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BASICS OF BOOKKEEPING
The topics to be covered in this section of the courseare described in Chapters 1 and 2 of the text
Chapter 1 pages 18 -24
Chapter 2 all
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TOPICS TO BE COVERED
NATURE OF ACCOUNTING
SINGLE ENTRY BOOKKEEPING
DOUBLE ENTRY BOOKKEEPINGTHE ACCOUNTING EQUATION
DEBITS AND CREDITS
THE ACCOUNTING CYCLE
PREPARATION OF THE BALANCE SHEET
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BASICS OF BOOKKEEPING
OBJECTIVE - to introduce students to themechanics of bookkeeping a solid foundation in bookkeeping is necessary to
be able to evaluate the effects of selectingalternative accounting policies
bookkeeping has specific procedures that must be
followed or the entries are incorrect
bookkeeping is only one component of accounting
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NATURE OF ACCOUNTING
Accounting is the process of identifying, measuring,recording, interpreting and communicating the resultsof economic activities of a business
identification and measurement require significantprofessional judgement
once it has been determined what should be
recorded, the bookkeeping or recording process isstraight forward
communication of the results of the economicactivities is done through the FINANCIAL
STATEMENTS
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SINGLE ENTRY ACCOUNTING
use of your cheque book is single entry accounting
cheques issued are recorded as a reduction inthe bank account, but there is not a separaterecord kept for each type of expense paid
for instance, if groceries were purchased, thereis no entry to show an increase to the total cost ofgroceries purchased during the year
the cheque register is part of the accounting system
it is referred to as an account
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Single entry accounting
Single entry accounting has been used forproprietorships where the owner prepares an incomestatement primarily for tax purposes
No balance sheet is prepared
Revenues and expenses are recorded from invoices
there is no way to determine if all have been
recorded
no attempt to record the changes in the assetand liability account balances
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DOUBLE ENTRY ACCOUNTING
Double entry accounting creates an account for eachtype of asset, liability, equity, revenue and expense
Every entry into a double entry accounting systemmust balance
If cash is received, the source must be recorded
If cash is paid out, the use must be recorded
If a sale is made on account, the receivable mustbe recorded
If a purchase is made on account, the debt must
be recorded
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double entry accounting permits preparation of both abalance sheet and an income statement
checks and balances are available to ensure alltransactions are recorded
Example
a bank reconciliation is prepared to ensure the
ending bank balance per the bank statementagrees to the balance in the accounting records
if it does not, any unrecorded amounts will beidentified and recorded
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the accounting equation is the foundation ofdouble entry accounting
ASSETS = LIABILITIES + EQUITIES
assets acquired by the business must be paid for,and the funds are either borrowed or invested by
the owners
Net Assets = Assets - Liabilities
THE ACCOUNTING EQUATION
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Double entry accounting requires that the accountingrecords of the business balance, just as the accountingequation balances
to accomplish this, left and right side entries arerecorded
DEBIT - an entry on the left side
- also used as a verb, to make an entry on the
left
CREDIT - an entry on the right side
- also used as a verb, to make an entry on
the right
MECHANICS OF BOOKKEEPING
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Assets appear on the left side of the accountingequation (debit side of the equal sign)
The normal balance for an asset account is a
debit balance
Assets are increased by a debit
Assets are decreased by a credit
ASSETS = LIABILITIES + EQUITIES
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Liabilities appear on the right side of the accountingequation (credit side of the equal sign)
The normal balance for a liability account is acredit balance
Liabilities are increased by a credit entry
Liabilities are decreased with a debit entry
ASSETS = LIABILITIES + EQUITIES
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Equities are on the right side of the accountingequation ( the credit side of the equal sign)
Accounts that increase equity are increased with
credit entries and decreased with debit entries
Accounts that decrease equity are increased withdebit entries and decreased with credit entries
ASSETS = LIABILITIES + EQUITIES
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The permanent equity accounts have a normalcredit balance
Temporary accounts may have debit or creditbalances:
Revenues and gains increase equity and have
normal credit balances
Expenses and losses reduce equity and havenormal debit balances
Dividends distributed, if recorded in a separateaccount, have a normal debit balance
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If a company earns $10,000, this amount in notpayable to creditors. The value of the company willincrease and it is the shareholders that benefit
Revenue and expense accounts are used tomeasure the profit or loss in the year
