THE RECORDING PROCESS CHAPTER 2

THE ACCOUNT An account is an individual accounting record of increases and decreases in a specific asset, liability, or owner’s equity item. A company will have separate accounts for such items as cash, salaries expense, accounts payable, and so on.

DEBITS AND CREDITS The terms debit and credit mean left and right, respectively. The act of entering an amount on the left side of an account is called debiting the account and making an entry on the right side is crediting the account. When the debit amounts exceed the credits, an account has a debit balance; when the reverse is true, the account has a credit balance. DRCR

ILLUSTRATION 2-1 BASIC FORM OF ACCOUNT Left or debit side Title of Account Right or credit side Debit balanceCredit balance In its simplest form, an account consists of 1. the title of the account, 2. a left or debit side, and 3. a right or credit side. The alignment of these parts resembles the letter T, and therefore the account form is called a T account.

ILLUSTRATION 2-2 TABULAR SUMMARY COMPARED TO ACCOUNT FORM Tabular Summary Cash $15, ,000 1,200 1, Cash DebitCredit 15,000 1,200 1, , Balance Account Form 8,050 $8, , ,300

Example: The owner makes an initial investment of $15,000 to start the business. Cash is debited and the owner’s Capital account is credited. DEBITING AN ACCOUNT Asset’s Account Liab./Own. Equity’s Account

Example: Monthly rent of $7,000 is paid. Cash is credited and Rent Expense is debited. CREDITING AN ACCOUNT

DEBITING AND CREDITING AN ACCOUNT Example: Cash is debited for $15,000 and credited for $7,000, leaving a debit balance of $8,000.

DOUBLE-ENTRY SYSTEM In a double-entry system, equal debits and credits are made in the accounts for each transaction. Thus, the total debits will always equal the total credits and the accounting equation will always stay in balance. AssetsLiabilitiesEquity

NORMAL BALANCE Every account classification has a normal balance, whether it is a debit or credit.

ILLUSTRATION 2-3 NORMAL BALANCES — ASSETS AND LIABILITIES Assets Increase Decrease Debit Credit Decrease Increase Debit Credit Liabilities Normal Balance

ILLUSTRATION 2-4 NORMAL BALANCE — OWNER’S CAPITAL Owner’s Capital Decrease Increase Debit Credit Normal Balance

ILLUSTRATION 2-5 NORMAL BALANCE — OWNER’S DRAWINGS Owner’s Drawings Normal Balance Increase Decrease Debit Credit

ILLUSTRATION 2-6 NORMAL BALANCES — REVENUES AND EXPENSES ILLUSTRATION 2-6 NORMAL BALANCES — REVENUES AND EXPENSES Increase Decrease Debit Credit Expenses Revenues Decrease Increase Debit Credit Normal Balance

ILLUSTRATION 2-7 EXPANDED BASIC EQUATION AND DEBIT/CREDIT RULES AND EFFECTS Liabilities Assets Owner’s Equity =+- += +- Assets Dr.Cr. + - Liabilities Dr.Cr. - + Dr.Cr. Owner’s Drawings + - Dr.Cr. Revenues - + Dr.Cr. Expenses + - Dr.Cr. Owner’s Capital - +

1. Analyse transactions 2. Journalize the transactions 3. Post to ledger accounts 4. Prepare a trial balance 5. Journalize and post adjusting entries 6. Prepare adjusted trial balance 7. Prepare financial statements 8. Journalize and post closing entries 9. Prepare post-closing trial balance STEPS IN THE ACCOUNTING CYCLE

Analyze each transaction and event from source documents Analyzing and Recording Process Record relevant transactions and events in a journal Post journal information to ledger accounts Prepare and analyze the trial balance

ILLUSTRATION 2-9 THE RECORDING PROCESS 1. Analyse each transaction. 2. Enter transaction in a journal. 3. Transfer journal information to ledger accounts. JOURNAL LEDGER

THE JOURNAL Transactions are initially recorded in chronological order in a journal before being transferred to the accounts. Every company has a general journal which contains 1. spaces for dates, 2. account titles and explanations, 3. references, and 4. two money columns.

The journal makes several significant contributions to the recording process: 1. It discloses, in one place, the complete effect of a transaction. 2. It provides a chronological record of transactions. 3. It helps to prevent or locate errors because the debit and credit amounts for each entry can be readily compared. THE JOURNAL

JOURNALIZINGJOURNALIZING Entering transaction data in the journal is known as journalizing. Separate journal entries are made for each transaction. A complete entry consists of 1. the date of the transaction, 2. the accounts and amounts to be debited and credited, and 3. a brief explanation of the transaction.

ILLUSTRATION 2-10 TECHNIQUE OF JOURNALIZING The date of the transaction is entered in the date column. GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Sept. 1Cash15,000 M. Doucet, Capital 15,000 Invested cash in business. 1Equipment7,000 Cash 7,000 Purchased equipment for cash.

ILLUSTRATION 2-10 TECHNIQUE OF JOURNALIZING The debit account title is entered at the extreme left margin of the Account Titles and Explanation column. The credit account title is indented on the next line. GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Sept. 1Cash15,000 M. Doucet, Capital15,000 Invested cash in business. 1Equipment7,000 Cash7,000 Purchased equipment for cash.

