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Lecture 4

Accounting and Bookkeeping II

Contents

Recording of business transactions


Journal Entries
Accounting Cycle
Underlying Assumptions
Basic Transactions

Repetition: Business Transactions


Do you remember the accounting equation?

Which topics on debits and credits are important?

Dead and clear how do they work?

3.3. Recording of Business


Transactions II

Overview
Recording of business transactions will occur in two steps:

Account assignment:
The business transaction is assigned to appropriate
accounts.
Booking:
The business transaction with its assigned accounts is
recorded in the journal.
To record a business transaction, all other concepts of the
double entry system applies.

3.3.1 From Business Transactions to Journal


Entries
The recording of a business transaction is a process.
It is up to the discretion of the accountant to decide how
and where business transactions are recorded.
Therefore, the selection of appropriate accounts is an
important step in recording the business transaction.
The process of selecting the apropriate account is called
account assignment.
Several activities have to be performed and decisions to
be made to assign the business transaction to appropriate
accounts.

Account assignment
During the account assignment you have to check:
Which accounts are involved.
What kind of account are they.
Is it an addition or divesture.
Which amount has to be assigned to which account.
You also have to check:
Is the balance of all accounts zero.
Are all items of the business transaction considered.
As a tools, account assignment stamps are often used.

Examples of Account Assignment Stamps

Exercise

Which accounts are involved for the following business


transactions?
Cash withdrawal from the bank
Cash collection from a customer

Purchase of a computer on account


Sale of goods to a customer

Purchase of spare parts with cash

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3.3.2. Journal Entries


Once accounts are assigned to business transactions, this
assignment has to be converted in journal entries.
Therefore, a journal entry always consist of a least two
accounts.
Journal entries are:
Simple journal entry
One business transaction
Two accounts
Combined journal entry
One business transaction
More than two accounts
Reversal journal entry
To adjust erroneous journal entries

11

Journal entry law

Debit

Credit

12

3.3.2.1 Bookings
Booking is a process.
Its main purpose is to record the account assigned business

Date

transaction (so the planned journal entry) in an accounting


system by placing the information in the journal.
Folio
Example:

Narrative
Debit
Account

Amount

Credit
Account
Cost Accounting
Information

13

Simple Journal Entries


One account is debited, another account is credited.
Journal entries:
dr

Cash
AR

The debit account always


comes first, the credit
account is offseted

cr

100
100

Presentation using T accounts:


Cash
100

AR
100

14

Combined Journal Entries


One or more accounts are debited, another account is
credited.
Journal entries:

All debit accounts come


first, the credit account is
offseted

dr

Inventory
VAT
AP

cr

dr

100
19

AR

119

cr

119
Revenue
100
VAT
19

Presentation using T accounts:


Inventory
100

AR
119

VAT
19

AP

Revenue
100

119

VAT
19

15

3.3.2.2. Reversals
Reversals are used if an erroneous entry is made.
Rule:
We document all transactions in the accounting system,
even errors are documented, corrected but not eliminated!

Types of corrections of erroneous entries are:


Calculated adjustment and add another journal entry (this
is doable but not a good accounting behaviour as it
makes transactions difficult to understand)
Revers erroneous entry and enter the correct entry by
using positive entries (acceptable but not a good practise)
Revers erroneous entry and enter the correct entry by
using negative entries (best way because the erroneous
entry will not impact financial items)

16

Reversals (2)
Case: A journal entry is made for provisions for social securtity, 2.000 EUR
instead of 5.000 EUR.
Original journal entry:
Expenses for social security 2.000
Provision
2.000

1. Corrections
Expenses for social security
Provisions

3.000
3.000

2. Reversal with positive entries


Provisions
Expenses for social security
Expenses for social security
Provisions

2.000
2.000
5.000
5.000

3. Reversal with negative entries


Expenses for social security
Provisions
Expenses for social security
Provisions

-2.000
-2.000
5.000
5.000

17

Example

18

Exercise
The purchase department has ordered spareparts for the
IT department, value 2.000 EUR net. Due to the lack of
information, the accounting department has booked am
amount of 2.500 EUR as material expenses.
Prepare the journal entries of the erroneous transaction
and adjust them to the correct business transaction. Use T
accounts.