These accounts are really part of the equity of thebusiness, but are kept separate to facilitate thepreparation of the income statement
Equity in a business
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ASSETS = LIABILITIES + EQUITY
EQUITY = SHARE CAPITAL + RETAINED EARNINGS
RETAINED EARNINGS = OPENING RETAINED
EARNINGS + NET INCOME - DIVIDENDS
NET INCOME = REVENUES - EXPENSES
COMPONENTS OF EQUITY OF A
CORPORATION
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Components of Equity of a
Proprietorship
For a proprietorship, contributions by the owner andprofits not withdrawn are combined in one account
Owners name, capital
Heather Johnston, capital
EQUITY = OPENING CAPITAL + NET INCOME -DRAWINGS
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Dividends are a distribution of the after-tax profits of abusiness to the shareholders (owners)
the term dividend only applies to a corporation
for a proprietorship and partnership, distributionsof profit to the owners are called drawings
Dividends reduce the equity in the business
Dividends are increased with a debit and have a
normal debit balance
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SHARE CAPITAL and RETAINED EARNINGS ( or
OWNERS CAPITAL) are referred to as permanentaccounts because they carry forward on the BalanceSheet from one year to the next
REVENUES, EXPENSES, GAINS and LOSSES arereferred to as temporary accounts because theyaccumulate the transactions for the year only, and thentheir balances are closed to Retained Earnings to
allow the next years transactions to be accumulated
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THE ACCOUNTING CYCLE
Steps carried out throughout the period: transaction analysis
journal entry preparation
posting journal entries to the general ledger
End of period procedures:
prepare trial balance
prepare adjusting journal entries
adjusted trial balance
financial statement preparation
closing journal entries
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Transaction analysis
determine whether an event should be recorded inthe accounting records at this time
if yes, determine which accounts are affected
determine whether each account affected isincreased or decreased by this transaction
requires significant professional judgement in the realworld
in this course, most events are very straightforward
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General journal entries
method of recording transactions in the accountingrecords
two columns needed for dollar amounts
left column for debit entries
right column for credit entries
formal journal entry page on page 69 of text
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simplification for the purposes of this course
omit description and date (unless you are asked
to prepare entries for several dates at one time)
Example
Heather contributes $10,000 cash to her business,
Heathers Shoes, Ltd. and receives 1,000 shares
Debit Credit
Cash 10,000
Share Capital 10,000
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General Ledger
The general ledger is made up of a series ofaccounts that resemble the cheque register
Each account lists all increases and decreases to the
account, in chronological order, and the accountbalance
Actual format shown on page 65 of text
T - account used in this course shown on page 59 account balance determined only after allentries to the account are posted
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Cash
10,000
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There should be a separate account in the generalledger for each type of asset, liability, equity, revenue,gain, expense and loss
Example
Assets:
Cash
Accounts receivable
Inventory
Prepaid expenses
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Land
Building
Equipment
Furniture
Goodwill
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Liabilities
Demand loan payable
Accounts payable
Salaries payable
Interest payable
Income tax payable
Unearned revenue / Deposits from customers
Current portion of long term debt
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Loans payable
Bonds payable
Deferred Tax Credits / Future Tax Payable
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Revenues
Sales revenue
Service revenue
Interest revenue
Gains (Losses)
Gain (Loss) on sale of fixed assets
Gain (Loss) on sale of investments
Gain (Loss) on repurchase of bonds
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Expenses
Cost of goods sold
Salaries expense
Rent expense
Repairs and maintenance
Office Supplies expense
Utilities expense
Interest expense
Income tax expense
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End of Period Procedures
Trial Balance
a listing of all general ledger accounts, withbalance
total debits must equal total credits
if not, must correct errors before proceedingfurther
Adjusting journal entries
record end of period adjustments that are notsupported by transactions
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Adjusted trial balance
another listing of general ledger accounts and
balances
same purpose, to ensure total debits equal totalcredits
done to ensure accounts are in balance prior topreparation of the financial statements
done twice to make identification of the erroreasier - fewer steps to review
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Preparation of the financial statements
Income Statement prepared first Statement of Retained Earnings prepared second
