Measuring: Financial Position

Recap From Week 1 Summary Recap From Week 1 Summary
We learned:
We learned: Financial Position and the Accounting Equation
What Accounting is:
the process of identifying, measuring, and communicating Financial Position
economic information to permit informed judgements and decisions Economic resources that belong to a company and the claims against
The Accounting Function: those resources at a point in time
Internal usage: Management Accounting (We will focus on Cost
Accounting part) Accounting Equation
External usage: Stewardship Accounting (We will focus on
Assets = Liabilities + Equity
Financial Accounting part)
Types of Businesses Business Transactions:
Proprietorship are economic events that affect the financial position of a business
Partnership entity
Corporation
How to show the effects of these business transactions on
Accounting Equation
Dr.Serhan Duran (METU) EM 501 Week 2 Industrial Engineering Dept. 1 / 45 Dr.Serhan Duran (METU) EM 501 Week 2 Industrial Engineering Dept. 2 / 45
Measuring Business Transactions Measuring Issues Measuring Business Transactions Accounts
In the measurement of business transactions

Business Transactions vast amount of data are gathered
Defined as the economic events that affect the financial position of a
data should be recorded and stored appropriately to facilitate easy
business entity. To measure a business transaction, accountants must
retrieval and easy usage
decide:
preparing the accounting equation for each transaction is time
1 when the transaction occurred (recognition issue)
consuming and can cause information losses
whenever the ownership passes to the firm
whenever revenue is earned Therefore, account is used as the basic storage unit for
whenever a cost is incurred accounting data, to accumulate similar transactions
2 what value to place on the transaction (valuation issue)
Accounts
original cost (the exchange price) associated with transaction at the
time of recognition. Accounting systems have separate accounts
The practice of recording transactions at cost is called cost principle for each Asset and for each Liability
and used due to its verifiability. for each Components of Owners Equity (also Revenues and
3 how the transaction should be categorized (classification issue) Expenses)
assigning all transactions to appropriate categories and finally to Each account is kept on a separate page and book that contains all
accounts.
these accounts is called General Ledger or simply Ledger. A unique
number is assigned to each account for easy reference.
Measuring Business Transactions Types of Commonly Used Accounts Measuring Business Transactions Types of Commonly Used Accounts
Liabilities Accounts
Assets Accounts
Another term is debt.
Cash Notes Payable
Notes Receivable Opposite of Notes Receivable
Written promissory note for a fixed date Accounts Payable
Accounts Receivable Opposite of Accounts Receivable
Oral or implied promises
Wages Payable
Prepaid Expenses
Taxes Payable
Pay for goods and services in advance
Asset until used or expired Rent Payable
Supplies, Prepaid Insurance, Prepaid Rent, Prepaid Taxes Interest Payable
Land Accounts opposite of Prepaid Expenses (customers pay in
Buildings advance)
Subject to wear-tear (depreciation) Unearned Fees
Customer Deposits
Equipment
Advances from Customers
Unearned Revenues
Measuring Business Transactions Types of Commonly Used Accounts Measuring Business Transactions Types of Commonly Used Accounts
Lets see the relationships of Owners Equity Accounts.

BALANCE SHEET
Owners Equity Accounts
Capital Account ASSETS = LIABILITIES + OWNER'S EQUITY
investments by the owners are recorded here
not a revenue by law
Withdrawals Account
withdrawals by the owners are recorded in this account
not an expense by law
CAPTIAL ACCOUNT
Revenue and Expense Accounts
Temporary accounts used to calculate net income
closed out at the end of the period with the net difference
transferred to capital account
One account for each to facilitate easy understanding of revenue
and expense sources WITHDRAWALS
INVESTMENTS
EXPENSE REVENUE
(Recorded Directly
ACCOUNT ACCOUNTS ACCOUNTS
in Capital Account)
Shown on Statement of Shown on Income

