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Debits and Credits: Analyzing and Recording Business Transactions

Chapter 2

Account

An individual accounting record of increases and decreases in a specific asset, liability, or owner’s equity item

Establish an account for each individual assets, liability, capital, withdrawal, revenue, expense

T-Account

Title of Account

Left side Right side

Debit Credit

Three parts: title, debit side, credit sidePositioning of these parts resembles the letter TTherefore called a T account

The Use of Accounts

Increases are recorded on one

side of the T-account, and decreases are

recorded on the other side.

Left or

Debit Side

Right or

Credit Side

Title of Account

T-Account

Account Name (Title)Account Name (Title)

Dr. (debit)Dr. (debit)4,0004,000 500500

Cr. (credit)Cr. (credit)300300400400

4,5004,500 700700

3,8003,800

EntriesEntries

FootingsFootings

BalanceBalance

Account Title.Account Title.

ttRevenue

Ledger

Group of accounts that records data from business transactions

ttCapital

ttAccountPayable

ttCash

RevenuesRevenues

NotesPayable

Accounts Receivable

C. Lapp,Capital

AccountsPayable

LedgerLedger

CashCash

All individual accounts combined make up the ledger

Debits & Credits Debit (Dr.) indicates left; Credit (Cr.) indicates

right Entering an amount on the left side is called “debiting

the account” Entering an amount on the right side is “crediting the

account” Debit balance

Debit amounts exceed the credits Credit balance

Credit amounts exceed the debits

AA = LL + OEOEASSETSASSETS

Debit for

Increase

Credit for

Decrease

EQUITIESEQUITIES

Debit for

Decrease

Credit for

Increase

LIABILITIESLIABILITIES

Debit for

Decrease

Credit for

Increase

Debits and credits affect accounts as follows:

Debit and Credit Rules

Rules of Debit and Credit

Assets = Liabilities + Owner’s EquityDr. Cr. Dr. Cr. Dr. Cr.

+ - +- +-

Rules of Debit and Credit

Dr. Cr.

ExpensesDr. Cr.

RevenuesDr. Cr.

Capital

WithdrawalsDr. Cr.

RevenuesRevenues ExpensesExpensesOwner’s Owner’s CapitalCapital

Owner’s Owner’s WithdrawalsWithdrawals

__ ++ __

Expanding the Rules of Debit and Credit

Owner’s Equity

Debit CreditDebit Credit - +- +

Debit CreditDebit Credit + + --

Footing

Add total debits and total credits in each account

Determine each account balance

AA = LL + OEOEDebit

balancesCredit Credit

balancesbalances=In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.

In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.

Double Entry AccountingThe Equality of Debits and Credits

Double-Entry Accounting

Double entry bookkeeping means to record the dual effects of each business transaction.

Assets = Liabilities + Owner’s Equity Assets are on the left (debit) side. Liabilities and Equity are on the right

(credit) side.

One debit One credit

Each transaction is recorded with at least:

Total debits must equal total credits.

The Double-Entry System

The Transaction Analysis

Step 1: Determine which accounts are affected.Step 1: Determine which accounts are affected.

Step 2: Determine which category accounts belong to.Step 2: Determine which category accounts belong to.

Step 3: Determine whether accounts increase or Step 3: Determine whether accounts increase or decrease.decrease.

Step 4: What do the rules of debits and credits say?Step 4: What do the rules of debits and credits say?

Step 5: Place amounts into T accounts.Step 5: Place amounts into T accounts.

Let’s record selected

transactions for JJ’s Lawn Care Service in the

accounts.

May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service.

Step 1: Which accounts are affected?Step 1: Which accounts are affected?

Step 2: Which category does the account belong to?Step 2: Which category does the account belong to?

Step 3: Is the account increasing/decreasing? Step 3: Is the account increasing/decreasing?

Step 4: Debit or credit?Step 4: Debit or credit?

Step 5: Place amounts into accounts.Step 5: Place amounts into accounts.

Cash Capital

Assets Owner’s Equity

Increasing Increasing

Debit Credit

Capital5/1 8.000

Cash5/1 8,000

May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service.

Cash increases $8,000 with a debit.

Capital increases $8,000 with a credit.

May 2: JJ’s purchased a riding lawn mower for $2,500 cash.

Will Cash increase or decrease?

Will Tools & Equipment increase

or decrease?

May 2: JJ’s purchased a riding lawn mower for $2,500 cash.