need net income from income statement
Balance Sheet prepared third need retained earnings balance at end ofperiod
Cash Flow Statement prepared last
uses information from other statements
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Closing Journal Entries
journal entries prepared at the end of the fiscal yearof the business
the temporary equity accounts (revenues, expenses,
gains and losses) are closed into Retained Earnings temporary account balances are reduced to zero
retained earnings increased by net incomeamount, or reduced by amount of loss
if dividends declared are recorded in a temporaryaccount, it is closed to Retained Earnings,reducing the retained earnings balance
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BALANCE SHEET
The classified Balance Sheet was introduced lastmodule and will be expanded on here
Example from text page AR - 13 from the appendixfollowing page 651 in volume 1
Loblaws Consolidated Balance Sheet
Consolidated - balance sheet is for more thanone corporation controlled by the same group of
people. (pages AR-4 and AR-5 identify thebusinesses included
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Loblaws Consolidated Balance Sheet
Balance sheet prepared as at January 3, 1998
January 3 is the year end of the business
this is a fiscal year end
a calendar year end is December 31
the fiscal year end may be a calendar yearend, it may be another date
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Loblaws Consolidated Balance SheetLoblaws Consolidated Balance Sheet
this is a reportform balance sheet assets are listed on top
liabilities and equities are listed on the bottom
assets = liabilities + equities
4,013 = 2,518 + 1,495
shown right on the statement
4,013 = 4,013
amounts stated in millions of dollars
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Loblaws Consolidated Balance Sheet
Assets divided between current and non-currentcurrent all listed under the headingCurrent
listed in order of liquidity
non-current listed by type
Franchise investment and receivables
Fixed assets
Goodwill
Other assets
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Loblaws Consolidated Balance Sheet
Liabilities divided between current and non-current all current liabilities reported together under theheading of Current
listed in order of maturity
non-current listed by type
long term debt
other liabilities
deferred income taxes
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Loblaws Consolidated Balance Sheet
Equity accounts that appear on the Balance Sheetare the permanent account balances only
Share capital
the amount received from selling shares whenoriginally issued by the company
not affected by sales betweenshareholders
does not reflect current fair market value ofthe shares
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Loblaws Consolidated Balance Sheet
Retained earnings this is the balance at the end of the year, in thiscase January 3, 1998 (even though it is noted as1997 in the column above the amounts reported)
this only agrees to the actual amount in theRetained Earnings account in the general ledgerimmediately after the temporary accounts areclosed, before any transactions for the next year
are recorded agrees to the amount reported on theConsolidated Statement of Retained Earnings
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BOOKKEEPING EXAMPLE
the text has excellent examples of bookkeepingentries in Chapters 2, 3, and 4
the text examples are for a proprietorship
this example is a corporation
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Heathers Shoe Store Ltd.
Heathers Shoe Store Ltd. intends to begin sellingshoes on January 1, 2000. The company will have aDecember 31 year end. In preparation for the openingof the retail store on January 1, 2000, the business
carried out the following transactions duringDecember, 1999:
1) Heather contributed $10,000 in cash to the businessand received 1,000 common shares in return
2) Display shelves costing $4,000 were purchased onaccount.
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Heathers Shoe Store Ltd.
3) a cheque for $500 was issued to the lawyer for thecost of incorporating the business
4) cash of $4,000 was deposited. The cash was theproceeds of a bank loan obtained to finance the
purchase of the display shelves5) the invoice for the display shelves was paid in full
6) shoe inventory with a cost of $12,000 was orderedon account
7) a shipment of shoes with a cost of $5,500 wasreceived before the end of December; the remainingshoes will be delivered in January
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Heathers Shoe Store Ltd.
8) insurance premium of $2,400 was paid for insurance
coverage from January 1 to December 31, 20009) rent for the month of January of $2,200 was paid,plus $2,200 for the last months rent in advance
10) a customer who knew the shoe store was openinggave Heather $100 for special order shoes. The shoeshave not yet been ordered
Required: prepare the necessary journal entries forDecember 1999 and post to T-accounts. Prepare a trialbalance and balance sheet as at December 31, 1999
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Solution - Heathers Shoe Store Ltd.
Journal entries for December 1999 Debit Credit1) Cash 10,000
Common shares 10,000
2) Fixtures 4,000Accounts payable 4,000
3) Incorporation costs 500Cash 500
4) Cash 4,000Bank loan payable 4,000
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Solution - Heathers Shoe Store Ltd.
