Basics of Accounting (The Language of Finance)

Devotional Introduction Video Discussion of Fundamentals Basic Accounting Problem Grade on Neatness Bring Back Problem on Wednesday Note: Use a Pencil & Take Good Notes

Business & Accounting

Accounting is the universal language of Business and Finance. More CEOs from fortune 500 companies have come up through the ranks of accounting than from any other area in business. Currently: 54% Small businesses and usually fail because of poor accounting understanding. Marriages usually fail because of poor financial management (80% of divorces are $$$$ related.) If you want to get ahead in business & marriage determine that you are going to understand accounting basics.

What do Accountants Account For?

Everything of value!

Terms
Assets: Tangible and Non-tangible resources of a business that have future value. Usually sub-classified as follows:

Quick Assets (Liquid Assets)

Cash Petty Cash Receivables - Securities

Current Assets (Turn into cash/use annually)

All the above + Inventories, Supplies

Fixed Assets (Depreciated over several yrs.)

Buildings, Equipment, Natural Resources

Land (Fixed, but never depreciated) Intangible Assets: Patents, Trademarks, Copyrights

What are your Assets?

Bank Account & Money in your pocket Car Clothes Books Stocks/Bonds/CDs Prepaid rent Computers & Electronic Equip. Knowledge???? Abilities????

Accounting Term: Liabilities

Other peoples claims against your assets!

What you owe!! Debts! Classified as:

Current Liabilities (one year debt)

Credit Card Debt, Accounts Payable Car, Mortgage, Note Payable

Long Term Liabilities

Unearned revenues Bonds (usually super long term)

What are your liabilities?

School Loan Car Loan Credit Card Balance J.C. Penny Account BYU-Idaho Amount Due

Capital or Owners Equity

The portion of your assets that you can legally claim. (Net Assets) What you really own legally. Assets (minus) Liabilities = Owners Equity (or Capital) Example (purchased a building for $500,000 with a 10% down payment ($50,000)

Cost of a building (sales price = Asset amount) $500,000 Less: What you still owe on the building (Liability) $450,000 Equals: Your equity in the building (Capital) or your net worth in the building. $50,000

Formula universally used in all financial and personal financial institutions:

Assets = Liability + Owners Equity (Balance Sheet Equation) (Resources you have) =(What you owe on them) + (the principle you have paid on them.)

Owners Equity Account Titles

Single Proprietorship:

Capital
Common Stock (what owners paid in) Preferred Stock (what owners paid in) Retained Earnings (profits that the business keeps in the business)

Corporation:

What is your net worth???

What you have minus what you owe. What format do we use in business and in personal finance to show our net worth?

A Balance Sheet Financial Statement

List of Assets (classified by type in accounts) Compared or balanced with:

List of Liabilities and Owners Equity (classified by type and in accounts)

Text Book Example Page 660

Example (Simplified)
John Does Business or Personal Records Balance Sheet September 10, 2003 Assets: Current: Cash at Home Cash Deposits in Bank Fixed: Wardrobe Equipment Car

$100 500 2000 1000 5000

Total Assets:
$500 $2000

$8,600

Liabilities: Current: Credit Card Payable Long Term: Note Payable (on Car) Total Liabilities Capital, John Doe: Total Liabilities & Owners Equity:

$2,500 6,100 $8,600

Other Terms
Temporary Accounts are used in addition to balance sheet accounts to record changes in owners equity each reporting period.

Expenses Decrease in owners equity during the period by using up an asset or a portion of an asset. (or creating additional liabilities) Revenue Increase in owners equity during the period by performing a service or selling an asset. Drawing or Dividends Decrease in owners equity due to personal withdrawals by the owner(s).

Income Statement Report

Used to determine the net income or net loss of an individual or business for a defined period of time.

Used for marking progress by comparing months and years Used by financial institutions for determining the progress and status of a company or individuals financial health. Used by the IRS for determining taxes

Income Statement What does it contain?

