Chapter 2

Recording Business Transactions

Chapter 2 Mugan-Akman 2007 2

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(b) Accrual basis of accounting– Revenues and expenses are recognized on an Revenues and expenses are recognized on an

economic basis regardless of when cash is paid or economic basis regardless of when cash is paid or receivedreceived

Chapter 2 Mugan-Akman 2007 3

Accounting Methods for Measuring Performance

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

expenses are recognized when cash is paidexpenses 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

X

Chapter 2 Mugan-Akman 2007 4

Recognition of Revenues

• Significant risks and benefits of ownership passes from the seller to the buyer

(Transfer of title of goods)

Chapter 2 Mugan-Akman 2007 5

Recognition of Expenses

• Expenses are recognized when they are incurred and helped to produce revenues

Chapter 2 Mugan-Akman 2007 6

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

Chapter 2 Mugan-Akman 2007 7

Accounting Cycle

Analyze and record the transactions

Post the transactions and prepare trial balance

Adjust the accounts and prepare trial balance

Close the accounts and prepare trial balance

Prepare the financial statements

Chapter 2 Mugan-Akman 2007 8

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

Chapter 2 Mugan-Akman 2007 9

Fundamental Accounting Equation

ASSETS = EQUITIES

ASSETS = LIABILITIES + OWNERS' EQUITY

Chapter 2 Mugan-Akman 2007 10

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.

Chapter 2 Mugan-Akman 2007 11

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”)

Title

Debit Credit

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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

Chapter 2 Mugan-Akman 2007 13

Behavior of Accounts

Liabilities and Owners’ Equity accounts increase on the credit side, decrease on the debit side

Liabilities or Owners’ Equity Accounts

- +

debit credit

Chapter 2 Mugan-Akman 2007 14

Yağmur Bulut completed the following transactions during October 2007:

1. 1 October, invested TL 50.000 to start an accounting practice, Yağmur Bulut, SMMM

2. 2 October, Rented office space and paid TL 1.200 for October and November.

3. 4 October, paid cash for a Dell computer, TL 2.000. The computer is expected to remain in service for five years

4. 5 October, purchased furniture and fixtures for the office on account, TL 5.400 . These items have an estimated useful life of 5 years.

5. 6 October, purchased supplies on account, TL 150

6. 8 October, performed tax filing services for a client on account, TL 375

P2-6

Chapter 2 Mugan-Akman 2007 15

7. 22 October, made an agreement with a client to perform bookkeeping for 6 months and received TL 1.200 in advance

8. 23 October, the electricity invoice for an amount of TL 52 was received, which will be paid in November

9. 27 October, paid the liability for the purchase of office supplies

10. 29 October, the client who was billed on 8 October paid TL 275

11. 31 October, Withdrew cash to pay her son’s school fee, TL 1.600

Chapter 2 Mugan-Akman 2007 16

Date Account Debit Credit1 October Cash 50,000

Y. Bulut, Capital 50,000

Chapter 2 Mugan-Akman 2007 17

Date Account Debit Credit1 October Cash 50,000

Y. Bulut, Capital 50,000

2 October Rent Expense 600Prepaid Rent 600 Cash 1,200

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Date Account Debit Credit1 October Cash 50,000

Y. Bulut, Capital 50,000

2 October Rent Expense 600Prepaid Rent 600 Cash 1,200

4 October Office Equipment 2,000 Cash 2,000

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Date Account Debit Credit1 October Cash 50,000

Y. Bulut, Capital 50,000

2 October Rent Expense 600Prepaid Rent 600 Cash 1,200

4 October Office Equipment 2,000 Cash 2,000

5 October Office Furniture 5,400 Accounts Payable 5,400

Chapter 2 Mugan-Akman 2007 20

Date Account Debit Credit1 October Cash 50,000

Y. Bulut, Capital 50,000

2 October Rent Expense 600Prepaid Rent 600 Cash 1,200

4 October Office Equipment 2,000 Cash 2,000

5 October Office Furniture 5,400 Accounts Payable 5,400

6 October Supplies 150 Accounts Payable 150

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Date Account Debit Credit1 October Cash 50.000