3.4 Accounting Cycle

20

3.4.1. Overview
Jan

Feb

Mar

Apr

May

Jun

Fiscal Year

Jul

Aug

Sep

Oct

Nov

Dec

Jan

Feb

Mar

Apr

May

Calendar Year
Regular business
Opening Balance
Sheet

Closing Balance
Sheet

An accounting cycle always covers one fiscal year.


The fiscal year is independent from the calendar year.
As a legal requirement, at the end of each fiscal year, a
financial statement has to be prepared.
This implies to prepare a balance sheet
All accounts have to be closed
The closing balance sheet will become the opening
balance sheet of the next fiscal year.

21

From Opening to Closing Balance Sheet


Opening Balance Sheet
Assets

Equity
Debt

Asset Accounts
Dr
Opening
Balance
+ Additions

Liability Accounts
Cr

Dr

./.
Reductions

./.
Reductions

Closing
Balance

Closing
Balance
Closing Balance Sheet
Assets

Equity
Debt

Cr
Opening
Balance
+ Aditions

22

3.4.2. Opening Transactions


At the beginning of the year, balance sheet accounts have
to be opened.
As these accounts represent the balance sheet items they
are also classified as permanent accounts.
Initial bookings to fill accounts:
Debit asset accounts / credit balance sheet
Credit liability & equity accounts / debit balance sheet
P&L accounts are always zero.

23

3.4.3 Ongoing Business


During the fiscal year, accounts are booked as business
transactions occur.
Balance sheet accounts are updated as they are
permanent accounts.
P&L accounts are adjusted as they are temporary
accounts.

24

3.4.4 Closing Transactions


To close the fiscal year requires several steps:
Balance sheet accounts are adjusted for year-end
purposes if required.
The same applies to P&L accounts.
P&L accounts are transferred to closing accounts.
All temporary accounts are cleared.
Final bookings to close all accounts are executed:
Credit asset accounts / debit balance sheet.
Debit liability accounts / credit balance sheet.

Process activities will be discussed in lecture 14.

25

Year-end adjustments
Year-end adjustments are made to comply with legal
requirements regarding the presentation and
measurement of selected balance sheet items.
Asset accounts have to be checked to assure that they are
not overstated.
Example: Are all AR collectible?
All liabilitiy accounts have to be checked to esure that they
are not understated.
Example: Is there a risk due to pending processes?

26

Closing the P&L

27

Dependency Balance Sheet Profit- & Loss


Statement
The profit & loss statement is part of equity, because the
profit belongs to the shareholders and therefore increases
Sales
x
equity.
./. Cost of Sales (Cost of Good sold)

./. x

Gross margin
Current FY
Current Assets
Cash
Securities
Inventory
Accounts Receivable
Prepayments
Other Assets
Deferred Items

xxx
xxx
xxx
xxx
xxx
xxx
xxx

Previous FY

xxx
xxx
xxx
xxx
xxx
xxx
xxx

Non-Current Assets
Property
Technical Equipment
Office Equipment
Assets under construction
Goodwill
Intangible Assets
Deferred Taxes
Subsidiaries

xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx

xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx

Total

xxx

xxx

Current FY

Previous FY

Current Liabilities
Accounts Payable
Borrowings
Taxes
Prepayments
Deferred Items
Other Liabilities

xxx
xxx
xxx
xxx
xxx
xxx

xxx
xxx
xxx
xxx
xxx
xxx

Non-Current Liabilities
Financial Liabilities
Other Provisions
Deferred Taxes
Pensions

xxx
xxx
xxx
xxx

xxx
xxx
xxx
xxx

Equity
Share Capital
Capital Reserves
Retained Earnings

xxx
xxx
xxx

xxx
xxx
xxx

Total

xxx

xxx

+ Other income

./. Distribution costs (sales)

./. (Research & develoment costs)

./. Administrative expenses

./. Other expenses

Total expenses

./. x

Finance costs

Taxes

Profit after taxes

28

Closing Profit Situation

Equity:
Assets

Share Capital

other Assets

Capital Reserves
Retained Earnings
Profit & Losses carried forward
Profit of the current fiscal year

Expenses
Earnings
Profit

other Debt

29

Closing Loss Situation

Equity:
Assets

Share Capital

other Assets

Capital Reserves
Retained Earnings
Profit / Losses carried forward
Loss of the current fiscal year

