THE UNIVERSITY OF NEW SOUTH WALES Australian School of Business School of Accounting ACCT 1501: Accounting and Financial Management 1A Week 3 The Double Entry System Student Handout Lecturer: Dr. Youngdeok Lim School of Accounting UNSW QUAD 3069 [email protected]Blackboard: http://telt.unsw.edu.au.
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THE UNIVERSITY OF NEW SOUTH WALES
Australian School of Business School of Accounting
1. Introduction Last week we discussed the importance of the balance sheet and income statement to managers. It is therefore critical that every manager understand the impact of transactions on these financial reports. This week covers those skills by extending transaction analysis, which considers the impact of specific transactions on the accounting equation. The double entry system involving debits and credits, which forms the basis of modern accounting, 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 elements of 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
AASB: Framework for Presentation of Financial Statements (downloadable from your
course website or http://www.aasb.gov.au )
2. Tutorial Questions – Week 4
Students should attempt these questions before the tutorial. Preparation Questions:
DQ 3.2 3.4;
P3.16, P3.18
Tutorial Questions:
DQ 3.3, 3.5, 3.7
P3.12, P3.19
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Accounting and Financial Management 1A
Dr. Youngdeok Lim
Quad 3069
Week 3, Session 1, 2013
The Double Entry System
Today’s lecture objectives:
Carry out transaction analysis and determine the impact of transactions on elements of balance sheets and income statements
Hot: Describe how debits and credits work in the double entry accounting system.
Understand debits and credits in the context of transaction analysis
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Revisit balance sheet and income statement
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
Consolidated B/S –Woolworths Limited
Current Assets $5,802 M Current Liabilities $6,766 M
Noncurrent Assets
$15,779 M Noncurrent Liabilities $6,369 M
Total Liabilities $13,135 M
Equities $8,446 M
Total Assets $21,581 M Total Liabilities and Equities
$21,581 M
As at 24 June 2012
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Revenue $55,268 M
- Cost of sales (Cost of goods sold) ($40,792 M)
Gross profit $14,476 M
+/- other revenue/expense ($12,659 M)
Net profit $1,817 M
For the 52 weeks ended on 24 June 2012
Consolidated I/S –Woolworths Limited
Transactions
Transactions are events that affect the operations or finances of an organisation. Analyze each transaction from the perspective of a
company! Accounting systems record transactions.
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Business Model
Company(e.g. Woolworths)
Customers(e.g. You)
Suppliers(e.g. farmers)
Purchase Sale
Payment(Cash/Accounts
Payable)
Payment(Cash/Accounts
Receivable)
Investors (e.g. banks, shareholders)
Financing
Property Plant and Equipment,
financial securities etc
Investing
Transaction analysis
Transaction analysis involves an examination of each business transaction with the aim of understanding its effect on the accounting equation.
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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Let’s consider seven transactions.
Transaction 1
Issued shares for $300 000 cash.
A = L + SE Does the accounting equation balance?
YES! It must balance!
Share capitalCash
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Transaction 1
Issued shares for $300 000 cash.
= Liabilities +
Cash
Accounts
Receivable/
Debtors Equipment Bank Loan
Share
Capital
Retained
Profits
1 +300,000 +300,000
Assets Shareholders’ equity
Transaction 2
Borrowed $50 000 cash from the bank.
A = L + SE Does the accounting equation balance?
YES! It must balance!
Bank LoanCash
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Transaction 2
Borrowed $50 000 cash from the bank.
= Liabilities +
Cash
Accounts
Receivable/
Debtors Equipment Bank Loan
Share
Capital
Retained
Profits
1 +300,000 +300,000
2 +50,000 +50,000
Assets Shareholders’ equity
Transaction 3
Purchase equipment for $100 000 cash.
A = L + SE
Does the accounting equation balance? YES! It must balance!
Equipment
Cash
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Transaction 3
Purchase equipment for $100 000 cash.
