Financial Statements
3.2 JOURNAL AND LEDGER EXAMPLE
The basic concepts of accounting are illustrated by the following simple example.
The example illustrates the flow of information depicted inFigure 3.1.
On January 1, 20XX, three people agreed to start a business to manufacture a specialty solvent, Nusolv. Anderson, Burns, and Carter named the company Nuchem, Inc. and their contributions to the venture were:
Anderson: $5000 cash Burns: $5000 cash
Carter: Basic process development information, a small reactor, and mixing vessels in addition to some raw materials
TABLE3.2 Nuchem, Inc.: Ledger
Date JPa Debit Credit
Asset accountsb
1/1 Cash (10) 1 5,000
5,000
Ending balance 10,000
1/1 Raw materials account (11) 1 1,000
Ending balance 1,000
1/1 Equipment account (12) 1 3,000
Ending balance 3,000
Liability accounts
1/1 Stockholders’ equity (50) 1 5,000
1 5,000
1 1,000
1 3,000
Ending balance 14,000
aJournal page.
bLedger pages in parentheses.
TABLE3.1 Nuchem, Inc.: Page 1 of General Journal
Date Account titles and explanation LPa Debit Credit
1/1 Cash 10 5000
Stockholders’ equity 50 5000
Capital invested by Armstrong
1/1 Cash 10 5000
Stockholders’ equity 50 5000
Capital invested by Bigelow
1/1 Raw materials 11 1000
Stockholders’ equity 50 1000
Raw materials from Custer
1/1 Equipment 12 3000
Stockholders’ equity 50 3000
Reactor and mixing vessels from Custer
aThe ledger page (LP) column is used as a cross-reference between the general journal and the various ledger accounts. The number in the column indicates the account to which the debit or credit has been transferred.
The three decided to distribute 1000 shares of stock as follows:
Anderson: 300 shares Burns: 300 shares Carter: 400 shares
All these initial transactions are recorded in a general ledger similar to the one shown inTable 3.1.Note that each transaction appears twice, once as a credit and once as a debit.
A ledger,Table 3.2,was set up containing the necessary accounts to record the transactions of January 1, 20XX. The number of accounts in the ledger depends on the information required by management to make decisions. Initially, Nuchem, Inc. required only asset and liability accounts; however, as the firm grew, more accounts were established as necessary to record business transactions.
Table 3.3 is an illustration of how information from the general ledger and the ledger accounts was used to prepare a consolidated balance sheet. During the month of January, manufacturing began, so new asset and liability accounts were created to accommodate the new type of transactions. The general journal,Table 3.4,reflects the debits and credits with appropriate explanations and ledger page entries. For example, on January 26, there was a transfer of assets, namely, the transfer of $5000 in raw materials to $5000 of finished goods.
Temporary revenue and expense accounts are used to classify changes affecting stockholders’ equity. Expense accounts, legal expense (40), deprecia-tion expense (41), and interest expense (42) were created. A revenue account was not needed in January because there was no income. These accounts are used to prepare an income statement. The balance of revenue and expense accounts is reduced to zero through an income summary account at the end of the month.
