BASICS OF BOOKKEEPING

The topics to be covered in this section of the course are described in Chapters 1 and 2 of the text

Chapter 1 Chapter 2

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TOPICS TO BE COVERED

NATURE OF ACCOUNTING
SINGLE ENTRY BOOKKEEPING DOUBLE ENTRY BOOKKEEPING

THE 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 the mechanics of bookkeeping a solid foundation in bookkeeping is necessary to be able to evaluate the effects of selecting alternative 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 results of economic activities of a business
identification and measurement require significant professional judgement once it has been determined what should be recorded, the bookkeeping or recording process is straight forward communication of the results of the economic activities is done through the FINANCIAL STATEMENTSINSTITUTE OF MODERN
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SINGLE ENTRY ACCOUNTING

use of your cheque book is single entry accounting

cheques issued are recorded as a reduction in the bank account, but there is not a separate record kept for each type of expense paid

for instance, if groceries were purchased, there is no entry to show an increase to the total cost of groceries 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 for proprietorships where the owner prepares an income statement 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 asset and liability account balances
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DOUBLE ENTRY ACCOUNTING

Double entry accounting creates an account for each type of asset, liability, equity, revenue and expense
Every entry into a double entry accounting system must 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 must be recorded
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 double entry accounting permits preparation of both a balance sheet and an income statement
checks and balances are available to ensure all transactions are recorded Example a bank reconciliation is prepared to ensure the ending bank balance per the bank statement agrees to the balance in the accounting records if it does not, any unrecorded amounts will be identified and recorded
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THE ACCOUNTING EQUATION

the accounting equation is the foundation of double 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
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MECHANICS OF BOOKKEEPING Double entry accounting requires that the accounting records of the business balance, just as the accounting equation balances to accomplish this, left and right side entries are recorded

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
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ASSETS = LIABILITIES + EQUITIES

Assets appear on the left side of the accounting equation (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

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ASSETS = LIABILITIES + EQUITIES

Liabilities appear on the right side of the accounting equation (credit side of the equal sign)
The normal balance for a liability account is a credit balance Liabilities are increased by a credit entry Liabilities are decreased with a debit entry

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ASSETS = LIABILITIES + EQUITIES

Equities are on the right side of the accounting equation ( 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 with debit entries and decreased with credit entries

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The permanent equity accounts have a normal credit balance Temporary accounts may have debit or credit balances: Revenues and gains increase equity and have normal credit balances

Expenses and losses reduce equity and have normal debit balances
Dividends distributed, if recorded in a separate account, have a normal debit balance

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Equity in a business

If a company earns $10,000, this amount in not payable to creditors. The value of the company will increase and it is the shareholders that benefit
Revenue and expense accounts are used to measure the profit or loss in the year These accounts are really part of the equity of the business, but are kept separate to facilitate the preparation of the income statement

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COMPONENTS OF EQUITY OF A CORPORATION

ASSETS = LIABILITIES + EQUITY

EQUITY = SHARE CAPITAL + RETAINED EARNINGS

RETAINED EARNINGS = OPENING RETAINED EARNINGS + NET INCOME - DIVIDENDS

NET INCOME = REVENUES - EXPENSES

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Components of Equity of a Proprietorship For a proprietorship, contributions by the owner and profits 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 a business to the shareholders (owners) the term dividend only applies to a corporation for a proprietorship and partnership, distributions of 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 permanent accounts because they carry forward on the Balance Sheet from one year to the next

REVENUES, EXPENSES, GAINS and LOSSES are referred to as temporary accounts because they accumulate the transactions for the year only, and then their 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 in the accounting records at this time if yes, determine which accounts are affected determine whether each account affected is increased or decreased by this transaction requires significant professional judgement in the real world in this course, most events are very straightforward
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General journal entries

method of recording transactions in the accounting records

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
Cash Share Capital 10,000

Credit

10,000

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General Ledger

The general ledger is made up of a series of accounts that resemble the cheque register
Each account lists all increases and decreases to the account, in chronological order, and the account balance Actual format shown on page 65 of text T - account used in this course shown on page 59

account balance determined only after all entries to the account are posted
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Cash
10,000

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There should be a separate account in the general ledger 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, with balance total debits must equal total credits if not, must correct errors before proceeding further Adjusting journal entries record end of period adjustments that are not supported by transactions
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 Adjusted trial balance

another listing of general ledger accounts and balances same purpose, to ensure total debits equal total credits done to ensure accounts are in balance prior to preparation of the financial statements done twice to make identification of the error easier - 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 of period

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 year of 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 income amount, or reduced by amount of loss if dividends declared are recorded in a temporary account, it is closed to Retained Earnings, reducing the retained earnings balance
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BALANCE SHEET The classified Balance Sheet was introduced last module and will be expanded on here Example from text page AR - 13 from the appendix following page 651 in volume 1 Loblaws Consolidated Balance Sheet Consolidated - balance sheet is for more than one corporation controlled by the same group of people. (pages AR-4 and AR-5 identify the businesses 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 year end, it may be another date

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Loblaws Consolidated Balance Sheet this is a report form 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-current current 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 the heading 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 Sheet are the permanent account balances only Share capital the amount received from selling shares when originally issued by the company not affected by sales between shareholders does not reflect current fair market value of the shares

