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Sample Module
Introduction to Financial Accounting I
 

Transactions

As you are learning in your course, accounting records are supposed to reflect the financial position of a firm. It does this by recording, accumulating, and summarizing the economic events - transactions - that characterize the firm's operations. An economic event, whatever it may be, should always generate a paper or electronic trail. A receipt, a bill, a check, a contract, a bill of lading, etc. are examples of such a trail. The information embedded in that trail is used to record the event as a transaction.

Also as you are learning, modern accounting systems are double entry. A transaction is recorded in more than one account, at least one with debits and at least one with credits, and the total debits must equal the total credits for each transaction.

 

Example 1.

A firm pays $300 for 6 months of fire insurance by check.

There are 2 accounts affected by this transaction; the cash account and the prepaid insurance account. The cash account is affected because the payment was made by check. The prepaid insurance account is affected, and not the insurance expense account, because the insured time period is in the future. The cash account is reduced by $300 and the prepaid insurance account is increased by the same amount. That means prepaid insurance is debited by $300 and cash is credited by $300.


       Prepaid Insurance   ........................     300.00
            Cash   ................................                300.00
               To record the purchase of fire insurance

This transaction increases assets due to the debit in the Prepaid Insurance account. It also decreases assets due to the credit to the cash account. There is no net change in total assets since assets were increased and decreased by the same amount.

 

Example 2.

A firm buys $1,000 of merchandise for inventory and $250 of office supplies on credit.

There are 3 accounts affected by this transaction; the inventory account, the supplies expense account, and the accounts payable account. The accounts payable account is affected because the purchase was made on credit. The inventory account is affected because merchandise is being purchased for resale. The supplies expense account is affected, and not the supplies inventory account, because the supplies in question, (paper, pens, staplers, file folders, toner), have negligible resale value. The accounts payable account is increased by $1,250, the inventory account is increased by $1,0000 and expenses are increased by $250. That means accounts payable is credited by $1,250, inventory is debited by $1,000, and supplies expense is debited by $250.


       Inventory  .................................   1,000.00
       Supplies Expense  ..........................     250.00
            Accounts Payable  .....................              1,250.00
               To record the purchase of inventory and supplies.

This transaction increases assets due to the debits in the Inventory account. It also increases liabilities due to the credit to the Accounts Payable account. There is a net increase in total assets of $1,000. This is because the Supplies Expense is embedded in the Owners' Equity account through the income statement. The increase in expenses has the effect of reducing the equity account. Liabilities increase $1,000, and not $1,250, because the $250 decline in equity partly offsets the $1,250 increase in Accounts Payable.

 

Sample Questions about Transactions.

 

 

Cash

The cash account is a central one for almost all firms. All operations affect cash in some manner. Firms usually have several specialized bank accounts, such as general, payroll, short-term investments, and sinking fund accounts for bond redemption. In this module, the focus is on general cash only; petty cash, cash receipts, cash disbursements, and bank reconciliations. Other aspects of the cash account will be discussed in other modules.

 

Example 1.

A petty cash fund is used to avoid the cost, formality, and delay for small value expenditures that the firm would incur if the usual cash disbursement procedures were followed. The petty cash fund is initiated and replenished by usual cash disbursements from the cash account. Drawdowns from petty cash occur as a firm incurs small cash expenditures. These might be paying for fast food delivered to employees who are working late, or buying cake and refreshments for a lunch time birthday celebration. As cash is removed from the fund, the receipts for the purchase replace it so that the cash-on-hand and the receipts total to the initial balance. The petty cash fund has its own journal in which transactions are recorded. The fund may be replenished weekly, monthly, or quarterly, at which time the period's transactions are summarized and an entry made to the cash disbursements journal.

A firm initiates a petty cash fund with a balance of $200. During the month the following expenditures were made; $35 for a taxi to deliver product to a client, $25 for an emergency purchase of printer paper, $80 for dinner delivery to the office from a local restaurant. The transactions are as follows:


                       Cash Disbursements Journal

       Date      Debit Account                              Amount
       Jan.  1   Petty Cash   .......................       200.00
                 To record the creation petty cash fund.

                       Petty Cash Record

       Date      Explanation                   Receipts    Disbursements
       Jan.  1   Initial receipt                 200.00
       Jan. 12   Delivery by taxi                              35.00
       Jan. 20   Printer paper                                 25.00
       Jan. 24   Dinner                                        80.00
       Jan. 31   Balance                          60.00
       Feb.  1   Replenish fund                  140.00

                       Cash Disbursements Journal

       Date      Debit Account                              Amount
       Feb.  1   Petty Cash   .......................       140.00
                 To record the replenishment of petty cash fund.

 

Example 2.

A firm records the day's cash sales of 2,670.00. The register contained $2,668.00

There are 3 accounts affected by this transaction; the cash account, the sales account, and an account called Cash Discrepancy (over or short). The cash discrepancy account exists due to the errors humans can make in counting cash received from customers and counting out their change. The cash register keeps an internal tally of the sales rung up. The cashier must count the actual cash in the register. Any difference is dealt with through the cash discrepancy account. It will be treated as an expense if short and a revenue if over. In this example there is a cash shortage of $2.00.