Table 3.4 is the general journal for the month of January andTable 3.5 is the corresponding ledger. A consolidated income statement,Table 3.6,is developed from income and expense accounts. Note that this statement reflects no income and that there was a loss of $1045 during that month.Table 3.7is the consolidated
TABLE3.3 Nuchem, Inc.: Consolidated Balance Sheet as of January 1, 20XX
Assets Liabilities and stockholders’ equity
Cash (10) $10,000 Current liabilities $0
Inventory (raw materials) (11) 1,000 Stockholders’ equity
Plant and equipment (12) 3,000 (50) $14,000
$14,000 $14,000
TABLE3.4 Nuchem, Inc.: Page 2 of General Journal
Date Account titles and explanation LP Debit Credit
1/3 Legal expense 40 1,000
Cash 10 1,000
Paid lawyer to set up corporation
1/4 Finished goods 14 1,000
Accrued wages payable 22 1,000
Hired Davis as production labor and promised to pay him $1000 on 2/1a
1/4 Prepared expenses 15 2,000
Cash 10 2,000
Cash down payment on equipment to be delivered later
1/10 Raw materials 11 10,000
Cash 10 4,000
Accounts payable 24 6,000
Purchased raw materials, paid $4000, balance of $6000 due in February
1/17 Cash 10 2,000
Bank loan 21 2,000
Obtained year loan from bank, interest at 12% per year
1/26 Finished goods 14 5,000
Raw materials 11 5,000
5000 liters of Nusolv manufactured using
$5000 of raw materialsb
Adjusting entries
1/31 Depreciation expense: Equipment 41 25
Equipment 12 25
$3000 £ 1/10 £ 1/12 = $25 per month
1/31 Interest expense 42 20
Interest payable 23 20
To record bank loan interest for January
1/31 Income summary 55 1,045
Legal expense 40 1,000
Depreciation expense: equipment 41 25
interest expense 42 20
To close the expense and revenue accounts for the period
1/31 Stockholder’s equity 50 1,045
Income summary 55 1,045
To close the income summary and transfer the gain (or loss) to the equity account
aNotice from 1/26 entry that we have now in the inventory 5000 liters of Nusolv, incorporating
$1000 of labor and $5000 of raw materials.
bGiven the costs of labor (see 1/4 entry), inventory value of this batch of Nusolv is
$6000/(5000 liters) or $1.20/liter.
TABLE3.5 Nuchem, Inc.: Ledger
Date JP Debit Credit
Asset accounts Cash (10)
1/1 Starting balance 1 10,000
1/3 2 1,000
1/1 Starting balance 1 1,000
1/10 2 10,000
1/26 2 5,000
Ending balance 6,000
Equipment (12)
1/1 Starting balance 1 3,000
1/31 2 25
balance sheet as of February 1, 20XX. If this balance sheet is compared with the January 1, 20XX sheet(Table 3.3),it will be noted that the stockholders’ equity decreased on the February statement by $1045, reflecting the loss during January.
The same procedure is followed for each succeeding month with each transaction being entered in the general journal and then posted to the appropriate ledger account. At the end of February, an income statement and balance sheet may be prepared. In this manner, information for an annual report is assembled.
TABLE3.5 Continued
1/1 Starting balance 1 14,000
1/31 2 1,045
Today, transactions are entered into a computer program, ledger accounts are assigned, and the data are manipulated electronically. Manual ledgers are no longer kept in modern business firms.
Up to this point in this chapter, “traditional” cost/managerial accounting has been presented. In the past, traditional methods helped finance departments to monitor operations and value inventory, but some people felt that this approach did not provide an accurate picture of a company’s costs but focused more on direct costs and relied on arbitrary cost allocations such as labor-based overhead rates [4].
In the late 1980s with the restructuring and downsizing of companies, new management tools were introduced. With these new tools, new accounting concepts were developed [4]. One of these new accounting systems is believed to provide useful information about direct and indirect expenses of a production unit or a service, provide tracking cost-contributing activities as well as separating and identifying value-added activities from non-value-added ones that contribute to current expenses. Major corporations in the United States are using this system and proponents believe that it will allow managers to make better decisions about TABLE3.6 Nuchem, Inc.: Consolidated Income
Statement, January 1 –31, 20XX
Revenue $0
Legal expenses $1000
Depreciation expense: equipment 25
Interest expense 20
Earnings (loss) ($1045)
TABLE3.7 Nuchem, Inc.: Consolidated Balance Sheet, February 1, 20XX
Assets Liabilities and stockholders’ equity
Cash (10) $ 5,000 Accrued wages (22) $ 1,000
Prepaid expense (15) 2,000 Short-term borrowing:
Inventory: Accounts payable (24) 6,000
Raw materials (11) 6,000 Bank loan (21) 2,000
Finished goods (14) 6,000 Interest payable (23) 20 Plant and equipment (12) 2,975 Total liabilities $ 9,020 Stockholders’ equity $12,955 Total liabilities and
Total assets $21,975 stockholders’ equity $21,975
what products and services to offer and what are the “real” expenses. This approach may affect how accounting information is handled and perhaps alter company financial reporting. It will be interesting to see how traditional accounting will withstand the test of time.