Matches Expenses with Revenues for a specific period of time. (Only the temporary type of accounts are on the income statement.) No Assets/Liabilities Income Statement accounts are closed out at the end of the reporting period and started over again the next period.so comparisons can be made. Personal Income Statement sometimes called a Cash Flow Statement example on page 661

Income Statement Example

Name of Individual or business Income Statement For period of time (Month of Sept. 2003) Revenue: Income from Job $500 Income from Pell Grant 2000 Total Revenue: Expenses: Clothes Expense $300 Rent Expense 200 Food Expense 50 Tuition Expense 1200 Misc. Expense 250 Total Expenses: Net Income for September:

$2500

$2000 $ 500

Pop Quiz Use a Pencil Today

1. Which financial report is a snapshot of the of the financial status of a business or a family..and is given a specific date? 2. Which financial report is a moving picture of the business/enterprise for a period of time? 3. What does a balance sheet balance? 4. What are the two kinds of accounts found on an Income Statement? 5. On what financial report(s) is the cash account found? 6. What are the three subtitles of a income statement. (name them in the order they are given on the report) 7. If the bank wanted to know your Net Worth what report would they ask for? 8. Capital in a corporation is entitled ? 9. Two ways to increase the capital account are? 10. Two ways to decrease the capital account are?

How do individuals or businesses keep track for all their assets, liabilities, capital, expenses, revenues. Etc.?

The Accounting Process or otherwise known as the Accounting Cycle. (also called the Audit Trail of business. Based on universally accepted accounting principles. (Generally accepted accounting principles) Double Entry Bookkeeping Accrual Accounting vs. Cash Accounting Bookkeeping part of accounting.

Verbs & Nouns for each step #1 Analyze Source Documents

Accounting Cycle Start with financial transactions (you will need to know these steps!)
Check, receipts, invoices, deposit slips, etc. Decide what accounts they represent Chronological record of transactions Book of original entry checks and balances Two or more accounts entered at cost

#2 Enter (journalize) data in the journal.

Make a Journal Required

Accounting Cycle
#3 Post from the journal to the individual ledger accounts. (to keep a running balance of each account)

Ledger divided up into these different accounts:

Assets (100 accounts) Liabilities (200 accounts) Capital/Owners Equity (300 accounts) Revenues (400 accounts) Cost of Goods Sold (Expense) (500 accounts) General Expenses (600 accounts)

Make some ledger accounts - required

Accounting Cycle #4
Adjust the necessary accounts to bring them up to date.

Requires internal transactions Requires journal entries & posting as well Example: Maybe some of your Supplies valued at $500 when you bought them have been usedyou need to bring their value up to date and expense what has been used. Example: Depreciation of Equipment

Accounting Cycle #5
#5 At the end of the period or at any time (with computers) balance all of the accounts in a trial balance. (Checks and balance step to see if all of your journal entries and posting was correct.)

The trail balance is a list of all of your accounts with balances. The total of the debit balances must equal the total of the credit balances.

Make a Trial Balance - Required

Accounting Cycle #6 & 7 & 8

#6 Prepare the Financial Statements

Income Statement Statement of Changes in Owners Equity Balance Sheet

Make Financial Statements - Required #7 Close out all the temporary accounts to zero, so that you can start a new period/cycle.

Requires journal entries and postin gs

#8. Analyze your financial findings.

The Balance Sheet and Debits and Credits Balance Sheet Equation

A = L + OE
Debits and Credits are terms used to increase or decrease various accounts and show balances. All Accounts have either a debit or credit balance. Assets/Expenses/Withdrawals have debit balances
Increased by debiting and decreased by crediting

Use of another checks & balance method

Liabilities, Capital, and Revenues have credit balances.

Increased by crediting, and decreased by debiting

Assets Cash
Debit + 100 75

Liabilities A/P
Debit Credit +

O.E. Capital
Debit + Credit 100

Credit 50

-Drawing -Expense +Revenue

Dr + Cr Dr + 50 Cr Dr Cr + 75

Each Transaction in finance has a debit and a credit. The debit amount must always equal the credit amount. (Checks & Balances) Example: Invested 100 Cash in my business. Example: Paid $50 for Advertising Expense. Example: Earned $75 for performing services At the end of the day: (Assets = 125) = (Liabilities = 0) + (OE = 125) and debits = 225 and credits = 225 (Double balance, double witness)

Quiz Preview Review with Partner

1-2. Give the accounting equation and define each element in the equation. _____________________________ = _________________________ + ______________________ Define:_________________________ _______________________ ______________________