Owner's Equity Statement
Measuring Business Transactions Double-Entry System Measuring Business Transactions The T Account
T Accounts
Very useful to understand how the double-entry system works. They
The Double-Entry System
are the basic representations of the accounts and have three parts:
backbone of accounting evolved in Renaissance 1 Title
based on principle of duality 2 A left side which is called the debit side
every economic event has two aspects that balance each other 3 A right side which is called the credit side.
effort and reward
sacrifice and benefit
source and use Title of Account
each transaction must be recorded with at least one debit and one
Debit Credit
credit
total dollar amount of debits and the total amount of credits equal
each other
An entry made on the left side of the account is a debit
therefore, whole system is always in balance
An entry made on the right side of the account is a credit
Debit and credit are simply accountants word for left and right.
NO ANY OTHER MEANINGS!
Measuring Business Transactions The T Account Measuring Business Transactions Rules Of Double-entry Bookkeeping
To illustrate the usage of T accounts, lets consider the cash account of

the Luxury Homes Realty. The transactions that involves:
the receipt of cash are recorded by entering on left (debit) According to the rules of double-entry bookkeeping
payment of cash are recorded by entering on right (credit) For every transaction:
Tabular Summary
1 at least one account is debited and at least one account is credited
Account Form 2 the total amount of debits must equal total of credits
Cash
50,000 Cash
-35,000 (1) 50,000 (2) 35,000 Consider the Accounting Equation
1,500 (5) 1,500 (4) 200
(7) 1,000 (8) 1,000
Assets = Liabilities + Owners Equity
-200
1,000 (9) 400
-1,000 (10) 600 1 if a debit increases assets, then a credit must be used to increase
-400 52,500 37,200 the liabilities or the owners equity
-600 Bal. 15,300
2 if a credit decreases the assets, then a debit should decrease the
15,300
liabilities or owners equity
The difference in the debit and credit footings is called the balance or
account balance. If the balance is a debit it is written on the left side of
the T-account and if it is credit on the right side.
Measuring Business Transactions Rules Of Double-entry Bookkeeping Measuring Business Transactions Rules Of Double-entry Bookkeeping
Assets = Liabilities + Owners Equity Assets = Liabilities + Owners Equity

Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
for for for for for for for for for for for for
Increase Decrease Decrease Increase Decrease Increase Increase Decrease Decrease Increase Decrease Increase
RULES: Historical Background

1 Increases in assets are debited to asset accounts; decreases in Accounts decide to enter increases in assets to the left side
assets are credited to the assets accounts. (debit) of accounts, since assets are on the left side of the
2 Increases in liabilities and owners equities are credited to accounting equation
liabilities and owners equities accounts; decreases in liabilities Accounts decide to enter increases in liabilities and owners equity
and owners equities are debited to the liabilities and owners to the right side (credit) of accounts, since liabilities and owners
equities accounts. equity are on the right side of the accounting equation
Measuring Business Transactions Rules Of Double-entry Bookkeeping Measuring Business Transactions Rules Of Double-entry Bookkeeping
The following relationship is useful to visualize that relationship:

