CHAPTER 2

Accounting Methods for Measuring Performance

CASH BASIS OF ACCOUNTING VS

ACCRUAL BASIS OF ACCOUNTING

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Accounting Methods for Measuring Performance

(a) Cash basis of accounting
Revenues are recognized when cash is received and expenses are recognized when cash is paid

(b) Accrual basis of accounting

Revenues and expenses are recognized on an economic basis regardless of when cash is paid or received

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Success Service Corporation - Dry Cleaning Company

TL 3.000 bank loan in January 2007- loan due 30 June 2007- monthly interest expense of TL 100. Paid two months rent on 1 January 2007 total TL 200 Paid insurance premium of TL 120 to cover the whole year from January 1 to December 31 Purchased supplies of TL 90 to be used for 3 months and paid TL 75 of it; agreed to pay the rest in February In January-provided TL 750 worth of services and collected cash of TL 500 from customers; the rest would be collected next month Paid salaries of TL 500 at the end of January
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SUCCESS SERVICE CORPORATION Measurement of Performance on Cash Basis For the Period Ending 31 January 2007 Cash Receipts from Services Rendered Less: Cash Expenditures for Supplies Salaries Rent Insurance Total Cash Expenditures Excess of Cash Expenditures over Cash Receipts
Chapter 2 Mugan-Akman 2007

TL 500

75 500 200 120 895

TL -395
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Accounting Methods for Measuring Performance

(a) Cash basis of accounting
Revenues are recognized when cash is received and expenses are recognized when cash is paid

(b) Accrual basis of accounting

Revenues and expenses are recognized on an economic basis regardless of when cash is paid or received

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SUCCESS SERVICE Income Statement For the Month Ended 31 January Revenues: Dry Cleaning Fees 750 Expenses: Salaries Interest Rent Expense Supplies Insurance Expenses Total Expenses Net Income Before Taxes
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500 100 100 30 10 740 TL 10

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Recognition of Revenues
Sales order 3 May
Shipment of the goods 5 May

MILLENIUM CO.

Receipt of the computer 6 May

Receipt of the bill 7 May

Payment of the bill 20 May

CUSTOMER

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Recognition of Service Revenues

Accrual basis of accounting generally requires that revenues be recognized when both of the following conditions are met: A company has performed all (or the major part of) the services, or has delivered the goods; i.e., when there is little or no uncertainty regarding the exchange of goods or services, and The price of the services or goods has been accepted by both seller and buyer, and seller has received either cash or some other form of asset, enabling reasonable determination of the time of payment (such as accounts receivable, which is the buyers promise to pay)
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Recognition of Expenses
Expenses are recognized when they are incurred and helped to produce revenue, regardless of the cash payment date

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Generally Accepted Accounting Principles and Concepts

Entity - Every entity is a separate economic unit and should be kept distinct from the activities of its owners and other companies Monetary Unit - only economic events that have monetary transactions will be reported in the financial statements Cost Principle - assets are presented at their original (historical) cost Going Concern - companies are established with the goal that they will operate for an indefinitely long period of time Periodicity - economic activities of any firm can be divided into discrete time periods for reporting purposes Matching Principle -all revenues must be recorded in the accounting period in which the goods are sold or services are rendered and all expenses must be recorded in the accounting period in which they are incurred to produce such revenues
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Accounting Cycle
Post the transactions and prepare trial balance

Analyze and record the transactions

Adjust the accounts and prepare trial balance

Prepare the financial statements

Chapter 2

Close the accounts and prepare trial balance

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Analysis and Recording Business Transactions

Business transaction is an economic event that causes a change in the financial position Financial Position:
What we own How we own

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Fundamental Accounting Equation

ASSETS = EQUITIES

ASSETS = LIABILITIES + OWNERS' EQUITY

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How do we use the balance sheet equation?

