Source Document: A business paper, such as an invoice, that is the original record of a transaction and that provides the information needed when accounting for the transaction. (Bills, receipts).
Account: A specially ruled page used to record financial changes. There is one account for each different item affecting the financial position. All of the accounts together form the ledger.
Account Balance: The value of an account showing the dollar amount and an indication as to whether it is a debit or a credit value.
Accounting Entry: All the changes in the accounts caused by one business transaction, expressed in terms of debits and credits. For each accounting entry, the total of the debit accounts will equal the total of the credit amounts.
Credit: To record an amount on the right-hand side of an account.
Debit: To record an amount on the left-hand side of an account.
In Balance: A state in which the total value of all accounts with debit balances is equal to the total value of all accounts with credit balances.
Ledger: A group of file of accounts that can be stored as pages in a book, as cards in a tray, as tape on a reel, or magnetically on a disk. E.g. Card ledger, Loose-leaf ledger, Computer Ledgers.
On Account: An item purchased or sold that is not paid for at the time; money received or paid to reduce an amount owed.
Out of Balance: A state in which the total values of all accounts with debit balances does not equal the total value of all accounts with credit balances.
Taking of a Trial balance: The process of comparing the total value of the debit accounts in a ledger with the total value of the credit accounts in a ledger.
Trail Balance: A special listing of all the account balances in a ledger, the purpose of which is to see if the dollar value of the accounts with debits balances is equal to the dollar value of the accounts with credit balances.
Accounting Period: The period of time over which the earnings of a business are measured.
Chart of Accounts: A list of accounts of a business and their numbers, arranged according to their order in the ledger.
Drawings: A decrease in owner’s equity resulting from a personal withdrawal of funds or other assets by the owner.
Expense: A decrease in equity resulting from the costs of the materials and services used to produce the revenue.
Fiscal Period: The period of time over which earnings are measured.
Income Statement: A financial statement that summarizes the items if revenue and expense and shows the net income or net loss of a business for a given fiscal period.
Matching principle: An extension of the revenue recognition convention. It states that each expense item related to revenue earned must be recorded in the same accounting period as the revenue it helped to earn.
Net Income: The difference between total revenues and total expenses if the revenues are greater than the expenses.
Net Loss: The difference between total revenues and total expenses if the expenses are greater than the revenues.
Revenue: An increase in equity resulting from the proceeds of the sales of goods or services.
Revenue Recognition Convention: the revenue must be recorded in the accounts at the time the transaction is completed.
Time Period Concept: Provides that accounting take place over specific time period known as fiscal periods.
The Accounting Cycle
Analyze, journalize transactions - Summarize accounts, General ledger posting - Trial balance preparation - Period-end adjusting entries - Adjusted trial balance Preparation - Preparing of Financial Statements - Close General ledger Account
General journal
What is the general journal?
- The book of original entry (first place you record transactions)
- Transactions are written in a journal in chronological order
- The format of the journal is important
- Journalizing is the process of entering information as debits and credits to the correct accounts.
Journalizing
- Debits are always recorded first
- Indent then record the credit below the debit
- A short explanation is included on the second line (identify what the transaction is)
- Leave a space between journal entries
- Must be neat
- Debits must always equal credits
- Amounts are recorded as revenue on the date in which they are earned
- When are revenue earned?
- When services are performed, not necessarily when cash is paid
Transactions-Journal-Ledger
- The ledger is a group of accounts
- Each account shows a complete, up-to-date record of all transactions affecting only that particular account
- The ledger may be a manually prepared paper record or a set of files in a computer system.
- Posting is the process of transferring information to the ledger from the journal.
- Chart of Accounts: 100-199 Assets, 200-299 liabilities, 300-399 owner’s equity, 400-499 revenue, 500-599 expense
Obtaining a Ledger Account
- Obtain an unused ledger account.
- Write the name at the top of the account(the Account Title)
- Write the number given to the account title in the space provided
- Insert the account into its proper place in the ledger.
Bank Credit Advice: A business form by means of which a bank informs a depositor that an increase has been made in the bank account and the reason for the increase.
Bank Debit Advice: A business form by means of which a bank informs a depositor that an decrease has been made in the bank account and the reason for the increase
Book of Original Entry: Any journal; that is, the book that contains the first, or original, record of each transaction.
Cash Receipts Daily Summary: A business paper, prepared daily, that lists the monies received by a business from customers on account and other sources.
Cash Sales Slip: A business form showing details of a transaction in which goods or services are sold to a customer for cash.
Cheque Copy: A copy of a cheque, used as the source document for a payment made by cheque.
Cost principle: States that the accounting for purchases must be at the cost price to the purchaser.