3. Accounting is called the _____________________________________ of business. 4-7. Name these two statements (The Trial Balance is not a Statement) used in accounting which are used by managers to make financial decisions (the ones completed in your accounting project) What type of accounts are on each statement? First Statement Prepared_____________________________________________________________ Types of accounts found on this statement._______________________________________________ Last Statement Prepared___________________________________________________________ Two accounts found on this statement?__________________________________________________ 8-12. Give the verbs and nouns of the Six first steps in the accounting cycle: (fill in the blanks) Verb Noun 1.) _________________________________ _________________________________ 2.) _________________________________ _________________________________ 3.) _________________________________ _________________________________ 4.) ____Adjust _______________________ ____Internal Accounts_______________ 5.) _________________________________ _________________________________ 6.) _________________________________ _________________________________

Accounting Quiz - Continued

13. If the accountant wanted to know the balance of cash currently owned by the business he would go to the: ______________________________________________________

14. If the accountant wanted to know what type of transaction happened on a specific day he would go to the: ______________________________________________________
15. The report that determines the net profit or loss of a business for a specific period of time is called the: ______________________________________________________ Credit Debit Matching 16. ______Increase to Assets when recorded in the journal are: 17._______Increase to Liabilities when recorded in the journal are: 18. _______Increase to Expenses when recorded in the journal are: 19._______Asset accounts carry what kind of balances: 20._______Revenue accounts carry what kind of balance:

A. Debit(s) B. Credit(s) C. Can be either Dr or Cr. D. Always both Dr & Cr

Quiz Last Page

21. What does ROI stand for in finance/accounting? _____________ __________ ______________________ 22. What is the Separate Entity Principle_______________________________________________________ 23. Net Income is added to what account in the Statement of Owners Equity__________________________ 24. In what two ways can you decrease the Capital Account? _________________ _____________________ On the Back 25-26. Draw/format the ledger account for cash (only) with a beginning balance of $2000 and post the following two transactions in the account that occurred today. (You do not need to make any journal entries.) A. Received $5000 into the business from a personal investment from the owner of the business. B. Paid out $1000 to employees in wages.

27-30. Format the April Income Statement for Ace company that has these accounts: (You may not need to use all of the accounts): Cash: $100, A/P $50, Service Revenue: $500, Sales Revenue: $1000, Cost of Goods Sold Expense: $400, Advertising Expense: $100, Misc. Expense: $300, Wages Expense $200, A/R: $300.

The best way to learn:

Complete a simplified practice set that covers the entire accounting cycle. Work in partnership with another student and the teacher. Use a pencil! Final product: Do your own set of personalized financial statements. Problem due on Friday 1/16/04. Quiz over the accounting language and Accounting Cycle on Friday.

Separate Entity Principle

(Keep your business records separate from you personal records)
Lets start a home cleaning business. First Transaction on 1/1
Pull $1,000 savings out of your personal account and put it into your business account. Assets = Liabilities + Owners Equity Cash = 0 Capital 1,000 1,000

Record in Daily Journal

Date

Entries

PR

DR

CR Pg1
$1000

1/1

Cash 101 $1000 Capital 301 Started business with personal investment.

Posting to the Ledger Accounts:

Post $1000 as a debit to the cash account Post $1000 as a credit to the capital account
Cash 101 Date Explanation 1/1 PR DR J1 $1000 CR BAL $1000

Capital 301 1/1

J1

$1000

$1000

2nd Transaction
Acquire a Loan of $5,000 to buy equipment and materials to start a cleaning business. Assets = Liabilities + OE Cash Loan Payable Capital $6,000 $5,000 $1,000 ($1,000 + $5,000) $6000 = $6000

Journal Entry
Date Explanation

PR

DR
$5000

CR
$5000

1/2

Cash 101 Loan Payable 201 Received cash on credit.