The application of those rules to the owners equity is a bit confusing Owners Equity
since its components; revenues, expenses,withdrawals and Decreases Increases
investments have different effects. (debits) (credits)
Revenues increase owners equity Expenses Revenues
Expenses decrease owners equity Increases Decreases Decreases Increases
Withdrawals decrease owners equity (debit) (credit) (debit) (credit)
Withdrawals Capital
Investment increase owners equity
Increases Decreases Decreases Increases
(debit) (credit) (debit) (credit)
Measuring Business Transactions Rules Of Double-entry Bookkeeping Measuring Business Transactions John Miller Advertisement Agency
OR SIMPLY January 1: John Miller invests $10,000 to start his own advertising
agency.
Assets Liabilities
Expenses Revenues Cash John Miller, Capital
Withdrawals Capital Jan.1 10,000 Jan.1 10,000
Debit Credit Debit Credit
for for for for Rules
Increase Decrease Decrease Increase Increase in assets are debited to the asset account, increase in
owners equity is credited to the owners equity account.
Measuring Business Transactions John Miller Advertisement Agency Measuring Business Transactions John Miller Advertisement Agency
January 2: John Miller rents an office, pays 2 months rent, $800 in January 4: Purchase art equipment, $4,200, with cash.
advance.
Cash
Cash Prepaid Rent Art Equipment
Jan.1 10,000 Jan.2 800
Jan.4 4,200
Jan.1 10,000 Jan.2 800 Jan.2 800 Jan.4 4,200
Rules Rules
Increase in assets are debited to the asset account, decrease in Increase in assets are debited to the asset account, decrease in
assets is credited to the asset accounts. assets is credited to the asset accounts.
January 5: Purchases office equipment, $3,000, pays $1,500 in cash January 6: Purchases art supplies, $1,800, office supplies, $800 on
and agree to pay the rest of the payment $1,500 next month. credit from Taylor Company.
Cash Office Supplies Art Supplies
Jan.1 10,000 Jan.2 800 Office Equipment Jan.6 800 Jan.6 1,800
Jan.4 4,200 Jan.5 3,000
Jan.5 1,500 Account Payable
Account Payable Jan.5 1,500
Jan.5 1,500 Jan.6 2,600
Rules
Rules
Increase in assets are debited to the asset account, decrease in
Increase in assets are debited to the asset accounts, increase in
assets is credited to the asset accounts, increase in liabilities are
liabilities are recorded as credits.
recorded as credits.
January 8: Pays for a one-year life insurance policy, $480, with January 9: Pays Taylor Company $1,000 of the amount owned.
coverage effective January 1.
Cash
Cash
Jan.1 10,000 Jan.2 800
Jan.1 10,000 Jan.2 800 Account Payable
Prepaid Insurance Jan.4 4,200
Jan.4 4,200 Jan.9 1,000 Jan.5 1,500
Jan.8 480 Jan.5 1,500
Jan.5 1,500 Jan.6 2,600
Jan.8 480
Jan.8 480
Jan.9 1,000
Rules
Rules
Increase in assets are debited to the asset account, decrease in
Decrease in assets is credited to the asset accounts, decrease in
assets is credited to the asset accounts.
liabilities is recorded as debits.
January 10: Performs a service by placing an advertisement for an January 12: Pays the two week wage of the secretary, $600.
automobile dealer and collects a fee, $1,400.
Cash
Cash Jan.1 10,000 Jan.2 800
Jan.1 10,000 Jan.2 800 Jan.10 1,400 Jan.4 4,200
Wages Expense
Jan.10 1,400 Jan.4 4,200 Adv. Fee Earned Jan.5 1,500
Jan.12 600
Jan.5 1,500 Jan.10 1,400 Jan.8 480
Jan.8 480 Jan.9 1,000
Jan.9 1,000 Jan.12 600
Rules Rules
Increase in assets is debited to the asset accounts, increase in owners Decrease in assets is credited to the asset accounts, decrease in
equity is recorded as credits. owners equity is recorded as debits.
January 15: Accepts an advance fee, $1000, for artwork to be done.

January 19: Performs a service by placing a major advertisement for
Cash Wall Mart. The fee, $2,800 is billed now but will be collected next
Jan.1 10,000 Jan.2 800 month.
Jan.10 1,400 Jan.4 4,200
Unearned Art Fees Adv. Fee Earned
Jan.15 1,000 Jan.5 1,500 Accounts Receivable
Jan.15 1000 Jan.10 1,400
Jan.8 480 Jan.19 2,800
Jan.9 1,000 Jan.19 2,800
Jan.12 600
Rules
Rules Increase in assets is debited to the asset accounts, increase in owners
Increase in assets is debited to the asset accounts, increase in equity is recorded as credits.
liabilities is recorded as credits.
January 26: John Miller pays this secretary two more weeks wages,
January 25: John Miller withdraws $1,400 for his personal usage. $600.
Cash Cash
Jan.1 10,000 Jan.2 800 Jan.1 10,000 Jan.2 800
Jan.10 1,400 Jan.4 4,200 Jan.10 1,400 Jan.4 4,200
Jan.15 1,000 Jan.5 1,500 John Miller, Withdrawals Jan.15 1,000 Jan.5 1,500 Wages Expense
Jan.8 480 Jan.25 1,400 Jan.8 480 Jan.12 600
Jan.9 1,000 Jan.9 1,000 Jan.26 600
Jan.12 600 Jan.12 600
Jan.25 1,400 Jan.25 1,400
Jan.26 600
Rules
Decrease in assets is credited to the asset accounts, decrease in Rules
owners equity is recorded as debits. Decrease in assets is credited to the asset accounts, decrease in
owners equity is recorded as debits.
January 29: John Miller receives and pay the utility bill, $100.
Cash
Jan.1 10,000 Jan.2 800 January 30: John Miller receives but not pay the telephone bill, $70.
Jan.10 1,400 Jan.4 4,200
Account Payable
Jan.15 1,000 Jan.5 1,500
Telephone Expense Jan.9 1,000 Jan.5 1,500
Jan.8 480 Utility Expense
Jan.30 70 Jan.6 2,600
Jan.9 1,000 Jan.29 100
Jan.30 70
Jan.12 600
Jan.25 1,400
Jan.26 600 Rules
Jan.29 100 Increase in liabilities is credited, decrease in owners equity is recorded
as debits.
Rules
Decrease in assets is credited to the asset accounts, decrease in
owners equity is recorded as debits.
Measuring Business Transactions Recording Transactions Measuring Business Transactions Recording Transactions
The General Journal