Y. Bulut, Capital 50.000

2 October Rent Expense 600Prepaid Rent 600 Cash 1.200

4 October Office Equipment 2.000 Cash 2.000

5 October Office Furniture 5.400 Accounts Payable 5.400

6 October Supplies 150 Accounts Payable 150

8 October Accounts Receivable 375 Revenues 375

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Debit Credit

22 October Cash 1,200

Unearned Revenues 1,200

Chapter 2 Mugan-Akman 2007 23

Debit Credit

22 October Cash 1,200

Unearned Revenues 1,200

23 October Utilities Expense 52

Accounts Payable 52

Chapter 2 Mugan-Akman 2007 24

Debit Credit

22 October Cash 1,200

Unearned Revenues 1,200

23 October Utilities Expense 52

Accounts Payable 52

27 October Accounts Payable 150

Cash 150

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Debit Credit

22 October Cash 1,200

Unearned Revenues 1,200

23 October Utilities Expense 52

Accounts Payable 52

27 October Accounts Payable 150

Cash 150

29 October Cash 275

Accounts Receivable 275

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Debit Credit

22 October Cash 1,200

Unearned Revenues 1,200

23 October Utilities Expense 52

Accounts Payable 52

27 October Accounts Payable 150

Cash 150

29 October Cash 275

Accounts Receivable 275

31 October Y. Bulut, Withdrawals 1,600

Cash 1,600

Chapter 2 Mugan-Akman 2007 27

Accounting Cycle

Analyze and record the transactions

Post the transactions and prepare trial balance

Adjust the accounts and prepare trial balance

Close the accounts and prepare trial balance

Prepare the financial statements

Chapter 2 Mugan-Akman 2007 28

Posting to The LedgerGENERAL JOURNAL Page 1Date Account Title and Description Ref* Debit Credit

1 Jan 2004Cash 100 100.000

Capital 500 100.000

Investment by the shareholders

LEDGER - Cash Acc. No. 100

Date Description Ref Debit Credit Debit Balance

Credit Balance

1 Jan 2004Investment by the shareholders P 1 100.000 100.000

LEDGER - Capital Acc. No. 500

Date Description Ref Debit Credit Debit Balance

Credit Balance

1 Jan 2004Investment by the shareholders P 1 100.000 100.000

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LEDGER - Cash Acc. No. 100

Date Description Ref Debit Credit Debit Balance

1 Jan Investment by the shareholders P 1 100.000 100.0001 Jan Payment of office rent P 1 600 99.4002 Jan Purchase of office furniture and equipment P 1 5.000 94.4003 Jan Payment of insurance P 1 120 94.28010 Jan Borrowing from the bank P 1 15.000 109.28010 Jan Purchase of office supplies P 1 2.500 106.78020 Jan Payment for an accounts payable P 1 5.000 101.78022 Jan Receipt of advance payment from a customer P 1 7.500 109.28023 Jan Receipt of payment from a customer P 1 5.000 114.28024 Jan Payment of salaries P 1 9.000 105.28031 Jan Withdrawal by the owner P 1 3.000 102.280

Chapter 2 Mugan-Akman 2007 30

50,000 1,200 375 275 150 600 1,200 2,000 100 150 600

275 150 1,600

51,475 4,950 46,525

2,000 5,400 150 5,400 2,000 5,400 150

52 150 5,602

5,452

1,200 50,000 1,600 375 1,200 50,000 1,600 375

600 52 600 52

Prepaid Rent

Accounts Payable

Unearned Revenues Capital

Rent Expense

Withdrawals Revenues

Utilities Expense

Cash Accounts Receivable Supplies

Office Equipment Office Furniture

Chapter 2 Mugan-Akman 2007 31

Debit CreditCash 46,525 Accounts Receivable 100 Supplies 150 Prepaid Rent 600 Equipment 2,000 Furniture 5,400 Accounts Payable 5,452 Unearned Revenues 1,200 Capital 50,000 Withdrawals 1,600 Revenues 375 Rent Expense 600 Utility Expense 52 Total 57,027 57,027

Trial Balance

Chapter 2 Mugan-Akman 2007 32

Category of the Account

Increase Recorded By

Normal Balance

Assets Debits Debit

Liabilities Credits Credit

Shareholders’ Equity

Capital Credits Credit

Dividends or Withdrawals

Debits Debit

Revenues Credits Credit

Expenses Debits Debit

NORMAL BALANCES OF ACCOUNTS