Journal and T-accounts

In bookkeeping system, transactions are recorded in chronological order in a journal. After analyzing the business documents that describe a transaction, the bookkeeper enters the effects on the accounts in the journal using debits and credits. The journal entry, then, is an accounting method for expression of the effects of a transaction on accounts and it is written in a debits-equal-credits format. Format of Journal Entry:

A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions. Format of T-Account:

Example: Papa John's purchases $10,000 of new ovens, counters, refrigerators, and other equipment, paying $2,000 in cash and signing a two-year note payable to the equipment manufacturer for the rest on August 1.

• To solve it, first, we identify and classify the accounts and effects:

1. Property and Equipment (Assets) increase for $10,000
2. Cash (Assets) decrease for $2,000
3. Notes Payable (Liabilities) increase for $8,000

• Is the accounting equation in balance?

Yes, there is an $8,000 increase on the left side and an $8,000 increase on the right side of the equation.

• Journal Entries

Aug 1 Dr Property and Equipment                  $10,000

               Cr Cash                                                            $2,000

               Cr Notes Payable                                             $8,000

Remember to keep practicing to understand well the concepts...=)

Double Entry System

Accounting focuses on certain events that have an economic impact on the entity. Those events are recorded as parts of the accounting process called transactions. The first step in translating the results of business events to financial statement numbers is determining which events to include.

To accumulate the dollar effect of transactions on each financial statement item, organizations use a standardized format called an account. An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item.

Transaction Analysis

Transaction analysis is the process of studying a transaction to determine its economy effect on the entity in terms of the accounting equation. The basic accounting equation and two principles are the foundation for this model. Recall from previous post that the basic accounting equation for a business that is organized as a corporation is as follows:

Assets = Liabilities + Capital

The two principles underlying the transaction analysis process follow:

1. Every transaction affects at least two accounts; correctly identifying those accounts and the direction of the effect (whether an increase or a decrease) is critical.
2. The accounting equation must remain in balance after each transaction.

The idea that every transaction has at least two effects on the basic accounting equation is known as the duality of effects. Example:

• Purchased land for cash

Assets                 =              Liabilities + Capital

          Land (increase)
          Cash (decrease)

• Purchased land on credit

Assets             =          Liabilities          +        Capital

    Land (increase)           Account payable (increase)

These are examples of the second principle, which the accounting equation must remain in balance after each transaction:

• J. Scott, the owner, contributed $20,000 cash to start the business

         The accounts involved are:

1. Cash (asset, increase)
2. J. Scott, Capital (equity, increase)

• Purchased supplies paying $1,000 cash

         The accounts involved are:

1. Cash (asset, decrease)
2. Supplies (asset, increase)

• Purchased equipment for $15,000 cash

         The accounts involved are:

1. Cash (asset, decrease)
2. Equipment (asset, increase)

• Purchased supplies of $200 and equipment of $1,000 on account

         The accounts involved are:

1. Supplies (asset, increase)
2. Equipment (asset, increase)
3. Accounts payable (liability, increase)

• Borrowed $4,000 from 1st American Bank

         The accounts involved are:

1. Cash (asset, increase)
2. Notes payable (liability, increase)

All of these above are the most fundamental things in accounting. So, understand these concepts are important. Keep practicing! =) 

Capital

Capital (Stockholders' Equity or Owner's Equity) is the financing provided by the owners and by business operations. Owner-provided cash (and sometimes other assets) is referred to as contributed capital. Owners invest in the business and receive shares of stock as evidence of ownership. Capital is increased when revenues exceed expenses (profit) and decreased when expenses exceed revenues (loss).

Profit = Revenues - Expenses

Loss = Expenses - Revenues

Company earn revenues from the sale of goods or services to customers, and normally are reported for goods or services that have been sold to a customer whether they have been paid for or not.

Expenses represent the dollar amount of resources the entity used to earn revenues during the period. Expenses reported in one accounting period may actually be paid for in another accounting period. Some expenses require the payment of cash immediately while some require payment at a later date.

Liabilities

Liabilities generally are the debts of a company. Specifically, liabilities are probable debts and obligations that result from an entity's past transactions and will be paid with assets or services. There two classifications of liabilities:

• Current Liabilities
• Long-term (non-current) Liabilities

Let's get the details of each of them.