       Cash   .....................................   2,668.00
       Cash Discrepancy   .........................       2.00
            Sales   ...............................              2,670.00
               To record daily total cash sales receipts.

 

Example 3.

Cash sales are recorded in a cash receipts journal along with other items that debit the cash account. At the end of the period, whether it is a day, week, or month, the general ledger will be updated for the debit to cash and the corresponding credits to the other affected accounts through an entry to the general journal.

A firm has cash sales for the week of $12,500. Three credit customers made payments to their accounts of $2,200, $1,850, and $3,250 respectively. In addition, the firm used $7,500 of its credit line. The cash receipts journal entries for the week are as are as follows:


                       Cash Receipts Journal

       Date      Credit Account                             Amount
       Mar. 12   Sales   ............................    12,500.00
                 To record cash sales.

       Mar. 14   Accounts Receivable   ..............     7,300.00
                 To record receivables payments.

       Mar. 17   Bank Loans   .......................     7,500.00
                 To record use of credit line.

The general journal entry for the transactions is as follows:


       Cash   .....................................  27,300.00
            Sales   ...............................             12,500.00
            Accounts Receivable   .................              7,300.00
            Bank Loans   ..........................              7,500.00
               To record the week's cash receipts.

 

Example 4.

A firm repays a short-term note of $25,000. It was sold to investors for $24,000.

Firms have several ways of raising short-term funds. One is by selling commercial paper. This is like an IOU for a specific dollar amount. A firm offers its paper to investors who bid on it. The paper is sold to the highest bidder. Investors do not pay the full face value of the paper, but they receive the full face value of the paper when it matures. The difference between the funds received from the paper and the face value that is repaid is treated as interest expense.


       Notes Payable   ............................  24,000.00
       Interest Expense   .........................   1,000.00
            Cash   ................................             25,000.00
               To record the repayment of commercial paper.

 

Example 5.

A firm reconciles its book balance of cash with its bank balance of cash to make sure the cash account is correct. The firm had 3 outstanding checks totaling $750, deposits-in-transit of $830, bank fees of $37.50, and a firm error in which a customer's check for a receivables payment $120 was incorrectly recorded as $210. The end of month book balance is $2,527.50 and the bank statement balance is $2,320.00.

Due to differences in the timing of when firms record transactions to the cash account and when banks record transactions to a firm's cash account, there is usually a difference in their respective balances. This difference comes about from; checks which have been written but not yet reached the bank (outstanding checks), after-hours deposits such as at night or on week-ends that are not yet recorded by the bank (deposits-in-transit), bank charges or NSF checks for which the firm has not yet been notified, and errors on the part of either the firm or the bank. As technology advances, that time difference grows smaller. Electronic funds transfers through debit cards or online banking transactions speed up the recording by banks of a firm's cash receipts. The amount of unrecorded deposits will be very small. The Fed's assistance with checking clearing and the acceptance of digital images of checks as equivalent to the paper check itself speed up the recording of a firm's cash disbursements. The amount of outstanding checks will be very small. The use of float and kiting (See your textbook.) are greatly reduced. Still, items such as bank fees, uncollectible checks, and errors continue to make the bank reconciliation an essential element of accounting for cash.

The steps of a bank reconciliation are as follows:

After receiving the monthly bank statement, check for errors by comparing the deposits on the bank statement to the deposits recorded in the accounting records. Compare the check payments on the bank statement and the checks themselves returned by the bank to the check register in both dollar amount and check number. Confirm that all outstanding checks and deposits in transit from the previous month were recorded by the bank on the current bank statement. Determine the current month's outstanding checks and deposits-in-transit. Prepare the reconciliation. Finally, make the necessary adjusting entries to account for firm errors, bank fees, and any NSF items.

The bank reconciliation is prepared as follows:
Starting from the book balance of the cash account, add any credits the bank gave the firm and any firm errors, subtract any debits such as fees or NSF items and any firm errors, and arrive at the reconciled balance. Starting from the bank statement cash balance, add deposits-in-transit and any bank errors, subtract outstanding checks and any bank errors, and arrive at the reconciled balance. The two reconciled balances should be, and must be, equal to each other.

For this example,


         Bank reconciliation as at Aug. 31, 2009.

       Book Balance   .............................     2,527.50
            Add:   ................................         0.00
            Deduct: Fees and Error   ..............       127.50
       Reconciled Balance   .......................     2,400.00

       Bank Balance   .............................     2,320.00
            Add:  Deposit 8/31   ..................       830.00
            Deduct:  o/s Checks   .................       750.00
       Reconciled Balance   .......................     2,400.00

The entry which corrects the book balance of cash for the recording error and adjusts the book balance of cash for the bank fees is as follows. The amount of the error correction is $210 - $120 = $90. It is a credit to cash because the original error overstated the cash balance. The corresponding debit will be to accounts receivable. The adjustment for the bank fees is a credit of $37.50 because it reduces the cash balance. The corrsponding debit will to an expense account.


       Accounts Receivable   ......................      90.00
       Bank Charges   .............................      37.50
            Cash   ................................                127.50
               To record adjustments from the bank reconciliation.


Sample Questions about the Cash Account.


 

 

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