Posting
Cash (101)

Date Explanation 1/1 1/2

PR DR CR BAL J1 1000 1000 J1 5000 6000

Loan Payable (201)

Date Explanation 1/2

PR J1

DR

CR BAL 5000 5000

3rd Transaction Jan 3rd

Purchased Equipment (Vacuum, Carpet Cleaner, Floor Polisher etc.) Cost: $3,000 Assets = Liabilities + OE Cash Loan Payable + Capital Equipment Accounting Equation Stays in Balance: Cash = $3000 = $5000 + $1000 Equipment = $3000

Journal Entry
Date

PR Dr
Equipment Cash
120
101

Cr___
$3000

1/3

$3000

Used cash to purchase equipment

Posting to the Ledger Accounts

Cash

101
PR J1 J1 J1 Dr 1000 5000 Cr Bal___ 1000 6000 3000

Date 1/1 1/2 1/3

3000

Equipment

120
PR J1 Dr 3000 Cr Bal__ 3000

Date 1/3

Pop Quiz Are you ready?

1. Give the accounting equation and define each element. 2. What is the separate-entity principle? 3. Give the first three steps in the accounting cycle using verbs and nouns. 4. When a family or a business does something to change their financial picture or position it is called what? 5. What are the two financial statements discussed in class and what type of accounts are on each. 6. When we increase an asset what do we say in terms of debits and credits? How about a liability? 7. What are the temporary accounts used in financial management? 8. What kind of a balance do the following accounts carry:?

Assets

Expenses

Revenues

Liabilities

Capital

Drawing

9. Format a balance sheet and income statement. 10. What do the following terms mean? ROI, Liquidity, Profit, Goodwill

4th Transaction 1/4

Paid $200 for full page ad in the Newspaper.

Journal Entry
Date PR 1/3 Advertising Expense 601 Cash 101 Purchased ad for business Dr 200 Cr 200

Postings
Advertising Expense

601
PR J2 Dr 200 Cr Bal______ 200

Date 1/4

Cash

101
PR J1 J1 J1 J2 Dr Cr 1000 5000 3000 200 Bal___ 1000 6000 3000 2800

Date 1/1 1/2 1/3 1/4

5th Transaction 1/5

Had my first cleaning job for $400. Was paid $100 down with the rest due at the end of the month.

Journal Entry
Date PR Dr 1/5 Cash 101 100 A/R 110 300 Revenue 401 Performed services and received down payment. Bal due: 1/31 Cr

400

Postings
Cash Date 1/1 1/2 1/3 1/4 1/5 PR J1 J1 J1 J2 J2 Dr 1000 5000 Cr 101 Bal___ 1000 6000 3000 2800 2900

3000 200 100

Accounts Receivable

110
PR J2 Dr 300 Cr Bal___ 300

Date 1/5

Service Revenue

401
PR J2 Dr Cr 400 Bal___ 400

Date 1/5

Transaction #6 #7#8#9&10
Hired my little brother to help me and paid him $100 in wages Worked all day on second cleaning job and was paid $500 Had to spend $300 on cleaning supplies to be used during the next two months. Took $200 out of my business to take my wife on a mini moon. Allocated 50% use of my truck to my business. Book price of truck = $6000

Journal Entries
Date 1/6 Wages Expense Cash 1/7 Cash Service Revenue 1/8 Cleaning Supplies Cash 1/9 Drawing Cash 1/10 Truck Capital PR
620 101 101 401 130 101 320 101 150 301

Debit 100 500

Credit 100 500

300 300 200 200 3000 3000

Postings
Wages Expense Date 1/6 PR J2 Dr 100 Cr 620 Bal 100

Cash Date 1/1 1/2 1/3 1/4 1/5 1/6 1/7 1/8 1/9

PR J1 J1 J1 J2 J2 J2 J2 J2 J2

Dr 1000 5000

Cr

3000 200 100 100 500

300 200

101 Bal___ 1000 6000 3000 2800 2900 2800 3300 3000 2800

Posting Cont.

Service Revenue

401
PR J2 J2 Dr Cr 400 500 Bal___ 400 900

Date 1/5 1/7

Cleaning Supplies

130
PR J2 Dr 300 Cr Bal_____ 300

Date 1/8

Anderson, Drawing

320
PR Dr Cr Bal______

Date

1/9

J2

200

200

Posting Cont. Truck

150
PR J2 Dr 3000 Cr Bal_____ 3000 301 $1000 $4000

Date 1/10

Capital 1/1 1/10

J1 J2

$1000 $3000

Adjustments at the end of the month Internal Transactions Step #4 in the Accounting Cycle
Adjusted the cleaning supplies to show that 33% had been used up. Adjusted the truck account to show that one month had been used up.