Harmonized Sales Tax (HST): A tax, collected that is a combined PST and GST and charged on all items.
Journal: A specially ruled book in which accounting entries are recorded in the order in which they occur. A transaction is recorded in the journal before it is recorded in the ledger.
Journal Entry: An accounting entry in a journal.
Journalizing: The process of recording entries in the journal.
Opening Entry: The first accounting entry in the general journal, the entry that records the beginning financial position of a business, thereby opening the books of accounts.
Point of Sale Summary: A document that provides information to the business on sales at the location for that day.
Point of Sale Terminal: An electronic cash register that is connected to and is able to interact with a central computer.
Purchase Invoice: The name given to a supplier’s sales invoice in the office of the purchaser.
Remittance Advice: the tear-off portion of a cheque, or a separate business form accompanying a cheque, which explains what the cheque is for.
Sales Invoice: A business form, prepared whenever goods or services are sold on account, showing a description of goods or services, the price and other information.
Source Document: A business paper, such as an invoice, that is the original record of a transaction and that provides the information needed when accounting for the transaction.
Transaction Log: A document generated by a point-of-sale terminal that contains detailed information about each transaction.
Posting
- Locate the account: Find the name of the account to be posted in the ledger
- Record the date: record the transaction date.
- Enter the amount: Record the correct amount in the column
- Calculate the new balance: determine the new balance and whether or not the balance is a debit or a credit
- Complete the Ledger posting Reference Column: Enter the journal page number from which it was posted in the (P.R) column of the ledger account. The page number is proceeded by the letter J (Journal) and a number (journal page number)
- Copy the account number from the ledger account into the posting reference column of the general journal. This shows that the amount has been posted from the ledger to the general journal.
Determining Account Balances
- The balance-column form of account provides a balance after each transaction.
- The DR/CR column indicates whether the balance is a debit or a credit
- There is less chance of error in the balance-column form of account than in a T-Account
Correcting Errors into the Books
Errors found immediately
- If the error is found immediately, simply stroke neatly through the incorrect figures or letters and write in the correct ones immediately.
Errors found later on
- In many cases, the error can be corrected by means of an accounting entry, reversing entry
- A correcting journal entry is an accounting entry that cancels the effect on an error
- For example, a journal entry for $20 was incorrectly debited to the cash account. The debit for $250 should have been applied to A/R. (Correct entry from July 2).
Account title: The account name
Balance Column Account: The most commonly used type of account, in which there are three money columns, one for the debit amounts, one for the credit amounts, and one for the amount of the balance.
Correcting Journal Entry: An accounting entry to rectify the effect of an error.
Cross-Referencing: Part of the posting sequence in which the journal page number for a given entry is recorded in the appropriate account, and the account number, in turn, is recorded on the journal page.
Decimal Point error: A mistake caused by misplacing the decimal point in an amount.
Forwarding: the process of continuing an account or journal on a new page by carrying forward all relevant information from the completed page.
Opening an Account: The process of setting up a new account in the ledger.
Posting: The process of transferring the accounting entries from the journal to the ledger.
Transposition Error: A mistake caused by the interchanging of digits when transferring figures from one place to another. The trial balance difference that results from such an error is always exactly divisible by 9.
The Worksheet
A worksheet is an accounting form used to organize information needed to prepare financial statements. Accountants use a worksheet to help them avoid errors and to organize their work before preparing financial statements. It is not part of the permanent accounting records so therefore, it can be done in pencil.
The format of a 6 column worksheet. All the account balances are taken from the ledger and written on the worksheet in the trail balance section. The assets, liabilities and owner’s equity accounts appear on the balance sheet. The revenue and Expenses appear on the Income Statement. Once the trail balance is complete the rest of the info is transferred to wither the Balance or Income Statement.
Financial Statement Analysis
There are 3 types of comparison’s when analysing financial statements:
- Intra-Company basis
- Intercompany or Competitor Basis
- Industry Averages
The Tools for FSA are:
- Horizontal or trend analysis
- Vertical Analysis or Common-Size Analysis
- Ration analysis
Comparative Income Statement
Purpose:
To determine the increase or decrease in financial data that has taken place over time. The change can be expressed as a dollar amount or a percentage.
% Change since Base Period = Current Year amount-Base year amount/Base Year Amount
Vertical or Common Size Analysis
Purpose:
Expresses each item on the financial statement as a percentage of a base amount (net sales, total assets etc.)
Percentage = Account (e.g. Sale)/Base Amount (total sales)
Year over Year Trend Analysis
Shows the financial data over a number of consecutive periods.
Percentage = year amount/ base year amount * 100
Accountability: The obligation of management (Or other group or person) to supply evidence, usually periodic, of its action or performance as required by custom, regulation or agreement.