Tools & Equipment5/2 2,500

Cash5/1 8,000 5/2 2,500

Cash decreases $2,500 with a credit.

Tools & Equipment increases $2,500

with a debit.

May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000.

Will Truck increase or decrease?

Will Cash and Notes Payable

increase or decrease?

May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000.

Truck5/8 15,000

Cash5/1 8,000 5/2 2,500

5/8 2,000

Notes Payable5/8 13,000

Truck increases $15,000 with a debit.

Cash decreases $2,000 with a credit.

Notes Payable increases $13,000

with a credit.

May 11: JJ’s purchased some repair parts for $300 on account.

or decrease?

Will Accounts Payable increase or

decrease?

May 11: JJ’s purchased some repair parts for $300 on account.

Tools & Equipment increases $300 with

a debit.

Accounts Payable increases $300 with

a credit.

Tools & Equipment5/2 2,500

5/11 300

Accounts Payable5/11 300

May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days.

or decrease?

Will Accounts Receivable increase

or decrease?

May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days.

Tools & Equipment decreases $150 with

a credit.

Accounts Receivable increases $150 with

a debit.

Tools & Equipment5/2 2,500 5/18 150

5/11 300

Accounts Receivable5/18 150

Net income is not an asset it’s an increase in owners’ equity from profits of the business.

AA = LL + OEOEIncrease Decrease Increase

Either (or both) of these effects occur as net income

is earned . . .

. . . but this is what “net income”

really means.

What is Net Income?

Revenue and ExpensesThe price for goods sold and services rendered during a given accounting period.

Increases owner’s equity.

The costs of goods and services used up in the process of earning revenue.

Decreases owner’s equity.

The Realization Principle: When To Record Revenue

Realization Principle

Revenue should be recognized at the

time goods are sold and services are

rendered.

The Matching Principle: When To Record Expenses

Matching Principle

Expenses should be recorded in the

period in which they are used up.

Debits and Credits for Revenue and Expense

EQUITIESEQUITIES

Debit for

Decrease

Credit for

Increase

REVENUESREVENUES

Debit for

Decrease

Credit for

Increase

EXPENSESEXPENSES

Credit for

Decrease

Debit for

Increase

Expenses decrease owner’s equity.

Revenues increase owner’s equity.

Let’s analyze the revenue, and

expense transactions for JJ’s Lawn Care Service for the month of May.

Let’s analyze the revenue, and

expense transactions for JJ’s Lawn Care Service for the month of May.

May 29: JJ’s provided lawn care services for a client and received $750 in cash.

Will Sales Revenue increase or decrease?

Sales Revenue5/29 750

May 29: JJ’s provided lawn care services for a client and received $750 in cash.

Cash increases $750 with a debit.

Sales Revenue increases $750 with

a credit.

Cash5/1 8,000 5/2 2,500

5/29 750 5/8 2,000

May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.

Will Gasoline Expense increase or

decrease?

Gasoline Expense5/31 50

May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.

Cash decreases $50 with a credit.

Gasoline Expense increases $50 with a

debit.

Cash5/1 8,000 5/2 2,500

5/29 750 5/8 2,000 5/31 50

May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.

Will Dividends increase or decrease?

Dividends5/31 200

May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.

Cash decreases $200 with a credit.

Dividends increase $200 with a debit.

Cash5/1 8,000 5/2 2,500

5/29 750 5/8 2,000 5/31 50 5/31 200

Learning Objectives

Setting up and organizing a chart of accounts

Chart of Accounts Lists accounts and their account numbers

Indicates where accounts can be found in the ledger

Usually starts with balance sheet accounts, followed by income statement accounts

Varies by company Number of accounts Types of accounts Numbering system

Assets101 Cash111 Accounts Receivable141 Office Supplies151 Office Furniture191 Land

Gay Gillen eTravelChart of Accounts

Liabilities201 Accounts Payable231 Notes PayableOwner’s Equity301 Capital311 WithdrawalsRevenues401 Service Revenue

Expenses501 Rent Expense503 Utilities Expense502 Salary Expense

The Recording Process

1. Analyze each transaction Determine effect on accounts

2. Enter transaction in a journal Book of original entry

3. Transfer journal information to ledger accounts

THE RECORDING PROCESSTHE RECORDING PROCESS

1 Analyze each transaction

2 Enter transaction in a journal

3 Transfer journal information to ledger accounts

JOURNAL

LEDGER

The Journal

Where transactions are first recorded Every company has a general journal Contributes to recording process:

Discloses complete transaction in one place Provides a chronological record Helps prevent and locate errors Provides explanation and identifies the source

document

Journalizing

Entering transaction data in the journal Separate journal entry for each

transaction A complete entry consists of

Transaction date Accounts & amounts to be debited and

credited Brief explanation of transaction

General Journal

Journal Page 1

Date Description Debit Credit

Jul 1 Cash 45,000

Lange, Capital 45,000

Investment from owner

Accounts AffectedAccounts Affected

Dollar amount of debits and credits

Explanation of transaction

Transaction Date

General Journal

Debits are ALWAYS entered first in an entry. Use the EXACT account title and do not abbreviate

Credits are INDENTED and listed second Do not use dollar signs SKIP A LINE between each entry Never split an entry between two pages

Journalizing Technique

Transaction date is entered in date column Debit account title is entered at the left margin of

the “Account Titles and Explanation” column Credit account title is indented on the next line.

GENERAL JOURNAL J1

Date Account Titles and Explanation Ref. Debit Credit2008

Sept. 1 Cash 15,000 M. Doucet, Capital 15,000

Invested cash in business.

1 Equipment 7,000 Cash 7,000

Purchased equipment for cash.

Journalizing Technique 2

Debit amounts are recorded in the Debit column Credit amounts are recorded in the Credit column A brief explanation of the transaction is provided

GENERAL JOURNAL J1

Separate entries with a blank line Ref. column is used later when transferred to ledger List all debits in each entry before listing credits

GENERAL JOURNAL J1

Simple entry: involves two accounts Compound entry: involves three or more

accountsGENERAL JOURNAL J1

Sept. 9 Cash 1,500

Service Revenue 3,500Performed services for cash and credit

Accounts Receivable 2,000

Posting involves copying

information from the

journal to the ledger

accounts.

Posting Journal Entries to the Ledger Accounts

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

May 1 Cash 8,000

Capital Stock 8,000

Owners invest cash in the business.General LedgerCash

Date Debit Credit Balance2003

May 1 8,000 8,000

Posting Journal Entries to the Ledger Accounts

Standard Form of Account

Date Explanation Ref. Debit Credit Balance2008Sept. 1 15,000 15,000

1 7,000 8,000 3 1,200 9,200 9 1,500 10,700

17 600 10,100 17 900 9,200 20 200 9,000 25 250 8,750 30 600 9,350 30 1,300 8,050

General LedgerCASH

Date Explanation Ref. Debit Credit Balance2008Sept. 1 15,000 15,000

1 7,000 8,000 3 1,200 9,200 9 1,500 10,700

17 600 10,100 17 900 9,200 20 200 9,000 25 250 8,750 30 600 9,350 30 1,300 8,050

General LedgerCASH

Learning Objectives

Preparing a trial balance

The Trial Balance

List of accounts and their balances at a specific time

Proves that debits equal credits after posting

Uncovers errors in journalizing and posting To prepare a trial balance:

1. List accounts and their balances

2. Total the debit and credit columns

3. Ensure the two columns are equal

Trial Balance

List of the ending balances of all the accounts in a ledger

Total debits should equal total credits

Limitations of a Trial Balance

Does not prove: That all transactions have been recorded, or That the ledger is correct

Numerous errors may exist even though the trial balance columns agree Total debits and total credits may be equal,

but may still be posted to the wrong account or in the wrong amount

Locating Errors

If trial balance does not balance, then: Re-calculate account balances Scan trial balance for errors:

If divisible by two, look for entry in wrong column

If divisible by nine, look for transposition errors

Otherwise, scan to see if an account balance has been omitted

JJ's Lawn Care Service Unadjusted Trial Balance

May 31, 2003

Cash 3,925$ Accounts receivable 75 Tools & equipment 2,650 Truck 15,000 Notes payable 13,000$ Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Total 21,900$ 21,900$

All balances are taken from

the ledger accounts on May 31 after

considering all of JJ’s

transactions for the month.

Proves equality of debits and

credits.

Journalize transactions.

Post entries to the ledger accounts.

Prepare trial balance.

Make end-of-year

adjustments.

Prepare adjusted trial balance.

Prepare financial

statements.

Prepare after closing trial balance.

Journalize and post closing

entries.

The Accounting Cycle

Learning Objectives

Preparing financial statements from a trial balance

End of Chapter 2

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