The usage of T accounts for recording the transactions is due to its All transactions are recorded to the Journal chronologically
simplicity and effectiveness. But; identification of the individual transactions easy
do not show the data of a transaction together (associated debits debits and credits related with a transaction is entered same place
and credits are on separate T accounts) A separate journal entry is used for each transaction
Not Chronological Entries in the general journal include:
the date
Therefore, T accounts are only used for analyzing complex
year and month not repeated unless a new month or page
transactions in practice.
names of accounts debited and credited
Formal process for recording the transactions: first the debited accounts, next to left margin
after them the credited accounts, indented from left margin
1 Analyze the transactions from the source documents amount of debits and credits made to the same line as the accounts
2 Enter the transactions into the Journal an explanation of the transaction
3 Transfer data from journal to the Ledger by debiting and crediting post reference is used to enter the ledger account number after
posting from journal takes place for
the particular accounts involved (called posting) convenient cross reference
indicating the transaction is already posted
a blank line is left after each journal entry
Measuring Business Transactions Recording Transactions Measuring Business Transactions Recording Transactions
Lets see how two transactions for the John Miller Advertising
Company would look like:
The T account is a simple and direct way to update the accounts, but
General Journal Page 1 in practice a more complicated form of account is needed.
Date Description Post Debit Credit
Ref. The General Ledger
2007 Jan. 6 Art Supplies 1,800 The name and number of the account appear at the top
Office Supplies 800 Date is entered similar to the journal
Accounts Payable 2,600
Purchase of art and office The Post. Ref. section indicates the page of the journal where the
supplies on credit original entry for the transaction recorded
The balance is computed and entered after each entry
8 Prepaid Insurance 480
Cash 480 The balance is always available (not in T accounts)
Paid one year life
insurance premium
Measuring Business Transactions Recording Transactions Measuring Business Transactions Posting
The accounts payable account in the ledger at the end of the month is
General Journal Page 2
given as:
Date Description Post. Ref. Debit Credit
General Ledger 2007 30 Telephone Expense 70

70
Jan. Accounts Payable
Accounts Payable Account No:212 Received Bill for
telephone expense
Post Balance
Date Item Ref. Debit Credit Debit Credit
2007 Jan. 5 J1 1,500 1,500
6 J1 2,600 4,100
9 J1 1,000 3,100
30 J2 70 3,170
Posting
Entries in the journal are transferred into the ledger regularly
Debit (credit) amount in the journal is transferred into the debit
(credit) column of the appropriate account in the ledger
After the entry is done, account number is entered to the Post.Ref.
column of the journal where the account is credited or debited. In the ledger, locate the debit and credit accounts named in the journal
Measuring Business Transactions Posting Measuring Business Transactions Posting
General Journal Page 2 General Journal Page 2
Date Description Post. Ref. Debit Credit Date Description Post. Ref. Debit Credit
2007 30 Telephone Expense 70 2007 30 Telephone Expense 70

Jan. Accounts Payable 70 Jan. Accounts Payable 70
Received Bill for Received Bill for
telephone expense telephone expense
General Ledger General Ledger

Accounts Payable Account No. 212 Accounts Payable Account No. 212
Balance Balance
Date Item Post. Ref. Debit Credit Debit Credit Date Item Post. Ref. Debit Credit Debit Credit
2007 2007
Jan. 5 J1 1,500 1,500 Jan. 5 J1 1,500 1,500
J1 2,600 4,100 J1 2,600 4,100
6 1,000 6 1,000
J1 3,100 J1 3,100
9 9 J2
30

