Accrual Accounting ProcessAn accountant’s functions includeT-AccountRecording changes in Assets and LiabilitiesHow does a T-account look like?Summary of T-account RulesAbout T-AccountsComponents of stockholders’ equityWhy record expenses and revenues separately in various T-accounts?Why record expenses and revenues separately in various T-accounts?Why record expenses and revenues separately in various T-accounts?Why record expenses and revenues separately? A SummaryRecording expenses: A SummaryRecording Revenues: A SummaryRecording Dividends: A SummaryExpenses and Revenues: Debits and CreditsThe LedgerThe Recording ProcessThe Journal1. Joe’s Landscaping ServiceJoe contributes $10,000 in cash2. The company borrows $3,000 from the bank3. Company purchases equipment for $5,000 cash4. Company performs service for $12,000. The customer pays $8,000 in cash and promises to pay the balance at a later date.5. Company pays $9,000 for expenses (wages, interest, and maintenance)6. Company pays a dividend of $1,000Posting to T-accountsSummaryAccruals (Accrue Today, Cash Tomorrow)Accruals (Accrue Today, Cash Tomorrow)Accruals (Accrue Today, Cash Tomorrow)Accruals (Accrue Today, Cash Tomorrow)Accruals (Accrue Today, Cash Tomorrow)Cost Expirations (Cash Yesterday, Accrual Today)Cost Expirations (Cash Yesterday, Accrual Today)Cost Expirations (Cash Yesterday, Accrual Today)Cost Expirations (Cash Yesterday, Accrual Today)Cost Expirations (Cash Yesterday, Accrual Today)Cost Expirations (Cash Yesterday, Accrual Today)Cost Expirations (Cash Yesterday, Accrual Today)Cost Expirations (Cash Yesterday, Accrual Today)Summary1Accrual Accounting Process15.501 AccountingSpring 2004Professor S. RoychowdhurySloan School of ManagementMassachusetts Institute of TechnologyFeb 17/18, 20042An accountant’s functions include Classifying and summarizing, made easier by the repetitive nature of business transactions All repetitive transactions of the same nature are recorded and summarized in one account An account is a storage unit used to classify and summarize money measurements of business activity of a similar nature Each account has a title3T-Account Has two sides Debit means Left Credit means Right Created for each type of  Asset Liability Stockholders’ equity4Recording changes in Assets and Liabilities Increases in assets are recorded on the left side of the T-account  Decreases are recorded on the right side of the T-account Reverse for liabilities and stockholders’ equity Assets = Liabilities + Stockholders’ equity Assets are on the left side of the Balance Sheet Equation Liabilities and owners’ equity are on the right sideHow does a T-account look like?5 Like a Capital “T”6Summary of T-account RulesAssets (cash, receivables, equipment)IncreasesDecreasesLiabilities (loans payable)Decreases IncreasesOwners’ equity (contributed capital, retained earnings)DecreasesIncreases7About T-Accounts What is one major objective of financial statements?  To provide information to “users” regarding the financial performance of a business Which T-account(s) includes the accountant’s estimate of financial performance over a given accounting period? Retained earnings (includes current period income) Which financial statement provides the details of the financial performance over a given accounting period? Income statement How do we construct an income statement from the T-account for retained earnings? Not very easily! But we will try.8Components of stockholders’ equityCommon Stock Retained EarningsAdditional Expenses RevenueCapital Dividends9Why record expenses and revenues separately in various T-accounts?Retained EarningsRent exp. 800Salaries 650Interest exp. 450Salaries 1,000Rent exp. 400Dividends 2,000Interest exp. 3501,000 Sales revenue1,100 Interest Income3,000 Sales Revenue200 Interest Income4,500 Sales RevenueSales Revenue (1,000 + 3,000 + 4,500) 8,500Interest Income (1,100 + 200) 1,300Rent expense (800 + 400) (1,200)Salaries expense (650 + 1,000) (1,650)Interest expense (450 + 350) (800)Net Income 6,15010Why record expenses and revenues separately in various T-accounts?Retained Earnings1,000 Sales revenue1,100 Interest Income3,000 Sales Revenue200 Interest Income4,500 Sales RevenueRent exp. 800Salaries 650Interest exp. 450Salaries 1,000Rent exp. 400Dividends 2,000Interest exp. 350 Interest Expense450350Dividends2,000Sales Revenue1,0003,0004,500Interest RevenueRent Expense1,100200800400Salaries Expense6501,00011Why record expenses and revenues separately in various T-accounts?Sales Revenue1,0003,0004,5008,500Interest Revenue1,1002001,300Interest Expense450350800Rent Expense8004001,200Dividends2,000Salaries Expense6501,0001,65012Why record expenses and revenues separately in various T-accounts?Sales Revenue1,0003,0004,5008,500Interest Revenue1,1002001,300Rent Expense8004001,200Salaries Expense6501,0001,650Retained Earnings8,500 Sales RevenueRent Exp. 1,200Salaries Exp. 1,650Interest Exp. 800Dividends 2,000Interest Expense450350800Dividends2,0008,5001,3008001,2002,0001,6501,300 Interest Revenue4,15013Why record expenses and revenues separately? A Summary Revenues, expenses and dividends are temporary T-accounts Information on changes in retained earnings pertaining to a single accounting periodis collected in these temporary accounts At the end of the accounting period, balances in these T-accounts are transferred to Retained Earnings The temporary accounts are set to zero at the end of an accounting period in order to start collecting information for the next period Revenues, expenses and dividend accounts are flowaccounts Retained earnings is a stock account In fact, all balance sheet accounts are stock accounts14Recording expenses: A Summary Expenses decrease retained earnings.  Decreases in retained earnings are recorded on the left side Expenses are recorded on the left side15Recording Revenues: A Summary Revenues increase retained earnings.  Increases in retained earnings are recorded on the right side (Increase in) revenues are recorded on the right side Decrease in revenues are recorded on the left side16Recording Dividends: A Summary Dividends decrease retained earnings Therefore, treated similarly to