Truck was expected to last for two more years $3000/24months = $125 use per month

Journal Entries Adjustments

Date PR 1/31 Adjustments Cleaning Supplies Expense 621 Cleaning Supplies 130

Dr 100

Cr__

100

Inventory showed that only $200 in supplies remained at the end of the month.

1/31 Adjustment Depreciation Expense/Trk Truck (Accum Dpr.)

650
151

125
125

Postings of Adjustment Entries

Cleaning Supplies Expense Date

PR
J2

Dr
100

621 Cr

Bal
100

1/31

Adjustment

Cleaning Supplies

130
PR J2 Dr 300 Cr 100 J2 Bal_____ 300 200

Date 1/8 1/31

Adjustment

Depreciation Expense Truck Date PR

Dr
125

650 Cr

Bal
125

1/31

Adjustment

J2

Truck Date

150

PR
J2 Adjustment

Dr
3000

Cr
125

Bal_____
3000 2875

1/10 1/31

Step # 5 Trial Balance

Account

Debit
$2800 300 200 3000 2875

Credit

Cash Accounts Receivable Cleaning Supplies Equipment Truck Loan Payable Anderson, Capital Anderson, Drawing Service Revenue Advertising Expense Wages Expense Cleaning Supplies Expense Depreciation Expense/Truck Total Balance

5000 4000 200 900 200 100 100 125

$9,900

$9,900

Step #6 Prepare Financial Statements

Anderson Cleaning Services
Income Statement Month of January 2004

Revenue: Service Revenue: Expenses: Advertising Expense: Wages Expense: Cleaning Supplies Expense: Depreciation Expense: Total Expenses: Net Income (Loss)

$900 $200 100 100 125 525

$375

Return on Cash Investment $375/1000 = 37.5% Return on Total Investment $375/4000 = 9.4% What is our Income Statement Missing???????

Statement of Owners Equity

Andersons Cleaning Business Statement of Owners Equity For May 2005 Beginning Capital 5/1/05: Add: New Investments (truck) Net Income (from Income Statement) Less: Drawing (mini-moon) Net Loss Ending Capital 5/31/05:

$1000 3000 375 (200) na $4175

Balance Sheet
Anderson Cleaning Balance Sheet January 31, 2204

Assets:

Cash Accounts Receivable Cleaning Supplies Equipment Truck Less Accum. Depr. Total Assets:

$2,800 300 200 3000 3000 125 2875 $9,175

________

Liabilities

Loan Payable Anderson, Capital

$5,000 4,175

Owners Equity

Total Liabilities & O.E:

$9,175 ______

Sample Quiz Questions

Terms: Assets, Liabilities, Owners Equity, Capital, Debits, Credits, Accounting Equation, Ledger, Accounting Cycle, Posting, Financial Statements, ROI Seven Steps in the Accounting Cycle? Verbs & Nouns??? Format an Income Statement/Balance Sheet? (Given the accounts) Record and post and business transaction

8 Steps Reviewed
1. 2. 3. 4. 5. 6.
7. 8.

Verb Analyze Enter (Journalize) Post Adjust Balance Prepare

Close Analyze

Noun Source Documents Journal Ledger Internal Entries Trial Balance

Financial Statements Temporary Accounts Data

Debits & Credits

Used for checks and balances in Acct. Must always be equal Every Transaction has equal debits/credits Debits increase Assets/Expenses/Drawing Credit increase Liabilities/Capital/Revenue Debits decrease Liabilities/Cap/Rev Credits decrease Assets/Exp/Drawing

Owners Equity
Two ways to increase this account:

1) New investments in the business

Cash Investments Equipment Investments

2) Revenues earned in the business

1) Expenses (Using assets up to generate a profit or incurring new liabilities) 2) Taking money out of the business for personal use.

Two ways to decrease this account:

Debits and Credits

Terms used to increase or decrease an account and keep everything in balance. Assets = Liabilities + O.E. Increases Increases Increases (Debits) (Credits) (Credits) Decreases Decreases Decreases (Credits) (Debits) (Debits)

Steps in the Accounting Cycle

1. Analyze the transaction source documents and decide what accounts are involved. What account needs to be increased and what account needs to be decreased..what account(s) needs to be debited and what account(s) need to be credited. Examples of Source Documents:

Deposit Slips, Invoices, Sales Slips, Contracts, memos, packing slips, electronic memos, etc.

