How Do Companies Keep Track of Account Balances

• General Journal

  • (chronological list of each transaction’s effects)

• General Ledger or T-accounts (a record of effects to and balances of each account)

The Journal Entry

• In an accounting system, transactions are recorded in chronological order in a general journal (or, simply, journal)

• After analyzing the business documents (such as purchase invoices, receipts, and cash register tapes) that describe a transaction

• The journal entry is an accounting method for expressing the effects of a transaction on accounts

• It is written in a debits-equal-credits format

Ledger/T-accounts

• Debit: simply the left side of an account

  • Increase in the asset account are on the left (debit) because assets are on the left side of the accounting equation

• Credit: simply the right side of an account

  • Increase in the liability and equity account are on the right (credit) because they are on the right side of accounting equation

Debits and Credits in Summary

Posting Transaction Effects From the Journal to the Ledger

• As a group, the accounts are called the general ledger

• This step (posting from journal entry to ledger) is usually computerized in larger organizations

• But in some small businesses, this is still done manually. The ledger is often a three-ring binder with a separate page for each account

Trial Balance

• List the names of the T-accounts in financial statement order (assets, liabilities, stockholder’s equity, revenues and expenses)

• The purpose of the trial balance in to check the equality of the debits and credits

• Errors may still exist if the wrong accounts or amounts were used in the journal entries

Prepare Financial Statements Summary

1. Analyze transactions

   1. Journal entry for each transaction

   2. Post to T-account

2. Trial balance

3. Classified financial statements

Report Transactions of Financial Statement

• Both IFRS & GAAP require firms to separately report their current and non-current assets, and their current and non-current liabilities

• IFRS & GAAP have different formatting of financial statements

Common-Size Analysis of the Balance Sheet

• Common size-analysis

  • State each balance sheet item as a percentage of total assets

  • Useful in comparing a company’s financial position over time & compare across companies in the same industry

• Analysis of a company’s balance sheet can provide insight into the company’s liquidity and solvency, as well as the economic resources the company controls

  • Liquidity: company’s ability to meet short-term financial commitments

  • Solvency: company’s ability to meet long-term financial obligations by assessing the company’s financial structure

Valuing Assets

• Valuing assets refers to how to record these assets on balance sheet

• According to historic cost convention, assets should be reported as historic cost. However, different types of assets may be measured differently (some use historical cost, some use fair value, some are adjusted for depreciation/impairment)

  • Value inventories

  • Valuing trade receivables

  • Valuing PPE

    • PPE will be used over time as a result of wear and tear and so on, so should allocate its cost over time in the form depreciation

    • The amount of depreciation will not only appear as depreciation expense on the I/S, but will also affect the carrying value (net book value) of asset on B/S

    • Record Accumulated depreciation on B/S as a net against PPE’s historical cost

    • Accumulated depreciation: the sum of depreciation which has already been taken since the purchase of the asset

Report Inventories

• Goods in inventory are initially recorded at cost

• When inventories are sold, they will be recognized as cost of goods sold (COGS) on the income statement

• Inventory flow process for merchandise inventory

• Refer to slides for “Inventory Flow Process for Merchandise Inventory” diagram

Inventories and COGS

What’s relationship between inventories and cost of goods sold

1. Company starts each accounting period with a stock inventory: beginning inventory (BI)

2. During the account period, new purchase (P) are added to inventory

3. The sum of two becomes goods available for sale during that period

4. The portion that are sold becomes cost of goods sold (COGS)

5. What remains unsold at the end of a period becomes ending inventory

This process and relationship can be explained by the cost of goods sold equation

Cost of Goods Sold Equation

• when inventory is sold to generate revenue, cost of goods (COGS) should be recognized on income statement: at the same time, inventory will decrease on balance sheet

Beginning inventory (BI) + Purchased (P) - Cost of Goods Sold (COGS) = ending inventory (EI)

COGS = BI + P -EI

Reporting Accounts receivables

• Problem with trade receivables: there is always risk that customers will not pay

• Allowance for doubtful debt is recorded as an estimate of uncollectible accounts receivables (bad debt). It recorded on B/S to net against the gross accounts receivables amount (prudence purpose)

• Allowance for doubtful debt is explained in income statement, it reflects the company’s estimate of the amount of receivable that will eventually uncollectible. It is a contra-asset account of account receivable. Prudence: not to overstate the assets (trade receivables)