Measuring Business Transactions

1
Measuring Business Transactions

• Chapter 2

2
Measurement Issues

• Recognition when a transaction occurred
• Valuation what value
• classification

3
The recognition issue

• When a business transaction should be recorded
• Ordered? Received? Payment?

4
A recordable event?

• Sent a purchase requisition
• Sent a purchase order
• Shipped the order
• Received the shipment
• Received the bill
• Paid the bill

5
Recognition point

• A transaction is recorded when title to the
  shipment passes from supplier to the purchaser,
  creating an obligation to pay

6
Recognition point

• If a project is going to take a long period to
  develop or complete, the transaction can be
  recorded upon some percentage of completion where
  a bill is sent and paid.

7
The valuation issue

• The assignment of a monetary value to a business
  transaction
• The original cost (historical cost)
• The exchange price associated with a business
  transaction at the point of recognition

8
The cost principle

• The practice of recording transactions at cost is
  referred to as the cost principle
• The market value of an asset may vary over the
  time, but the asset will remain on the record at
  its original transaction cost

9
The cost principle

• Verifiable
• Objective
• Is not subject to manipulation
• Challenges? Decision usefulness?

10
The classification issue

• The assignment of transactions to appropriate
  accounts
• E.g. Is a 1000 tool an asset or an expense?
• Remodeling of kitchen is (1) an addition to the
  long term asset or (2) an expense for the year

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Accounts

• An account is a setup to file the same kind of
  transactions and also to compute the ending
  balance of all the transactions for financial
  reporting
• Amount of accounts depends on the need of each
  financial entity

12
General ledger

• In a manual accounting system, each account is
  kept on a separate page or card. The pages or
  cards are placed together in a book or file
  called the general ledger

13
Chart of Accounts

• Help identify accounts
• Help computerized system in storing transactions
  or in data entry
• Usually assigned a systematic arranged number
  like 100 for assets and 200 for liabilities, 300
  for stockholders equities, 400 for revenues, 500
  for expenses

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Chart of accounts

• See exhibit 1 on page 95
• See the assignment of account numbers

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Relationships of SE Accounts

• Page 97
• Revenue and expense accounts shown on income
  statement
• Dividends and NI or NL shown on statement of
  retained earnings

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The double-entry system

• The basic method of accounting
• 1494 on a book written by Pacioli
• one of the finest discoveries of the human
  intellect
• Based on the principle of duality

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Duality of Effects

• Business transactions
• With external parties
• An exchange by giving up something to receive
  others
• No external parties
• Adjusting entries on source and use

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Double-entry system

• Each transaction must be recorded with at least
• One debit
• One credit
• The total amount of debits and credits equals
  each other
• Self-correction by being balanced

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T-account

• A simple accounting system
• Drawn out like a T with
• A title on the top
• A left side called the debit side
• A right side called the credit side

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T Account

• Footings totals of two columns on a T account
• Balance the difference in between the total
  debit footing and the total credit footing
• If LS is more than RS, a debit balance
• If RS is more than LS, a credit balance

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Rules for processing transactions

• Assets on LHS
• Debit is the accountants word for left
• Increase assets -- debit them
• Decrease assets put on the opposite side of
  debit credit them
• Credit is the accountants word for right

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rules

• Liabilities and stockholders equities are on the
  RHS
• Increase L or SE put them on RHS, that is,
  credit them
• Decrease L or SE put them on the opposite side,
  that is, debit them

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Revenues

• Related to Retained earnings
• Revenues helps increase R/E, that is, revenues
  and R/E have a positive relationship or have the
  same behavior
• Inc. revenues credit them
• Decrease revenues debit them

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expenses

• Has an opposite behavior as retained earning
• Which means, increase expenses will put on the
  decreasing side of R/E, debit them
• Decrease expenses credit them

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dividends

• Similar to expenses in processing transaction
• Increase dividends debit them

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Analyzing and processing transactions

• Figure 2 on Page 100
• From source documents like sales invoice
• Apply the rules of double entry
• Record the entry
• Posting and then
• preparing Trial Balance

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Example on p. 100

• Borrowed 100,000 from its bank on a promissory
  note

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Determining effects

• Receiving 100,000 cash
• Incurring 100,000 liability through a signed
  note
• Which means increase cash
• Also increase liability

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Applying rules

• Increase asset ? debit
• Increase liability ? credit
• That is, debit cash for 100,000
• Credit ??? For 100,000

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Posting the entry

• Transfer the date and amount to
• Cash account for 100,000
• Notes payable account for 100,000

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Preparing trial balance

• Calculate balance for each account
• Calculate totals for left and right sides
• Check the totals of two sides
• If not equal, some errors made!!

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Investment in business

• Increase cash ? debit cash
• Increase common stock ?credit common stock
• Page 101

33
Rent paid in advance

• Prepaid rent
• An asset or an expense??
• Cash used up (decrease)
• Therefore, credit cash

34
Prepaid rent

• An asset why?
• Prepaid rent is an asset therefore it will be
  debited

35
Order supplies

• Recognition problem?
• When should it be recognized?

36
Purchase of equipment

• Equipment is classified as ???
• Pay cash ? decrease cash ? debit cash

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Purchase with partial payment

• Two entries on payment
• Decrease cash ? credit cash
• Increase liability ? credit accounts payable
• Office equipment is classified as

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Purchase on credit

• Art supplies and office supplies
• Both are assets
• Both are debited
• Credit accounts payable

39
Purchase insurance in advance

• Prepaid insurance is an asset or an expense
  account?
• Used up cash therefore, credit cash
• Increase asset therefore, debit asset

40
Payment of liability

• Decrease accounts payable ? debit accounts
  payable
• Decrease cash ? credit cash

41
Revenues earned

• Increase revenues ? credit revenues
• In this case, a specific name called Advertising
  Fees Earned

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Payment of expense

• Wages expense increase ? debit wages expense
• Paid by cash ? decrease cash ? decrease asset ?
  credit cash

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Unearned revenues

• A revenue or a liability???
• Future obligation
• Received cash ? increase cash ? debit cash
• Credit unearned revenues
• Specifically, unearned art fees

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Revenue earned

• But payment to be received
• Accounts receivable
• An asset
• Debit accounts receivable
• Credit advertising fees earned

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Dividends

• Page 106
• Paid cash ? decrease cash ? debit cash
• Dividends which side?

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Preparing trial balance

• Calculate balance for each account
• Calculate totals for left and right sides
• Check the totals of two sides
• If not equal, some errors made!!
• Exhibit 3 on Page 108

47
Normal balance

• The usual balance
• Assets should usually be debit balance
• That is, accounts receivable should be debit
  balance
• Equipments should be debit balance
• The normal balances for Liabilities usually
  should be credit balances

48
Normal balance

• Common stock ? credit balance
• Retained earnings ? credit balance
• Expenses ? debit balance
• Revenues ? credit balance

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Journal

• Book of original entry
• Record all transactions chronologically, I.e.,
  recorded according to its time order

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A journal entry

• The date
• Debit entry or entries with amount or amounts
• Credit entry or entries with amount or amounts
• Explanation
• Account identification number

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General ledger

• Used to file and update each account
• Exhibit 5 Accounts payable in the general ledger

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posting

• The process of transferring journal entry
  information from the journal to the ledger

53
Assignment

• P4 on page 125 Transaction Analysis, Journal
  form, T account as general ledger and Trial
  balance
• It is very similar to review problem on page 115