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Loblaws Consolidated Balance Sheet Retained earnings this is the balance at the end of the year, in this case January 3, 1998 (even though it is noted as 1997 in the column above the amounts reported) this only agrees to the actual amount in the Retained Earnings account in the general ledger immediately after the temporary accounts are closed, before any transactions for the next year are recorded

agrees to the amount reported on the Consolidated Statement of Retained Earnings

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BOOKKEEPING EXAMPLE

the text has excellent examples of bookkeeping entries 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 selling shoes on January 1, 2000. The company will have a December 31 year end. In preparation for the opening of the retail store on January 1, 2000, the business carried out the following transactions during December, 1999: 1) Heather contributed $10,000 in cash to the business and received 1,000 common shares in return 2) Display shelves costing $4,000 were purchased on account.

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Heathers Shoe Store Ltd. 3) a cheque for $500 was issued to the lawyer for the cost of incorporating the business

4) cash of $4,000 was deposited. The cash was the proceeds of a bank loan obtained to finance the purchase of the display shelves 5) the invoice for the display shelves was paid in full
6) shoe inventory with a cost of $12,000 was ordered on account

7) a shipment of shoes with a cost of $5,500 was received before the end of December; the remaining shoes 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, 2000 9) 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 opening gave Heather $100 for special order shoes. The shoes have not yet been ordered Required: prepare the necessary journal entries for December 1999 and post to T-accounts. Prepare a trial balance and balance sheet as at December 31, 1999
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Solution - Heathers Shoe Store Ltd. Journal entries for December 1999 1) Cash Common shares 2) Fixtures Accounts payable 3) Incorporation costs Cash Debit Credit 10,000 10,000 4,000

4,000
500 500

4) Cash Bank loan payable

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4,000
4,000
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Solution - Heathers Shoe Store Ltd. Debit Credit 5) Accounts payable Cash 4,000 4,000

6) no entry is required - no liability until shoes are received 7) Inventory Accounts payable 8) Prepaid insurance Cash
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5,500 5,500 2,400 2,400

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Solution - Heathers Shoe Store Ltd.

9) Prepaid rent Cash 10) Cash Unearned revenue

Debit Credit 4,400 4,400

100

100

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Solution - Heathers Shoe Store Ltd.

Cash (1) 10,000

Common shares 10,000 (1)

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Solution - Heathers Shoe Store Ltd.

Cash (1) 10,000

Common shares 10,000 (1)

Fixtures (2) 4,000

Accounts payable 4,000 (2)

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Solution - Heathers Shoe Store Ltd.

Cash (1) 10,000 (4) 4,000 500 (3) 4,000 (5)

Incorporation costs (3) 500

Bank loan payable 4,000 (4)

Accounts payable (5) 4,000 4,000 (2)

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Solution - Heathers Shoe Store Ltd.

Cash (1) 10,000 (4) 4,000 500 (3) 4,000 (5) 2,400 (8)

Inventory (7) 5,500

Prepaid insurance (8) 2,400

Accounts payable (5) 4,000 4,000 (2) 5,500 (7)

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Solution - Heathers Shoe Store Ltd.

Cash (1) 10,000 (4) 4,000 (10) 100 500 (3) 4,000 (5) 2,400 (8) 4,400 (9)

Prepaid rent (9) 4,400

Unearned revenue 100 (!0)

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Solution - Heathers Shoe Store Ltd.

Cash (1) 10,000 (4) 4,000 (10) 100 2,800 Prepaid insurance (8) 2,400 500 (3) 4,000 (5) 2,400 (8) 4,400 (9)

Inventory (7) 5,500

Prepaid rent (9) 4,400

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Solution - Heathers Shoe Store Ltd. Fixtures Incorporation costs

(2) 4,000

(2)

500

Bank Loan Payable 4,000 (4)

Accounts payable (5) 4,000 4,000 (2) 5,500 (7) 5,500

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Solution - Heathers Shoe Store Ltd. Unearned revenue 100 (!0) Common shares 10,000 (1)

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Solution - Heathers Shoe Store Ltd. Trial Balance Debits Cash 2,800 Inventory 5,500 Prepaid insurance 2,400 Prepaid rent 4,400 Fixtures 4,000 Incorporation costs 500 Bank loan payable Accounts payable Unearned revenue Common shares 19,600
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Credits

4,000 5,500 100 10,000 19,600

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Heathers Shoe Store Ltd. Balance Sheet as at December 31, 1999

ASSETS

CURRENT Cash Inventory Prepaid insurance Prepaid rent

2,800 5,500 2,400 4,400 15,100

CAPITAL Fixtures INCORPORATION COSTS

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4,000
500 19,600

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Heathers Shoe Store Ltd. Balance Sheet as at December 31, 1999 LIABILITIES CURRENT Bank loan payable Accounts payable Unearned revenue $ 4,000 5,500 100 9,600

SHAREHOLDERS EQUITY SHARE 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 to narrow 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 be a transposition error. 450 / 9= 50. The result, 50, also provides guidance on where to look. The transposed numbers are 5 digits apart, and the transposition is between the hundreds and tens column. For example 1,380 recorded as 1,830 or 940 recorded 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 most difficult.
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