Telephone Expense Account No. 513 Telephone Expense Account No. 513
Balance Balance
2007 2007
Jan. Jan. 30 J2
In the ledger, enter the date and journal page to post. ref. In the ledger, transfer the debit and credits amounts from journal
Measuring Business Transactions Posting Measuring Business Transactions Posting
General Journal Page 2 General Journal Page 2
Date Description Post. Ref. Debit Credit Date Description Post. Ref. Debit Credit
2007 30 Telephone Expense 70 2007 30 Telephone Expense 70

Jan. Accounts Payable 70 Jan. Accounts Payable 70
Received Bill for Received Bill for
telephone expense telephone expense

Accounts Payable Account No. 212 Accounts Payable Account No. 212
Balance Balance
2007 2007
Jan. 5 J1 1,500 1,500 Jan. 5 J1 1,500 1,500
J1 2,600 4,100 J1 2,600 4,100
6 1,000 6 1,000
J1 3,100 J1 3,100
9 J2 9 J2
70 70 3,170
30 30

Telephone Expense Account No. 513 Telephone Expense Account No. 513
Balance Balance
2007 2007
Jan. 30 J2 70 Jan. 30 J2 70 70
In the ledger, calculate the account balances in balance columns In the journal, in post. ref. enter the account numbers from ledger
Measuring Business Transactions Posting Measuring Business Transactions The Trial Balance
General Journal Page 2 For every amount debited in the ledger, an equal amount must be
Date Description Post. Ref. Debit Credit
credited. Which means the total of debits must be equal to the total of
2007 30 Telephone Expense 70
Jan. Accounts Payable
513
212 70 the credits. This is tested periodically by preparing a trial balance.
Received Bill for
telephone expense The steps in preparing a trial balance:
General Ledger
Account No. 212
1 List each account that has a balance; debit balances entered into
Accounts Payable
Balance
the left column, credit balances into the right.
Date Item Post. Ref. Debit Credit Debit Credit 2 Add each column.
2007
Jan. 5 J1 1,500 1,500 3 Left and right columns must equal each other.
J1 2,600 4,100
6 1,000
J1 3,100
9 J2 70 3,170
30 CAUTION!
General Ledger
Trial balance proves whether or not the ledger is in balance
Telephone Expense Account No. 513
Balance
Does not prove that the transactions were analyzed and recorded
Date Item Post. Ref. Debit Credit Debit Credit in proper accounts
2007
Jan. 30 J2 70 70
Measuring Business Transactions The Trial Balance
Lets see the trial balance for the John Miller Advertising Company at
the end of January.
John Miller Advertising Company
Trial Balance
January 31, 2007
Cash $1,720
Accounts Receivable 2,800
Art Supplies 1,800
Office Supplies 800
Prepaid Rent 800
Prepaid Insurance 480
Art Equipment 4,200
Office Equipment 3,000
Accounts Payable $3,170
Unearned Art Fees 1,000
John Miller, Capital 10,000
John Miller, Withdrawals 1,400
Advertising Fees Earned 4,200
Wages Expense 1,200
Utility Expense 100
Dr.Serhan Duran (METU) EM 501 Week 2
Telephone Expense 70 Industrial Engineering Dept. 45 / 45

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Recap From Week 1 Summary Recap From Week 1 Summary

In the measurement of business transactions

Lets see the relationships of Owners Equity Accounts.

Shown on Statement of Shown on Income

To illustrate the usage of T accounts, lets consider the cash account of

Assets = Liabilities + Owners Equity Assets = Liabilities + Owners Equity

RULES: Historical Background

The following relationship is useful to visualize that relationship:

January 15: Accepts an advance fee, $1000, for artwork to be done.

The General Journal

General Ledger 2007 30 Telephone Expense 70

General Journal Page 2 General Journal Page 2

2007 30 Telephone Expense 70 2007 30 Telephone Expense 70

General Ledger General Ledger

General Ledger General Ledger

General Journal Page 2 General Journal Page 2

2007 30 Telephone Expense 70 2007 30 Telephone Expense 70

General Ledger General Ledger

General Ledger General Ledger

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