust equal total Credits.
Owner’s Equity
LO 1

14. 2-14
1 Normal Account Balances
Kate Browne has just rented space in a shopping mall. In this space,
she will open a hair salon to be called “Hair It Is.” A friend has advised
Kate to set up a double-entry set of accounting records in which to
record all of her business transactions. Identify the balance sheet
accounts that Kate will likely need to record the transactions needed
to open her business. Indicate whether the normal balance of each
account is a debit or a credit.
Assets
Cash (debit)
Supplies (debit)
Equipment (debit)
Liabilities
Notes payable (credit)
Accounts payable
(credit)
Equity
Owner’s Capital (credit)
DO IT!
LO 1

15. 2-15
Business documents, such as a sales slip, a check, or a bill,
provide evidence of the transaction.
Analyze each transaction Enter transaction in a journal
Transfer journal information to
ledger accounts
Steps in the Recording Process
LEARNING
OBJECTIVE
Indicate how a journal is used in the
recording process.
2
Illustration 2-12
LO 2

16. 2-16
Book of original entry.
Transactions recorded in chronological order.
Contributions to the recording process:
1.Discloses the complete effects of a transaction.
2.Provides a chronological recordof transactions.
3.Helps toprevent or locate errorsbecause the debit
and credit amounts can be easily compared.
The Journal
Steps in the Recording Process
LO 2

17. 2-17
JOURNALIZING-Entering transaction data in the journal.
Illustration:On September 1, Ray Neal invested $15,000 cash in
the business, and Softbyte purchased computer equipment for
$7,000 cash.Account Title Ref.Debit CreditDate
Cash
Owner’s Capital
Sept. 1 15,000
15,000
GENERAL JOURNAL
Equipment
Cash
7,000
7,000
Illustration 2-13
Steps in the Recording Process
LO 2

18. 2-18Account Title Ref.Debit CreditDate
SIMPLE AND COMPOUND ENTRIES
Illustration:On July 1, Butler Company purchases a delivery truck
costing $14,000. It pays $8,000 cash now and agrees to pay the
remaining $6,000 on account.
Equipment
Cash
July 1 14,000
8,000
6,000Accounts payable
Illustration 2-14
Compound journal entry
Steps in the Recording Process
GENERAL JOURNAL
LO 2

19. 2-19 LO 2

20. 2-20
DO IT!
Kate Browne engaged in the following activities in establishing
her salon, Hair It Is:
1.Opened a bank account in the name of Hair It Is and
deposited $20,000 of her own money in this account as her
initial investment.
2.Purchased equipment on account (to be paid in 30 days) for
a total cost of $4,800.
3.Interviewed three persons for the position of hair stylist.
Prepare the entries to record the transactions.
2 Recording Business Activities
LO 2

21. 2-21
DO IT!2 Recording Business Activities
Prepare the entries to record the transactions.
1.Opened a bank account and deposited $20,000.
2.Purchased equipment on account (to be paid in 30 days) for
a total cost of $4,800.
3.Interviewed three persons for the position of hair stylist.
Cash 20,000
Owner’s Capital 20,000
Equipment 4,800
Accounts Payable 4,800
No entry
LO 2

22. 2-22
General Ledgercontains all the asset, liability, and owner’s
equity accounts.
Illustration 2-15
The Ledger
LEARNING
OBJECTIVE
Explain how a ledger and posting help in the
recording process.
3
LO 3

23. 2-23 LO 3

24. 2-24
The Ledger
STANDARD FORM OF ACCOUNT
Illustration 2-16
Three-column form
of account
LO 3

25. 2-25
POSTING
Transferring
journal entries
to the ledger
accounts.
Illustration 2-17
Posting a journal
entry
Ledger
LO 3

26. 2-26
Posting:
a.normally occurs before journalizing.
b.transfers ledger transaction data to the journal.
c.is an optional step in the recording process.
d.transfers journal entries to ledger accounts.
Posting
Question
LO 3

27. 2-27
Chart of Accounts
Illustration 2-18
LO 3

28. 2-28
Follow these steps:
1. Determine what
type of account is
involved.
2. Determine what
items increased or
decreased and by
how much.
3. Translate the
increases and
decreases into
debits and credits.
Illustration 2-19
The Recording Process Illustrated
LO 3

29. 2-29
LO 3
Illustration 2-20
Purchase of office equipment

30. 2-30
Illustration 2-21
Receipt of cash
for future service
LO 3

31. 2-31
Illustration 2-22
Payment of monthly rent
LO 3

32. 2-32
Illustration 2-23
Payment for
insurance
LO 3

33. 2-33
Illustration 2-24
Purchase of supplies on credit
LO 3

34. 2-34
The Recording Process Illustrated
Illustration 2-25
Hiring of employees
LO 3