Current Liabilities

Current Liabilities are short-term obligations that will be paid in cash (or other current assets) within the current operating cycle or one year, whichever is longer. Because most companies have an operating cycle that is shorter than one year, current liabilities normally can be defined as simply as liabilities that are due within one year. Examples of current liabilities:

1. Accounts Payable (A/P) or Creditors
2. Notes Payable
3. Bank Overdraft
4. Accrued Liabilities
5. Unearned Revenues

Long-term Liabilities

Long-term Liabilities include all obligations that are not classified as current liabilities, such as long-term notes payable, bonds payable, mortgages, long-term loans, debentures, etc. Typically, a long-term liability will require payment more than one year in the future. These obligations may be created by borrowing money, or they may result from other activities.

Assets

As I promised, now let's discuss about assets, the details of them. Generally, assets are all resources that a business owns, but the specified definition refers to service potential or future economic benefits controlled by the entity as a result of past transactions or other events. Assets are categorized into several classifications, they are:

• Current Assets
• Fixed Assets
• Intangible Assets
• Natural Resources Assets

We'll discuss each of them generally.

Current Assets

Current Assets are cash and other assets expected to be converted to cash, sold, or consumed either in a year (less than 12 months) or in the operating cycle. These assets are continually turned over in the course of a business during normal business activity. There are 5 major items included into current assets:

1. Cash on hand or Cash at bank
2. Short-term investments
3. Account receivable (A/R) or Debtors
4. Inventory
5. Prepaid expenses

Fixed Assets

Fixed Assets also known as property, plant and equipment (PP&E), is a term used in accountancy for assets and property which cannot easily be converted into cash. In most cases, only tangible assets are referred to as fixed assets. Some examples of fixed assets : land and buildiings/premises, motor vehicles, furniture, office equipment, computers, fixtures and fittings, and plant and machinery.

Intangible Assets

Intangible Assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset. There are several intangible assets, such as:

1. Patent, the government grants patents to encourage the invention of new technology, mechanical devices, and production process. A patent is an exclusive right granted to its owner to manufacture and sell a patented item or to use a process of 20 years.
2. Copyright, gives its owner the exclusive right to publish or sell a musical, literally, or artistic working during life of the creator plus 70 years.
3. Leaseholds, refer to the rights that the lessor (the one who gives the lease) grants to the lessee (the one who receives the lease) under the term of the lease. A leasehold is an intangible asset for the lessee
4. Franchises and Licenses, are rights that a company or government grants an entity to deliver a product of service under specified conditions. Example : McDonald's and Pizza Hut
5. Trademarks and Trade Names, are symbols such as names, phrases or jingles identified with a company, product or service. Example : Coca Cola, Big Mac, etc.
6. Goodwill, is the amount by which a company's value exceeds the value of its individual assets and liabilities. This usually implies that the company as a whole has certain valuable attributes not measured among its individual assets and liabilities.

Natural Resources Assets

Natural Resources Assets are assets that are physically consumed when used. Since they are consumed when used, they are often called wasting assets. Examples : standing timber, mineral deposits, and oil and gas fields. 

The Accounting Equation

This is the very basic concept of accounting, the important thing that we must understand when we are learning accounting. This is what we called as "The Accounting Equation". It is a simple equation, which assets equal to liabilities and capital (also known as stockholders' equity or owner's equity).

Assets = Liabilities + Capital

Although it is a simple equation, but we won't understand it if we haven't known the meaning of each elements in the equation. In this post, I will just tell the short definition of each elements, as I will post the details of each elements on the next posts. Assets are the resources owned by a business. Liabilities are the debts of a business, and capital are the rights of the owners.

Let's get into the examples of accounting equation's questions:

1. Suppose a business has $1,000 worth of liabilities and $2,500 capital, how much are the assets that the business has?
2. A company needs to find its liabilities value, knowing its assets worth $5,700 and its capital are worth of $3,200.

Well, the solution for number 1 is simple, just implement the accounting equation:

Assets = Liabilities + Capital

Assets = $1,000 + $2,500

Assets = $3,500

Hence, the assets of the business are worth of $3,500


The same equation can be applied for the second question's solution:

Assets = Liabilities + Capital

Because we need to find the value of liabilities, we must change the equation into:

Liabilities = Assets - Capital

Liabilities = $5,700 - $3,200

Liabilities = $ 2,500

We got $2,500 value of the company's liabilities.

That's all about the accounting equation, it's simple yet the most fundamental thing in accounting. Practice to understand more about this topic. =D