Balance Sheet- account form: information on a balance sheet presented in a side-by-side or vertical format.
Balance Sheet-report form: information on a balance sheet presented in a one-above-the-other or vertical format.
Classified Balance Sheet: A financial statement in which dates are grouped according to major categories.
Common-size statements: a financial statement that shows individual items as percentage of a selected figure, known as the base figure.
Consistency Principle: requires that a business must use the same accounting methods and procedures from period-period
Control Accounts: A general ledger account, the balance of which represents the sum of the balances in the accounts contained in a subsidiary ledger.
Current Asset: Unrestricted cash, an asset that will be converted into cash within one year, or an asset that will be used up within one year.
Current liability: a short-term debt, payment of which is expected to occur within one year.
Fixed Asset: A long-term asset held for its usefulness in producing goods or services.
Full disclosure principle: states that all information needed for a full understanding of a company’s financial statements must be included with the financial statements.
Long-term liability: A liability which, in the ordinary courses of business, will not be paid within one year.
Materiality principle: requires accountants to follow generally accepted accounting principles except when to do so would be expensive or difficult.
Plant and Equipment: long-term assets such as trucks, held for their usefulness in producing goods and services, and not normally for sale.
Trend Analysis: A document that presents financial data in percentages, for a number of periods, so that tendencies can be seen that are not evident when looking at the dollar figures.
Work Sheet: An informal business form prepared in pencil on columnar book-keeping paper, used to organize and plan the information for the financial statements.
Working capital: the difference between the current assets and the current liabilities of a business.
Adjusting the Books
Adjusting Entries
Purpose: To ensure accounts and financial statements are accurate
Supplies: Your business owns supplies valued at $1000. During this accounting period, the remaining supplies is valued at $200
Dr supplies Expense, CR Supplies
Prepaid expenses: payments made in advance are classified as current assets.
Rent is paid for January, February and March at a cost of $3000. At the end of January $100 is used up.
DR rent Expense, Credit Prepaid rent
Depreciation
Depreciation systematically allocates the cost of fixed assets to the periods of their use. {Matching principle}
Assets that benefit the business for less than 1 year are considered short term and do not need to be depreciated.
Book Value of Asset does not equal market price
Accounting recognizes that the asset will render useful services for only a limited number of years, and that the assets full cost must be allocated as an expense of those years regardless of fluctuations in the market value.
Causes of Depreciation
- Physical Depreciation, Obsolescence, Inadequacy
The accounts used for depreciation of assets:
Depreciation Expense (Income Statement), Accumulated Depreciation (balance Sheet)
Contra Accounts
Accumulated depreciation accounts have debit balances because they are subtracted from an asset to show the net value.
An asset less its accumulated depreciation.
Straight line Method: cost-residual value / years of useful life=Annual Depreciation Yearly
Declining Balance Method: Depreciation % * Book value of asset = Annual depreciation
Close Accounts
-
Close sales account: Debit sales, Credit Income Summary
-
Close Expense Accounts: DR Income Summary and Credit Expenses
-
Close Income Summary: Income(Dr income Summary and credit capital)
-
Close Drawings: DR Capital, Credit drawings.
Adjusting Entries: an entry made before finalizing the books for the period to apportion amounts of revenue or expense to the proper accounting periods or operating divisions.
Audit: An examination of the accounting records and internal controls of a business in order to be able to express an opinion about the business’s financial position and result of operation.
Closing an account: to cause an account to have a nil balance by means of a journal entry.
Contra Account: An account that must be considered along with a given asset account o show the true book value of the asset account.
Depreciation: the decrease in value of a fixed asset over time.
Income Summary Account: the temporary account to which the total revenues and the total expenses are transferred during the closing process. The balance of the account represents the net income or the net loss for the period and is transferred to the capital account.
Nominal Account: an account with a balance that does not carry into the next fiscal period (revenue, Expenses and Drawings).
Post-closing Trial Balance: The trial balance that is taken after closing the entries have been posted.
Prepaid Expense: an expense other than for inventory, which benefits that extend into the future, paid in for advance.
Real Account: An account balance of which is not closed out at the end of the fiscal period but which is carried forward into the succeeding periods.
Valuation account: An account that must be considered along with a given asset account to show the true value of the asset account.
Service
Net Income= revenue – Expenses
Merchandising
Revenue – Cost of Goods Sold = Gross Profit
Gross Profit – Expenses = Net Income
Income Statement for a Merchandising Company
Name
Income Statement
Month Ended ...