Earnings
Expenses
Losses

other Debt

30

Exercise
Exercise 421
Description
A company has the following opening balance sheet:
Office Equipment
Inventory
Accounts Receivable
Cash

1.700
200
800
300

Equity
Provisions
Loans
Accounts Payable

1.000
400
850
750

Total Assets

3.000

Total Equity & Liabilities

3.000

The following transactions took place:


Purchase of inventory
Cash collection from a customer
Payment of invoices

20
100
150

Your task
Prepare the closing balance sheet by following the accounting cycle. Perform all bookings on T
accounts.

3.5 Underlying assumptions

32

3.5.1 Accrual Accounting


Accrual accounting recognises revenue and expenses as
earned or incurred.
Standard approach.
Revenues
Jan

Feb

Mar

Apr

May

Jun

Jul

Revenue
Recognition

Aug

Sep

Feb

Mar

Apr

Nov

Dec

Goods delivered
and invoiced

Expenses
Jan

Oct

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan

Feb

Mar

May

Apr

May

Customer pays

Jan

Feb

Mar

Service Period

Current Fiscal Year

Apr

Next Fiscal Year

Monthly expense recognition split up between fiscal years

33

3.5.2 Cash Accounting


Cash accounting recognises revenue and expenses when
cash is received or paid.
Non-GAAP principle, often used by small companies and
Revenue
individuals or for tax purposes.
Recognition
Revenues
Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Feb

Mar

Apr

Nov

Dec

Goods delivered
and invoiced

Expenses
Jan

Oct

May

Jun

Jul

Aug

Sep

Oct

Service Period

Expense recognition

Nov

Dec

Jan

Feb

Mar

Apr

May

Apr

May

Customer pays

Jan

Feb

Mar

34

Example

Shipment of goods 15.11.10:


Customer paid 10.1.11
Expenses of goods incurred:
Invoice paid 15.12.10
Service expenses next 12 month beginning 1.9.
Invoice received 30.8.10, paid 21.12.10

Accrual Accounting
Current FY:
Revenues
Goods
Service expenses
(2.400 * 4/12)
Profit
Next FY:
Revenues
Goods
Service expenses
(2.400 * 8/12)
Profit

10.000
7.200
800
2.000

1.600
-1.600

10.000 EUR
7.200 EUR
2.400 EUR

Cash Accounting
Current FY:
Revenues
Goods
Service expenses
(2.400 * 4/12)
Profit
Next FY:
Revenues
Goods
Service expenses
(2.400 * 8/12)
Profit

7.200
2.400
-9.600

10.000

10.000

35

Exercise
Exercise 441
Description
The following transactions took place:
Purchase of goods to be sold in an order
Delivery (sale) of goods
Office expenses
Insurance expenses (12 month service period beginning in August)

20
180
140
24

Your task
Calculate the profit of the fiscal year 2010 by applying the accrual and the cash method.

3.6 Business Transactions

37

Overview
We focus on business transactions that involve

Revenues
Expenses
Assets
Liabilities

38

3.6.1 Revenue Recording

The sales process (a business transaction) requires


A delivery of goods or rendering of services
An exchange transaction
If both conditions are met, revenue can be recorded. They
are earned.
Unearned revenues (billed to customer) stay in the
balance sheet until all conditions are met for revenue
recording. Example: Advanced invoicing for services.
Challenges of complex transactions:
Bundling of goods and / or services
Long term orders or projects
Discounts

39

Journal Entries
As a general rule, journal entries are treated as follows:
Revenue accounts are credited.
Balance sheet account Accounts Payable is debited.

Unearned revenue is accrued in the balance sheet


account Other Liabilities.

40

Quiz

Which of the following transactions constitutes revenue


recording?
Transaction
Sale of Goods

Rendering of services where the services are


already performed
Rendering of services where the services will be
performed in the next fiscal year

Sale of licenses
Executing a project, duration 3 years, where half of
the project is finished
Introduction of a EPD system at the customer where
licenses are already sold and customizing has to be
performed in the next month
Return of a defect product

Y/N

41

3.6.2 Expense Recording


Expenses follow three approaches:
Follow revenues. Expenses are recorded when
revenue is recorded. Example: Sales commissions.
Multiple periods. Expenses are allocated over a
defined period. Example: Prepaid expenses.
Immediate recording. Expenses are recorded
immediately. Example: Placed advertising.
Expenses are recorded when they occur and not when the
are paid! Payment is not a criteria for expense recognition.