Source documents are usually kept on file (three years) as backup for tax and company audits.

Step #2 - Enter source document data in a chronological journal. (Data Entry on the Computer)
The Journal is called the book of original entry, and is on the computer in most companies.

It gives the date of the transaction. It gives a record of the accounts debited and credited in the transaction. (the accounts increased or decreased) It gives the post reference number of the ledger accounts involved. (after the transaction has been posted to the ledger accounts)

Step #3 Post (transfer) transaction data from the journal to the individual ledger accounts.
The Ledger Accounts are individual records of all the assets, liabilities, and owners equity accounts. Each Ledger Account is updated daily and keeps a ongoing record of activity in the account and balance of the account. All data that goes into the ledger accounts must first be put into the journal and then posted from the journal to the ledger account on the day the information is journalized.

Step #4 Adjustments
Adjustments are the internal transactions of a company that a good accountant will make to set in order each account. They must be journalized first and then posted to the ledger. Adjustments are usually made at the end of an accounting period. Examples: Depreciation, Use of pre-paid rent or insurance, interest earned or expensed, use of supplies and materials, unearned revenues earned during the period.

Step #5 Trial Balance

Before preparing your statements, make sure that all of your accounts have the correct balance. List of all accounts with debit and credit balancesDEBITS MUST EQUAL CREDITS. If not in balance you must go back in your audit trail and find your errors.

#6 Prepare your Financial Statement Income Statement, Statement of OE, & Balance Sheet
This is the main product of the accounting system that outsiders/investors/creditors etc. will look at to see the financial health of your business. These statements and how to read them and create profitability ratios from their numbers should become second nature to a business owner, or anyone interested in finance. This knowledge is essential.

#7 Close all the temporary accounts and start over.

Close the temporary accounts:

All Expense Accounts All Revenue Accounts All Drawing or Dividend accounts.

Transfer the net increases or decreases of these temporary accounts into the permanent owners equity account of capital or retained earnings. This makes it possible for the company to start a new set of reports to compare with the old etc.

#8 Analyze Data
A list of the accounts you start the new accounting period with. A check to see if Debits = Credits with these continuing accounts. If total DEBITS DO NOT EQUAL total CREDITS a mistake has been made and needs correction.

Final Quiz
1. Define:

Asset: Liability: Capital: Expense: Revenue:

2. Write out the proper accounting equation: (formula)

Final Quiz:
3. What is the first accounting book called that is used to record transactions chronologically? 4. For any and all transactions Debits must always equal _______________? 5. If I wanted to know what balance I had in cash what record/book would I turn to? 6. Cash carries what kind of a balance?

Quiz:
7. The use of a fixed asset over a period of time is called what? 8. What is ROI and what two figures in accounting do you use to determine it? 9. The accounting cycle is also known as the _______________ _____________?

Quiz Last Question

10. Using the following accounts, format in titles only the Income Statement and the Balance Sheet. (List titles and total lines were appropriate.)

Cash, Accounts Payable, Accounts Receivable, Equipment, Advertising Expense, Depreciation Expense, Service Revenue, Capital

Mondays Assignment
1. Using the Balance Sheet Format, prepare your own personalized or family Balance Sheet Report listing at least seven accounts. (Make it neat (with heading) and type it up) 2. Using the income statement format, complete a cash flow personalized income statement showing all the revenue (money) you received in January, and the expenses (money) you spent. The bottom line would be your net profit or net loss for January. Show at least seven items in this report. Examples of Revenue: (money from parents) (money from pell grant) (money from savings) (money earned from work) (money borrowed from roommates) (money received from loans) etc. Examples of expenses: (money paid for tuition) (money paid for books) (food) (entertainment) (utilities) (phone) etc. Both Reports need to have headings and both need to be in the format for balance sheet and income statement that we have learned in class. Both Need to be typed.

Monday
Turn in your neat & complete accounting problem with three statements. Be prepared for a quiz on the basics of accounting.

Know the 8 steps of the accounting cycle. Know the financial report formats for the income statement and balance sheet.and the format of a ledger account. Also debits & credits.

Turn in your personal balance sheets and income statements for January.