Recall the Balance Sheet Equation: Assets = Liabilities + Shareholders Equity Implications: If assets increase : either Liabilities and/or Shareholders should also increase and vice versa For example: borrow cash, cash (asset) will increase and Liabilities will increase when it is paid back: cash (asset) will decrease and liabilities will decrease
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How do we record?
an ACCOUNT: accounting report of a specific asset, liability or owners equity item Has 3 elements: title, debit side and credit side (also called the T-Account) Changes in the accounts are entered manually into a book called a ledger computerized Basic forms of book ledgers: the two-column account format, and the four-column account format Chart of accounts
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Forms of Ledgers
Two-Column Account
Account Account No: Date Item Post. Ref. * Debit Date Item Posting Reference Credit

T-Account form that depicts the two-column account:

Account Name Account No:

Left-hand or Debit Side

Right-hand or Credit Side

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How do accounts behave?

Assets = Liabilities + Shareholders Equity + + + So Assets increase on the left hand or debit side then they decrease on the credit side Assets + debit credit
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Behavior of Accounts
Liabilities and Owners Equity accounts increase on the credit side, decrease on the debit side Liabilities or Owners Equity Accounts debit
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+ credit
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Transaction Analysis and The Duality Concept

if an asset account increases, because of duality concept there must be a corresponding 1. increase in a specific liability account 2. or a decrease in a another asset account 3. or an increase in owners' equity account.
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Illustration of Express Travel Agency

1. Ms. Fodor invested TL100.000 at the inception

Event Assets Liabilities Owners No Equity 1 +100.000 No change +100.000 Total 100.000 0 100.000
GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit 1 Jan 2004 Cash Capital Investment by the shareholders
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Credit 100.000

100 100.000 500

2. On 1 January employed a full time secretary and a

sales representative.

Event No

Total

Assets Liabilities Owners Equity 1 +100.000 No change +100.000 2 No change No change No change 100.000 0 100.000

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3. On 1 January rented an office building and paid 3 months rent of TL 600.

Event No Assets 1 +100.000 2 No change 3 +600 -600 100.000 Liabilities Owners Equity No change +100.000 No change No change No change No change No change No change 0 100.000
Credit 600

Total

GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit 1 Jan 2004 Prepaid Rent Cash Payment of 3 months of rent in advance
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180 100

600

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4. On 2 January office furniture and equipment is purchased for TL 15.000 , for which TL 5.000 is paid in cash and the rest would be paid later in January and February 2007.
Event No 1 2 3 4 Total Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 110.000 10.000 100.000
Page 1 Debit Credit 5.000 10000
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GENERAL JOURNAL 2 Jan 2004 Furniture and Equipment

Date Account Title and Description Acct.No Cash Accounts Payable Purchase of furniture and equipment
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255 15.000 100 320

5. On 3 January insured the office building and the equipment effective from 1 January to 31 December 2004 and paid TL 120 for the whole period.
Event No 1 2 3 4 5 Total Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 110.000 10.000 100.000

GENERAL JOURNAL 3 Jan 2004 Prepaid Insurance

Page 1 Credit 120

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Date Account Title and Description Acct.No. Debit 180 100 120 Cash Purchase of insurance policy
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6. On 5 January the company agreed with Turkish Airlines to sell airline tickets of THY and receive commissions in return.
Event No 1 2 3 4 5 6 Total Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change 110.000 10.000 100.000

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7. On 10 January Express Travel Agency borrowed TL 15.000 from the bank at an annual interest rate of 24% for six months. The principal and the interest of the loan will be paid together on 10 July 2007.
Event No 1 2 3 4 5 6 7 Total
Chapter 2

Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change +15.000 +15.000 No change 125.000 25.000 100.000
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7. On 10 January Express Travel Agency borrowed TL 15.000 from the bank at an annual interest rate of 24% for six months. The principal and the interest of the loan will be paid together on 10 July 2004.

GENERAL JOURNAL 10 Jan 2004 Cash

Page 1 Credit 15.000 100 15.000 300

Date Account Title and Description Acct.No. Debit Bank Loan Borrowing from the bank

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8. On 10 January purchased office supplies for TL 2.500 in cash.

Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change +15.000 +15.000 No change +2.500 No change No change -2.500 125.000 25.000 100.000
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Event No 1 2 3 4 5 6 7 8 Total
Chapter 2

8. On 10 January purchased office supplies for TL 2.500 in cash.

GENERAL JOURNAL 10 Jan 2004 Office Supplies

Page 1 Debit 2.500 2.500 Credit 136 100

Date Account Title and Description Acct.No. Cash Purchase of office supplies

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9. During the first half of January the agency sold tickets to various customers and on 16 January issued a commission invoice to THY amounting to TL 5.000 that will be collected later in January 2007. Event No Assets Liabilities Owners Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 Total 130.000 25.000 105.000
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9. During the first half of January the agency sold tickets to various customers and on 16 January issued a commission invoice to THY amounting to TL 5.000 that will be collected later in January 2004.
Revenue Accounts Left or Debit Side Right or Credit Side Decrease Increase

GENERAL JOURNAL 16 Jan 2004 Accounts Receivable

Page 1 Credit 5.000 120 5.000

Date Account Title and Description Acct.No. Debit Commission Revenue 600 Recognition of commission on ticket sales

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10. On 20 January the company paid TL 5.000 for the furniture and equipment that were purchased on 2 January. Event No Assets Liabilities Owners Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 7 +15.000 +15.000 No change 8 +2.500 No change No change -2.500 9 +5.000 No change +5.000 10 -5000 -5000 No change Total 125.000 20.000 105.000
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10. On 20 January the company paid TL 5.000 for the furniture and equipment that were purchased on 2 January.

GENERAL JOURNAL 20 Jan 2004 Accounts Payable

Page 1 Credit 5.000 320 100 5.000

Date Account Title and Description Acct.No. Debit Cash Payment for an accounts payable

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11. On 22 January received TL 7.500 from a customer for organizing the accounting conference that will be held on February 2, 2004.
Event No 1 2 3 4 5 6 7 8 9 10 11 Total
Chapter 2

Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change +15.000 +15.000 No change +2.500 No change No change -2.500 +5.000 No change +5.000 -5.000 -5.000 No change +7.500 +7.500 No change 132.500 27.500 105.000
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11. On 22 January the company received TL 7.500 from a customer for organizing the accounting conference that will be held on 2 February 2007.

GENERAL JOURNAL 22 Jan 2004 Cash

Page 1 Credit 7.500 100 7.500

Date Account Title and Description Acct.No. Debit Unearned Revenues 340 Receipt of advance payment from a customer

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12. The company received the full payment of commission charged to THY of TL 5.000 on 23 January.
Event No 1 Assets Liabilities Owners Equity +100.000 No No No No change change change change +100.000 No change No change No change No change +10.000 No change No change +15.000 No change No change -5.000 +7.500 No change 27.500

Total
Chapter 2

2 No change 3 +600 -600 4 +15.000 -5.000 5 +120 -120 6 No change 7 +15.000 8 +2.500 -2.500 9 +5.000 10 -5.000 11 +7.500 12 +5.000 -5.000 132.500

No change No change No change No change +5.000 No change No change No change 105.000

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12. The company received the full payment of commission charged to THY of TL 5.000 on 23 January.

GENERAL JOURNAL 23 Jan 2004 Cash

Page 1 Credit 5.000 100 120 5.000

Date Account Title and Description Acct.No. Debit Accounts Receivable Receipt of payment from a customer

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13. On 24 January paid salaries of TL 9.000 employees in cash.

Event No Assets 7 8 9 10 11 12 13 Total

Chapter 2

Liabilities +15.000 No change No change -5.000 +7.500 No change No change 27.500

Owners Equity No change No change +5.000 No change No change No change -9.000 96.000
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+15.000 +2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 -9.000 123.500

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13. On 24 January paid salaries of TL 9.000 employees in cash.

Expense Accounts Left or Debit Side Right or Credit Side Increase Decrease

GENERAL JOURNAL 24 Jan 2004 Salary Expense Cash Payment of salaries

Page 1 Debit 9.000 9.000 Credit 770 100

Date Account Title and Description Acct.No.

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14. During the second half of January the agency sold tickets to various customers and on 31 January issued a commission invoice to THY amounting to TL 7.500 which will be collected in February 2004.

Event No Assets 8 9 10 11 12 13 14 Total

Chapter 2

Liabilities Owners Equity No change No change -5.000 +7.500 No change No change No change 27.500 No change +5.000 No change No change No change -9.000 +7.500 103.500
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+2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 -9.000 +7.500 131.000

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14. During the second half of January the agency sold tickets to various customers and on 31 January issued a commission invoice to THY amounting to TL 7.500 which will be collected in February 2007.