ILLUSTRATION 2-10 TECHNIQUE OF JOURNALIZING The amounts for the debits are recorded in the Debit column and the amounts for the credits are recorded in the Credit column. GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Sept. 1Cash15,000 M. Doucet, Capital 15,000 Invested cash in business. 1Equipment7,000 Cash 7,000 Purchased equipment for cash.

ILLUSTRATION 2-10 TECHNIQUE OF JOURNALIZING A brief explanation of the transaction is given. GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Sept. 1Cash15,000 M. Doucet, Capital15,000 Invested cash in business. 1Equipment7,000 Cash7,000 Purchased equipment for cash.

ILLUSTRATION 2-10 TECHNIQUE OF JOURNALIZING A space is left between journal entries. The blank space separates individual journal entries and makes the journal easier to read. GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Sept. 1Cash15,000 M. Doucet, Capital15,000 Invested cash in business. 1Equipment7,000 Cash7,000 Purchased equipment for cash.

ILLUSTRATION 2-10 TECHNIQUE OF JOURNALIZING The column entitled Ref. is left blank at the time the journal entry is made and is used later when the journal entries are transferred to the ledger accounts. GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Sept. 1Cash15,000 M. Doucet, Capital15,000 Invested cash in business. 1Equipment7,000 Cash7,000 Purchased equipment for cash.

GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Oct. 2Delivery Equipment14,000 Cash14,000 Purchased truck for cash. If an entry involves only two accounts, one debit and one credit, it is considered a simple entry. SIMPLE AND COMPOUND JOURNAL ENTRIES

When three or more accounts are required in one journal entry, the entry is referred to as a compound entry. ILLUSTRATION 2-11 COMPOUND JOURNAL ENTRY GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Oct. 2Delivery Equipment34,000 Cash8,000 Note Payable26,000 Purchased truck for cash and note payable

GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Oct. 2 Cash8,000 Delivery Equipment34,000 Note Payable26,000 Purchased truck for cash and note payable. COMPOUND JOURNAL ENTRY This is the wrong format; all debits must be listed before the credits are listed.

Example Kate Browne engaged in the following activities in establishing her salon, Hair It Is: 1. Opened a bank account in the name of Hair It Is and deposited $20,000 of her own money in this account as her initial investment. 2. Purchased equipment on account (to be paid in 30 days) for a total cost of $4, Interviewed three people for the position of hair stylist. Prepare the entries to record the transactions.

Solution The three activities would be recorded as follows. 1. Cash 20,000 Owner’s Capital 20,000 (Owner’s investment of cash in business) 2. Equipment 4,800 Accounts Payable 4,800 (Purchase of equipment on account) 3. No entry because no transaction has occurred.

THE LEDGER The entire group of accounts maintained by a company is referred to collectively as the ledger. A general ledger contains all the assets, liabilities, and owner’s equity accounts. GENERAL LEDGER

Individual Liabilities Individual Assets Individual Owner’s Equity ILLUSTRATION 2-12 THE GENERAL LEDGER Equipment Supplies Accounts Rec. Cash Interest Payable Salaries Payable Accounts Payable Notes Payable Salaries Expense Service Revenue Doucet, Drawings Doucet, Capital

ILLUSTRATION 2-14 POSTING A JOURNAL ENTRY In the ledger, enter in the appropriate columns of the account(s) debited the date, journal page, and debit amount shown in the journal and the account number to which the journal was posted.

ILLUSTRATION 2-14 POSTING A JOURNAL ENTRY In the ledger, enter in the appropriate columns of the account(s) credited the date, journal page, and credit amount shown in the journal and the account number to which the journal was posted.

THE TRIAL BALANCE A trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove the mathematical equality of debits and credits after posting. A trial balance also uncovers errors in journalizing and posting. The procedures for preparing a trial balance consist of 1. listing the account titles and their balances, 2. totaling the debit and credit columns, and 3. proving the equality of the two columns.

PIONEER ADVERTISING AGENCY Trial Balance October 31, 2002 DebitCredit Cash$ 15,200 Advertising Supplies2,500 Prepaid Insurance600 Office Equipment5,000 Notes Payable$ 5,000 Accounts Payable2,500 Unearned Revenue1,200 C. R. Byrd, Capital10,000 C. R. Byrd, Drawings500 Service Revenue10,000 Salaries Expense 900 $ 28,700 The total debits must equal the total credits. ILLUSTRATION 2-28 A TRIAL BALANCE Rent Expense 4,000

LIMITATIONS OF A TRIAL BALANCE 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. The trial balance may balance even when 1. a transaction is not journalized, 2. a correct journal entry is not posted, 3. a journal entry is posted twice, 4. incorrect accounts are used in journalizing or posting, 5. offsetting errors are made in recording the amount of the transaction.

Appendix On October 1, C. R. Byrd invests $10,000 cash in an advertising company called Pioneer Advertising. On October 1, Pioneer purchases office equipment costing $5,000 by signing a 3-month, 12%, $5,000 note payable. On October 2, Pioneer receives a $1,200 cash advance from R. Knox, a client, for advertising services that are expected to be completed by December 31. On October 3, Pioneer pays office rent for October in cash, $900. On October 20, C. R. Byrd withdraws $500 cash for personal use.