35. 2-35
Illustration 2-26
Withdrawal of cash by owner
LO 3

36. 2-36
Illustration 2-27
Payment of salaries
LO 3

37. 2-37
Illustration 2-28
Receipt of cash for services performed
LO 3

38. 2-38
Summary Journalizing and Posting
Illustration 2-29
LO 3

39. 2-39 Illustration 2-29 LO 3

40. 2-40
LO 3
Illustration 2-30

41. 2-41
DO IT!
Kate Brown recorded the following transactions in a general journal
during the month of March. Post these entries to the Cash account.
Mar. 4 Cash 2,280
Service Revenue 2,280
Mar. 15 Salaries and Wages Expense 400
Cash 400
Mar. 19 Utilities Expense 92
Cash 92
3 Posting
LO 3

42. 2-42
LEARNING
OBJECTIVE
Prepare a trial balance.4
Illustration 2-31
LO 4

43. 2-43
Trial balance may balance even when:
1.A transaction is not journalized.
2.A correct journal entry is not posted.
3.A journal entry is posted twice.
4.Incorrect accounts are used in journalizing or posting.
5.Offsetting errors are made in recording the amount of a
transaction.
Trial Balance
Limitations of a Trial Balance
LO 4

44. 2-44
Dollar Signs
Do not appear in journals or ledgers.
Typically used only in the trial balance and the financial
statements.
Shown only for the first item in the column and for the total
of that column.
Underlining
A single line is placed under the column of figures to be
added or subtracted.
Totals are double-underlined.
Dollar Signs and Underlining
LO 4

45. 2-45
A trial balance will not balance if:
a.a correct journal entry is posted twice.
b.the purchase of supplies on account is debited to Supplies
and credited to Cash.
c.a $100 cash drawing by the owner is debited to Owner’s
Drawing for $1,000 and credited to Cash for $100.
d.a $450 payment on account is debited to Accounts
Payable for $45 and credited to Cash for $45.
Trial Balance
Question
LO 4

46. 2-46 LO 4

47. 2-47
DO IT!4 Trial Balance
LO 4

48. 2-48
LO 4
DO IT!4 Trial Balance

49. 2-49
Key Points
Similarities
Transaction analysis is the same under IFRS and GAAP.
Both the IASB and the FASB go beyond the basic definitions
provided in the textbook for the key elements of financial
statements, that is assets, liabilities, equity, revenue, and
expenses. The implications of the expanded definitions are
discussed in more advanced accounting courses.
A Look at IFRS
LEARNING
OBJECTIVE
Compare the procedures for the accounting
process under GAAP and IFRS.
5
LO 5

50. 2-50
Key Points
Similarities
As shown in the textbook, dollar signs are typically used only in
the trial balance and the financial statements. The same practice
is followed under IFRS, using the currency of the country where
the reporting company is headquartered.
A trial balance under IFRS follows the same format as shown in
the textbook.
A Look at IFRS
LO 5

51. 2-51
Key Points
Differences
IFRS relies less on historical cost and more on fair value than do
FASB standards.
Internal controls are a system of checks and balances designed
to prevent and detect fraud and errors. While most public U.S.
companies have these systems in place, many non-U.S.
companies have never completely documented the controls nor
had an independent auditors attest to their effectiveness.
A Look at IFRS
LO 5

52. 2-52
The basic recording process shown in this textbook is followed by
companies across the globe. It is unlikely to change in the future. The
definitional structure of assets, liabilities, equity, revenues, and
expenses may change over time as the IASB and FASB evaluate their
overall conceptual framework for establishing accounting standards.
Looking to the Future
A Look at IFRS
LO 5

53. 2-53
Which statement is correct regarding IFRS?
a)IFRS reverses the rules of debits and credits, that is, debits
are on the right and credits are on the left.
b)IFRS uses the same process for recording transactions as
GAAP.
c)The chart of accounts under IFRS is different because
revenues follow assets.
d)None of the above statements are correct.
IFRS Self-Test Questions
A Look at IFRS
LO 5

54. 2-54
A trial balance:
a)is the same under IFRS and GAAP.
b)proves that transactions are recorded correctly.
c)proves that all transactions have been recorded.
d)will not balance if a correct journal entry is posted twice.
IFRS Self-Test Questions
A Look at IFRS
LO 5

55. 2-55
One difference between IFRS and GAAP is that:
a)GAAP uses accrual-accounting concepts and IFRS uses
primarily the cash basis of accounting.
b)IFRS uses a different posting process than GAAP.
c)IFRS uses more fair value measurements than GAAP.
d)the limitations of a trial balance are different between IFRS
and GAAP.
IFRS Self-Test Questions
A Look at IFRS
LO 5

56. 2-56
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