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Chapter 2: Analyzing Transactions into Debit and Credit Parts

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Using T AccountsA T-account is an accounting device used to analyze transactions.

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The balance of an account increases on the same side as the normal balance side.

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2. How is each account classified?

3. How is each classification changed?

4. How is each amount entered in the accounts?

August 1. Received cash from owner as an investment, $5,000.00.

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33 33

44 44

1. Which accounts are affected?Each transaction changes the balances in at least two accounts.

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2. How is each account classified?

3. How is each classification changed?

4. How is each amount entered in the accounts?

August 3. Paid cash for supplies, $275.00.

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33 33

44 44

1. Which accounts are affected?

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1. Which accounts are affected?

2. How is each account classified?

3. How is each classification changed?

4. How is each amount entered in the accounts?

August 4. Paid cash for insurance, $1,200.00.

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33 33

44 44

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August 7. Bought supplies on account from Supply Depot, $500.00.

1. Which accounts are affected?

2. How is each account classified?

3. How is each classification changed?

4. How is each amount entered in the accounts?

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33 33

44 44

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August 11. Paid cash on account to Supply Depot, $300.00.

1. Which accounts are affected?

2. How is each account classified?

3. How is each classification changed?

4. How is each amount entered in the accounts?

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33 33

44 44

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August 12. Received cash from sales, $295.00.

1. Which accounts are affected?

2. How is each account classified?

3. How is each classification changed?

4. How is each amount entered in the accounts?

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33 33

44 44

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August 12. Sold services on account to Oakdale School, $350.00.

1. Which accounts are affected?

2. How is each account classified?

3. How is each classification changed?

4. How is each amount entered in the accounts?

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33 33

44 44

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August 12. Paid cash for rent, $300.00.

1. Which accounts are affected?2. How is each account classified?

3. How is each classification changed?4. How is each amount entered in the accounts?

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44

44

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33

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August 18. Received cash on account from Oakdale School, $200.00.

1. Which accounts are affected?

2. How is each account classified?

3. How is each classification changed?

4. How is each amount entered in the accounts?

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33 33

44 44

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August 12. Paid cash to owner for personal use, $125.00.

1. Which accounts are affected?

2. How is each account classified?

3. How is each classification changed?4. How is each amount entered in the accounts?

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44

22

22

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Withdrawals are recorded in the owner’s drawing account.

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• Planning phase Setting goals and objectives for business

activities

• Performing phase Completing the planned business activities

and recording the results of those activities

• Evaluating phase Providing information to interested users to

assess the success of the business activities

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• Business organization and strategy process Determines the plan of action for the company

• Operating processes Profit-making activities of the company

• Capital resources processes Financing and investing activities of the

company

• Performance measurement and management process Balanced scorecard (see next slide)

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• Approach to planning and measuring performance; “How did we do as a company?”

• 4 perspectives Financial; determine the return on the investment &

accounts payable (see next slide) Internal; time it takes to process an order Customer; inventory turnover time; customer

satisfaction & loyalty Learning and growth; company research & growth,

employee training, new technology

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• Accounts receivable turnover Days in the collection cycle are compared to the credit

terms your company offers it’s customers; 2/10; n/30• Inventory turnover

Days in the selling cycle are compared to the shelf life of the item; how long did the item sit on the shelf?

• Accounts payable turnover Days in the payment cycle are compared to the credit

terms offered by the supplier; how long does your company have to pay its bill.

Return on Sales (ROS) indicates a company's operating profit (or loss) for a particular period—usually one year. Essentially the formula is profit divided by sale revenue, expressed as a percentage.

ROS is a useful measure of a company's operational efficiency as well as its profitability. It reflects how resourcefully each dollar of sales revenue is used, how well the company manages costs, and how it responds to difficulties like a sales downturn, increasing costs, or a fall in prices. A higher ROS indicates that a company is likely to cope well with such circumstances, and may be able to hold out against cutting its prices or entering into a price war.

ROS can be helpful in analyzing companies with seasonal or irregular income patterns, or those with a large volume of depreciating assets—perhaps as a result of substantial capital investment.

LESSON 2-119

The formula for ROS is simply:

operating profit / total sales × 100 = percentage return on sales

For example, if a business makes $150 on a sale worth $950, ROS is:

150 / 950 = 0.158 × 100 = 15.8%

LESSON 2-120

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Internal control is the process designed to ensure reliable financial reporting, effective and efficient operations, and compliance with applicable laws and regulations. Safeguarding assets against theft and unauthorized use, acquisition, or disposal is also part of internal control.

Control activities are the specific policies and procedures management uses to achieve its objectives. The most important control activities involve segregation of duties, proper authorization of transactions and activities, adequate documents and records, physical control over assets and records, and independent checks on performance.

Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.  ROE is the amount of net income returned as a percentage of shareholders equity.

Shareholder equity is equal to total assets minus total liabilities. It's what the shareholders "own". Shareholder equity is a creation of accounting that represents the assets created by the retained earnings of the business and the paid-in capital of the owners.

Return on Equity (ROE) is one of the financial ratio used by stock investors in analyzing stocks. It indicates how effective the management team is in converting the reinvested money into profits. The higher the ROE, the more money a company able to generate for the same dollar amount spent.

ROE is expressed as a percentage and calculated as:

Return on Equity = Net Income/Shareholder's Equity

So if $50,000 was invested into a company by it’s stockholders and at the end of the year the company had a net income (revenue - expenses) of $10,000, what is the return on equity?

Answer: $10,000/$50,000 = 20%

LESSON 2-122

Segregation of duties requires that different individuals be assigned responsibility for different elements of related activities, particularly those involving authorization and recordkeeping. For example, the same person who is responsible for an asset's recordkeeping should not be responsible for physical control of that asset. Having different individuals perform these functions creates a system of checks and balances.

Proper authorization of transactions and activities helps ensure that all company activities adhere to established guidelines. For example, a fixed price list may serve as an official authorization of price for a sales staff.

Adequate documents and records provide evidence that financial statements are accurate. Controls designed to ensure adequate recordkeeping include the creation of invoices and other documents that are easy to use and sufficiently informative; the use of prenumbered, consecutive documents; and the timely preparation of documents.

LESSON 2-123

Physical control over assets and records helps protect the company's assets. These control activities may include electronic or mechanical controls (such as a safe, employee ID cards, fences, cash registers, fireproof files, and locks) or computer-related controls dealing with access privileges or established backup and recovery procedures.

Independent checks on performance, which are carried out by employees who did not do the work being checked, help ensure the reliability of accounting information and the efficiency of operations. For example, a supervisor verifies the accuracy of a retail clerk's cash drawer at the end of the day. Internal auditors may also verity that the supervisor performed the check of the cash drawer.

LESSON 2-124

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• Prevention

Reducing the opportunity for error to occur

• Employee training, product and process design

• Continuous inspection, testing

• Appraisal

Finding errors as early in the process as possible• Internal failure

Correcting errors before the customer knows the error occurred; example: reworking a product until it runs properly.

• External failure Correcting errors after the customer knows the error occurred Includes customer ill will

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• Proper authorization; don’t purchase supplies without following proper procedures; get a signed purchase order.

• Separating duties; one employee writes checks while another employee signs the checks; they create a check and balance system.

• Maintaining adequate documentation; keep copies of receipts, purchase orders, and all documents related to any transaction.

• Physically controlling assets and documents; depositing checks received from sales every night at the bank and record it in the computer/general journal as a backup.

• Providing independent checks on performance; use internal controls to check cash flow: check cash receipts, cash disbursements, bank statements, & company charge card statements. Assigned these job tasks to different employees (separation of duties).