Debit Credit5) Accounts payable 4,000
Cash 4,000
6) no entry is required - no liability until shoes are
received
7) Inventory 5,500Accounts payable 5,500
8) Prepaid insurance 2,400Cash 2,400
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Solution - Heathers Shoe Store Ltd.
Debit Credit9) Prepaid rent 4,400
Cash 4,400
10) Cash 100Unearned revenue 100
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Solution - Heathers Shoe Store Ltd.
Cash Common shares
(1) 10,000 10,000 (1)
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Solution - Heathers Shoe Store Ltd.
Cash Common shares
(1) 10,000 10,000 (1)
Fixtures Accounts payable
(2) 4,000 4,000 (2)
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Solution - Heathers Shoe Store Ltd.
Cash Incorporation costs
(1) 10,000 500 (3) (3) 500(4) 4,000 4,000 (5)
Bank loan payable Accounts payable
4,000 (4) (5) 4,000 4,000 (2)
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Solution - Heathers Shoe Store Ltd.
Cash Inventory
(1) 10,000 500 (3) (7) 5,500(4) 4,000 4,000 (5)
2,400 (8)
Prepaid insurance Accounts payable
(8) 2,400 (5) 4,000 4,000 (2)5,500 (7)
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Solution - Heathers Shoe Store Ltd.
Cash Prepaid rent
(1) 10,000 500 (3) (9) 4,400(4) 4,000 4,000 (5)
(10) 100 2,400 (8)4,400 (9)
Unearned revenue
100 (!0)
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Solution - Heathers Shoe Store Ltd.
Cash Inventory
(1) 10,000 500 (3) (7) 5,500(4) 4,000 4,000 (5)
(10) 100 2,400 (8)4,400 (9)2,800
Prepaid insurance Prepaid rent
(8) 2,400 (9) 4,400
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Solution - Heathers Shoe Store Ltd.
Fixtures Incorporation costs
(2) 4,000 (2) 500
Bank Loan Payable Accounts payable
4,000 (4) (5) 4,000 4,000 (2)
5,500 (7)
5,500
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Unearned revenue Common shares
100 (!0) 10,000 (1)
Solution - Heathers Shoe StoreLtd.
S l ti H th Sh St Ltd
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Solution - Heathers Shoe Store Ltd.
Trial Balance
Debits CreditsCash 2,800Inventory 5,500Prepaid insurance 2,400Prepaid rent 4,400Fixtures 4,000Incorporation costs 500Bank loan payable 4,000
Accounts payable 5,500
Unearned revenue 100Common shares 10,000
19,600 19,600
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Heathers Shoe Store Ltd.
Balance Sheetas at December 31, 1999
ASSETSCURRENT
Cash $ 2,800Inventory 5,500
Prepaid insurance 2,400Prepaid rent 4,400
15,100
CAPITALFixtures 4,000
INCORPORATION COSTS 500$ 19,600
Heathers Shoe Store Ltd
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Heather s Shoe Store Ltd.
Balance Sheetas at December 31, 1999
LIABILITIES
CURRENT
Bank loan payable $ 4,000
Accounts payable 5,500Unearned revenue 100
9,600
SHAREHOLDERS EQUITYSHARE CAPITAL
Common shares 10,000$ 19,600
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TIPS TO HELP LOCATE ERRORS
Supplemental topic Chapter 2 - page 80
If total debits do not equal total credits, it is possible tonarrow down the places to look. If debits = 14,720 and
credits = 14,270, the difference is 14,720 - 14270 =450. Since 450 is divisible evenly by 9, it is likely to bea transposition error. 450 / 9= 50.
The result, 50, also provides guidance on where to
look. The transposed numbers are 5 digits apart, andthe transposition is between the hundreds and tenscolumn. For example 1,380 recorded as 1,830 or 940recorded as 490.
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QUESTIONS FOR PRACTICE - NOT FOR MARKS
Chapter 1 6,13,14,15,17
Exercises E1-8, E1-9,
Problems P1-1, P1-4, P1-7, P1-9
Chapter 2 4,7,9,10,15,18
Exercises E2-3, E2-6, E2-8, E2-11
Problems P2- 2, P2- 4, P2- 6, P2- 8, P2-10
The problems listed always go from least to mostdifficult.