Financial Accounting 1

Topic 3 Recording Transactions: Double-Entry System

Professor Aileen Pierce Room Q206 Quinn School

Phone 716 4745 (x4745)

aileen.pierce@ucd.ie

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Luca Pacioli

Summa de arithmetica, geometrica, proportioni et proportionalita (Venice 1494), a synthesis of the mathematical knowledge of his time, is also notable for including the first published description of the method of keeping accounts that Venetian merchants used during the Italian Renaissance, known as the double-entry accounting system. Although Pacioli codified rather than invented this system, he is widely regarded as the "Father of Accounting".

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See pages 30 33 of SLD

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Luca Pacioli

The system he published included most of the accounting cycle as we know it today. He described the use of journals and ledgers, and warned that a person should not go to sleep at night until the debits equaled the credits! His ledger had accounts for assets (including receivables and inventories), liabilities, capital, income, and expensesthe account categories that are reported on an organization's balance sheet and income statement, respectively. He demonstrated year-end closing entries and proposed that a trial balance be used to prove a balanced ledger. Also, his treatise touches on a wide range of related topics from accounting ethics to cost accounting. (From http://en.wikipedia.org/wiki/Luca_Pacioli )
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Luca Pacioli

Painting of Luca Pacioli, attributed to Jacopo de' Barbari, 1495 (attribution controversial). Table is filled with geometrical tools: slate, chalk, compass, a dodecahedron model. A rhombicuboctahedron half-filed with water is suspended from the ceiling. Pacioli is demonstrating a theorem by Euclid.
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Objective of Double Entry Accounting System

Record and summarise financial transactions
Classify transactions Keep orderly records

Build up to reports providing information to users

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Accounting Equation
Assets

Accounting records are maintained in way that ensures accounting equation holds

Liabilities = Equity

Whether recording 10 transactions or trillions of transactions

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Example

A business buys a car for 20,000

Purchase of Car Assets Car Bank Equity Issued share capital Shares of 1.00 each +20,000 -20,000

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Accounting System: Double Entry

Every transaction has two effects:
Increase one asset and reduce another asset Increase assets and increase liabilities Increase assets and increase equity/capital Reduce assets and reduce liabilities Reduce assets and reduce equity/capital

Exercise for you: Think up examples to fit Scoil Ghn each of above! U Chuinn UCD UCD Quinn School of Business

SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS Resources ReceivOther ables assets Claims Outsiders Owner +100 +50 +50 +45 -15

Transaction 1 2 3 4 5 Original capital Borrowing Buy property Buy inv. for cash Sell some inventory

Cash +100 +50 -50 -45

+35

+20

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What is going on here?

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SAMPLE TRANSACTIONS: IMPACT ON RESOURCES AND CLAIMS Resources ReceivOther ables assets Claims Outsiders Owner +100 +50 +50 +45 -15

Transaction 1 Original capital 2 Borrowing 3 Buy property 4 Buy inv. for cash 5 Sell some inv. 6 Pay wages 7 Customer pays 8 Buy inv. on credit TOTALS

Cash +100 +50 -50 -45

+35 -4 +16 +67 -16 +19

+20 -4 +25 +75

+25 +105

+116

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Statement of financial position (Balance sheet) '000 Property 50 Inventory 55 Receivables 19 Cash 67 191 Financed by: Share capital 100 Retained earnings 16 Equity 116 Loan 50 Payables 25 191
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Study pages 47-59 in Chapter 2 of SLD

Figure 2.11 Summary table

Figures 2.3 to 2.11 in Chapter 2 of SLD

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Table 2.3 Statement of financial position (Balance sheet) on 31 December X1

Assets Non-current assets Equipment

Equity and liabilities 210 Shareholders equity 125 Share capital 150 Earnings (net income) 60 Liabilities 70 Financial debt (Loan) 68 Accounts payable 263 Total equity and liabilities

Current assets Accounts receivable Cash at bank Total assets

48 5 263

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Statement of financial position on 31 December X1 vertical format

Non-current assets Equipment Current assets Accounts receivable Cash at bank 70 68 138 263 125

Equity and liabilities

Ordinary share capital Retained earnings 150 60 210

Long-term loan
Accounts payable

48
5 53 263
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Accounting System: Practicalities

Transactions too numerous to calculate impact on SFP for each transaction
System developed over time to:
Summarise similar systematically Stages involved:
o Record volume in Books of first entry

transactions

and

record

o Journal entries to indicate 2 sides of record

o T Accounts
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Double-entry book-keeping: Terminology

Two sides to each transaction or to record total of similar transactions

DEBIT

CREDIT

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Double-Entry Bookkeeping: Exercise 1

Debit Increase in Decrease in An asset A liability or equity item Credit A liability or equity item An asset

Is there any logic to this?

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Example

Purchase of car for 20,000

Use Table in Exercise 1 to work out the two sides of this transaction

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Journal Entry Journal entry specifies which account is debited and which is credited
Date Account Car Bank Debit 20,000 20,000 Credit

Being purchase of car

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Journal Entries

One per transaction or per total of similar

Debits must equal credits to reflect both sides of transaction Keeps the accounting equation in balance

Brief description of the transaction under the journal entry

Note the format

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Debit X Account; Credit Y Account

What do we mean by ACCOUNT?

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Keeping Track of Transactions: T-account

One for every asset, liability, revenue, expense and equity item
Records date, nature and amount of transaction
Debit Date Account Bank Amount Date Account Credit Amount

Where other side is recorded

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Using T Accounts to Record Transactions

Debit Date ...

Account Bank

Car Amount Date 20,000

Account

Credit Amount

side is recorded

Debit Where other Date Account

Bank Amount Date ...

Account Car

Credit Amount 20,000

Where other side is recorded

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Balancing T Accounts

Debit Date ... ...

Account Issued share capital Bank loan Balance

Bank Amount Date 1,000 ... 1,500 2,500 2,000

Account Machine Balance

Credit Amount 500 2,000 2,500

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The Trial Balance: so far!

The trial balance is a list of balances on all T accounts: Two columns

Debit Credit

Each column should have same total (debits should equal credits)
Debits indicate assets .. for the moment!

Credits indicate liabilities and equity . ditto

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Example: Simple Trial Balance

Account Bank Machine Bank loan Issued share capital

Debit 2,000 500

Credit

2,500

1,500 1,000 2,500

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Summary

1. Record transactions in a way that is consistent with the accounting equation

2. Use debits and credit to reflect increases/decreases in assets, liabilities and equity 3. Use T accounts to accumulate transactions for each item

4. Extract a trial balance that list the balance on each T account in the appropriate column
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To-Do-List
Prepare for Tutorial Sessions on Financial Statement Analysis
Study material from Session 2 Re-read sections from SLD

Complete problems set for Tutorials (Week 3)

Tutorial Exercises A,B and C (on BB); Past exam questions

Remember: Next online Test focuses on above

Read specified pages of textbook (S4) before Monday 6th February

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