42

Journal entries
As a general rule, journal entries are treted as follows:
Expense accounts are debited.
Balance sheet account Accounts Payable is credited
when transaction is agreed on account.
Balance sheet account Cash is credited when
immediate payment is made.

Expenses are accrued on the balance sheet account e.g.


Accrued expenses when expenses do not relate to the
appropriate period.

43

Quiz

Which of the following transactions constitutes expense


recording?
Transaction
Sales commission on pending sales
Purchase of goods on account
Consuming utilities (gas, oil, electricity)
Hiring a new sales prepresentative
Paying monthly salaries
Depreciation of a machine on the shop floor
Monthly rent
Tax on vehicles received in July

Calculation of provisions for social security


Bonus payment for management
Interest payment on loans

Y/N

44

3.6.3 Asset Recording


Assets current as well as non-current represent items
a company use in the ordinary course of the business.
The initial recognition usually is done at cost.
The subsequent recognition usually requires an
adjustment of the asset due to its actual value.

All assets a company has are recorded.

45

Journal entries
The general rule on assets is:
Assets accounts are debited upon additions.
Asset accounts are credited upon divestures.

Opposite journal entries can be recorded as


Liabilities
Revenue
Expenses

46

Quiz

Which of the following transactions constitutes an asset?


Transaction
Purchase of a computer for the shop floor
Purchase of goods to be sold later
Calculation of work im progress
Recording of work in progress
Paying VAT
Reallocation of building under construction to
building

Write-off of a receivable
Cash collection from a customer
Bonus payment for management
Adjusting of accounts receivable

Y/N

47

3.6.4 Liability & Equity Recording


Liabilities follow (more or less) the same rule like assets.

48

Journal entries
The general rule on liabilities and equity is:
Liability accounts are debited upon divestures.
Liability accounts are credited upon additions.

Opposite journal entries can be recorded as


Assets
Revenue
Expenses

49

Quiz

Which of the following transactions constitutes an asset?


Transaction
Purchase of a computer for the shop floor
Purchase of goods to be sold later
Calculation of work im progress
Recording of work in progress
Paying VAT
Reallocation of building under construction to
building

Write-off of a receivable
Cash collection from a customer
Bonus payment for management
Adjusting of accounts receivable

Y/N

50

Accounting Game
See separate Sheet

51

Complex exercise
Max Meieris a sole proprietor, having a company that produces toys. His preliminary balance sheet at the end
of the fiscal year 2010 is presented as follows:
(000s EUR)

Machinery
Inventory
AR
Petty Cash
Cash on Bank
Sum

280
140
82
2
66
570

Equity
Provisions
Loans
AP

200
62
250
58

Sum

570

A review unveiled that some business transactions are not recorded:


a)
Purchase of a machine for 25 TEUR (net) at 3.4.10, payment occured at 16.6.10.
b)

Sale of toys to a distributor totalling 100 TEUR (net) at 5.5.10, the distributor paid at 21.6.10. Max Meier had materials used for an amount of 40 TEUR.

c)

Collection of a receivable from a customer at 13.3., 8.8. and 17.9. with amounts of 5, 14 and 21 TEUR.

d)

Payment of liabilities (AP) of 34 TEUR at 24.10.10

Your task: Prepare the closing balance sheet at 31.12.10. Profit and / or losses have to be shown seperately
in the balance sheet.

52

Tools
for the exerciseCr(1)
Dr

Dr

Cr

Dr

Cr

Dr

Cr

Dr

Cr

Dr

Cr

53

Tools
for the exerciseCr(2)
Dr

Dr

Cr

Dr

Cr

Dr

Cr

Dr

Cr

Dr

Cr

54

Solution
(000s EUR)

Machinery
Inventory
AR
Petty Cash
Cash at bank
Sum

305
100
42
2
147
596

Equity
Profit
Provisions
Loans
Liabilities
Sum

200
60
62
250
24
596

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