GENERAL JOURNAL 31 Jan 2004 Accounts Receivable

Page 1 Credit 7.500 120 7.500

Date Account Title and Description Acct.No. Debit Commission Revenues 600 Recognition of commission on ticket sales

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15. Ms. Fodor withdrew TL 3.000 on 31 January for personal use.

Event No Assets 7 8 9 10 11 12 13 14 15 Total
Chapter 2

Liabilities Owners Equity +15.000 No change No change -5.000 +7.500 No change No change No change No change 27.500 No change No change +5.000 No change No change No change -9.000 +7.500 -3.000 100.500
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+15.000 +2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 -9.000 +7.500 -3.000 128.000

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15. Ms. Fodor withdrew TL 3.000 on 31 January for personal use.

Owners' Withdrawals or Dividends Left or Debit Side Right or Credit Side Increase Decrease

GENERAL JOURNAL 31 Jan 2004 Withdrawals

Page 1 Credit 3.000 XXX 600 3.000

Date Account Title and Description Acct.No. Debit Cash Withdrawal by the owner

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Summary
1. determine the effects of transactions on three components of the accounting equation, 2. determine which specific accounts are affected, and 3. assure that total of the increases should be equal to either increases on the other side of the equation or to decreases on the same side, or a combination there of.
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Behavior Summary
Assets = + Dr Cr Liabilities + + Dr Cr Owners Equity + Dr Cr Expense Revenue + + Dr Cr Dr Cr Withdrawals/Dividends + Dr Cr
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Accounting Cycle
Analyze and record the transactions Adjust the accounts and prepare trial balance

Post the transactions and prepare trial balance

Prepare the financial statements

Close the accounts and prepare trial balance

Mugan-Akman 2007 47-52

Chapter 2

Posting to The Ledger

GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit 1 Jan 2004 Cash Capital Investment by the shareholders
LEDGER - Cash Date Description Acc. No. 100 Ref Debit

Credit 100.000

100 100.000 500

Credit Debit Credit Balance Balance 1 Jan 2004 Investment by the shareholders P 1 100.000 100.000
LEDGER - Capital Date Description Acc. No. 500 Ref Debit Credit 100.000 Debit Credit Balance Balance 100.000
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1 Jan 2004 Investment by the shareholders P 1

Chapter 2 Mugan-Akman 2007

LEDGER - Cash Acc. No. 100 Date Description 1 Jan 1 Jan 2 Jan 3 Jan 10 Jan 10 Jan 20 Jan 22 Jan 23 Jan 24 Jan 31 Jan Investment by the shareholders Payment of office rent Purchase of office furniture and equipment Payment of insurance Borrowing from the bank Purchase of office supplies Payment for an accounts payable Receipt of advance payment from a customer Receipt of payment from a customer Payment of salaries Withdrawal by the owner Ref Debit P 1 100.000 P1 P1 P1 P 1 15.000 P1 P1 P1 7.500 P1 5.000 P1 P1 Credit Debit Balance 100.000 600 99.400 5.000 94.400 120 94.280 109.280 2.500 106.780 5.000 101.780 109.280 114.280 9.000 105.280 3.000 102.280

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Express Travel Agency Trial Balance 31 January 2004 in TL Accounts Debit Credit Cash 102.280 Accounts Receivable 7.500 Office Supplies 2.500 Prepaid Rent 600 Prepaid Insurance 120 Office Furniture and Equipment 15.000 Bank Loan 15.000 Accounts Payable 5.000 Unearned Revenues 7.500 Capital 100.000 Withdrawal 3.000 Commission Revenues 12.500 Salary Expenses 9.000 Total 140.000 140.000
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Trial Balance

Normal Balances of Accounts

Category of the Account Increase Recorded By Debits Credits Normal Balance Assets Liabilities Shareholders Equity Capital Dividends or Withdrawals Revenues Credits Debits Credits Credit Debit Credit Debit Credit

Expenses

Debits

Debit

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Chapter 2

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