= Liabilities +
Cash
Accounts
Receivable/
Debtors Equipment Bank Loan
Share
Capital
Retained
Profits
1 +300,000 +300,000
2 +50,000 +50,000
3 -100,000 +100,000
Assets Shareholders’ equity
Transaction 4
Signed six-month agreement to provide catering service for a monthly fee of $2500 starting next month.
A = L + SEWhat if the company received $2500 in advance for the service to be provided in this month?
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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.
Transaction 5
Catering services provided for an office function; billed customer for $2500.
A = L + SE Does the accounting equation balance? YES! It must balance!
Accounts receivable
Revenue
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Transaction 5
Catering services provided for an office function; billed customer for $2500.
= Liabilities +
Cash
Accounts
Receivable/
Debtors Equipment Bank Loan
Share
Capital
Retained
Profits
1 +300,000 +300,000
2 +50,000 +50,000
3 -100,000 +100,000
4
5 +2,500 +2,500
Assets Shareholders' equity
Revenue
Transaction 6
Customer paid $2500 they owed on their account.
A = L + SE
Does the accounting equation balance? YES! It must balance!
Accounts receivable
Cash
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Transaction 6
Customer paid $2500 they owed on their account.
Assets = Liabilities + Shareholders’ equity
Cash Accsrec.
Equipment Bank loan Share capital
Retained profits
1 +300,000 +300,000
2 +50,000 +50,000
3 -100,000 +100,000
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5 +2,500 +2,500
6 +2,500 -2,500
Revenue
Transaction 7
Paid the bank $5000 as part repayment of the loan.
A = L + SE
Does the accounting equation balance? YES! It must balance!
Bank loanCash
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Transaction 7
Paid the bank $5000 as part repayment of the loan.
Transaction analysis: The accounting equation extended
The equation you were introduced to earlier is as follows:
Assets = Liabilities + Equity
This is extended to:
A = L + SECA + NCA = CL + NCL + SEWhat is SE made up of?
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Accounting equation, cont.
Shareholders’ equity contributions by shareholders
Profit revenues expenses
Distribution to shareholders(dividends)
Expanding the accounting equation
A = L + SE CA + NCA = CL + NCL + SE Where 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
Balance sheet
CA + NCA = CL + NCL + SC + Op. RP + R – E – D
CA + NCA = CL + NCL + SE
An illustrative example: Prepare transaction analysis
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.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
In accounting we use debit (Dr) and credit (Cr) to describe changes in accounts
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 Capital Sources of Capital Always record on the right-hand side
Always record on the left-hand side
Simultaneous recording of the use of capital and the source of capital
Basic orientation of the “double-entry bookkeeping system”
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 CreditLiabilities Credit Credit DebitShareholder’s equity Credit Credit DebitRevenues Credit Credit DebitExpenses Debit Debit Credit
Debit and credit
Company record v.s. Bank statement
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Journal entries
Journal entries are, essentially, a shorthand version on transaction analysis.
They are prepared using the rules of debit and credit. Debits must always equal credits.
Journal entries
ExampleMachinery is purchased for $10 000 cash.
Journal entry:
Dr Machinery 10 000Cr Cash 10 000
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MCQ. Identify the journal entry required to correctly record each of the
following transactions.
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
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
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 catering service for a monthly fee of $2500 starting next month.
5: Catering services provided for an office function; billed customer for $2500.
6: Customer paid $2500 they owed on their account.
7: Paid the bank $5000 as part repayment of the loan.
Solution: Transaction 1-7 1.
2.
3.
4.
5.
6.
7.
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LRM ltd transactions for April 2012
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.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.
Solution: LRM ltd case 8.
9.
10.
11.
12.
13.
14.
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Wrap-Up
• Double entry system: Debit and Credit– Debit Credit
+A +L
+SE
+E +R
-L -A
-SE
-R -E
Relationship between transaction analysis and journal entries
A negative figure in transaction analysis implies the abnormal side in journal entries.
Next Lecture…
Record-Keeping
Please bring comprehensive class example from the black board.