Revenue
Sales 56 000
Cost of Goods Sold
Cost of Goods Sold (per schedule) 34 000
Gross Profit 22 000
Expenses
Total Expenses 12 600
Net Income 9 400
- 3 sections
- The cost of goods sold is obtained from the schedule of Costs of Goods Sold
Name
Schedule of Cost of Goods Sold
Month Ended ...
Merchandise Inventory May 1 16 000
Add: Purchases 36 000
Total Cost of Merchandise 52 000
Less: Merchandise Inventory, May 31 18 000
Cost of Goods Sold 34 000
- The schedule of costs of goods sold is prepared before the inco0me statement
Merchandise Inventory
Merchandise Inventory: the total value of goods on hand for resale.
Costs of Goods Sold: Shows both the beginning and ending inventory.
Balance Sheet: shows the ending inventory as a Current Asset.
2 methods of taking Inventory
- Periodic Method: Inventory is taken at the end of the accounting period. Generally used for low-priced items. Retailers take a physical count of goods on hand. This amount is recorded in the Merchandise Inventory account. The value of the inventory is used on both the schedule of cost of goods sold and balance sheet.
- Perpetual Method: Inventory is taken each time something is sold. Ex. Retailers have computerized point-of-sale-terminals. Each time a sale is made, the cash register records both the sale and updates the inventory at the same time.
Accounting for a Merchandising Business
Under the periodic system the inventory of a business is kept in 2 accounts: Merchandising Inventory & Purchases
The Purchases Account: Expense
Any merchandise bought or purchased during the fiscal period is collected in the Purchases Account. If merchandise for resale is purchased, the accounting entry (at cost price) is:
Purchases $100
HST Recoverable $13
Bank or A/P $113
Sales Account:
The revenue account for a merchandising business is called Sales and those entries are the same as for a service business
The Freight-In Account:
The freight on incoming merchandise is one of the costs of goods & the freight-in account is used to accumulate any transportation charges on incoming goods.
They are separate from transportation charges on outgoing goods which are recorded in Delivery Expense.
Formula for costs of goods sold
(Beginning inventory+ purchase+ freight-in) – ending Inventory = CGS
Cash Discount: A reduction that may be taken in the amount of a bill provided that the full amount is paid within the discount period shown on the bill.
Cash Refund: The return of money to the buyer by the seller in respect to deficient goods that were paid for and later returned.
C.O.D (cash on delivery): a term of sale whereby goods must be paid for at the time they are delivered.
Cost Accounting: a specialized area of accounting that concentrates on determining, controlling and reposting costs of doing business.
Cost of goods manufactured: total costs of raw materials, direct labour, and factory overhead in a fiscal period.
Cost of goods sold: the total cost of goods sold during an accounting period.
Credit Invoice: a business form issued by a vendor to reverse a charge that has been made on a regular sale invoice. The reason is explained in detail on the invoice.
Credit Note: a business form issued by a vendor to reverse a charge that has been made on a sales invoice. The reason is explained in detail on the note.
Direct labour: An expense that has a direct link in making finished goods, for example, workers on an assembly line.
Duty: Special charges imposed by the government of a country on certain goods imported from a foreign country.
Factory Overhead: Costs that include a range of expenses that support the manufacturing process.
Freight-In Account: transportation charges on incoming merchandise.
Goods in Process: goods that have had some raw materials, direct labour, or factory overhead applied to them, but that are not yet in a finished state.
Gross profit: in a trading business, the excess of net sales over the cost of goods sold.
Indirect Labour: an account that represents wages to workers who support the manufacturing process, for example, janitorial staff.
Manufacturing Business: a business that buys raw materials which it converts into new products and sells to earn a profit.
Manufacturing Statement: accounting form that shows the cost of manufacturing goods in a fiscal period.
Merchandise Inventory: the goods handled by a merchandising business.
Merchandise Business: a business that buys goods to resell them at a profit.
Periodic Inventory System: a method of accounting for merchandise inventory in which the cost of the inventory sold is determined only at the end of an accounting period.
Perpetual Inventory System: a method of accounting for merchandise inventory in which the record of items in stock is kept up to date on a daily basis.
Physical Inventory: the procedure by which the unsold goods of a merchandising business are counted and valued at the end of a fiscal period.
Raw Materials: essential components that become part of a finished product.
Retailer: a merchandising that buys goods from wholesalers and manufacturers and sells them to the general public with a view to making a profit.
Stock-in trade: the goods handled by a merchandising business.
Terms of sale: the conditions agreed to at the time of sale, between the buyer and the seller, in respect to the length of time allowed for payment and whether a cash discount can be taken.
Wholesaler: a merchandising business that buys goods from manufacturers and other suppliers and sells them to retailers with a view to making a profit.
