McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Recording Business Transactions Chapter 3

3-2 The Role of Accounting Records Establishes accountability for assets and transactions. Keeps track of routine business activities. Obtains detailed information about a particular transaction. Evaluates efficiency and performance within company. Maintains evidence of a company’s business activities.

3-3 1) THE LEDGER The entire group of accounts is kept together in an accounting record called a ledger. Cash Accounts Payable Share Capital Accounts are individual records showing increases and decreases.

3-4 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

3-5 The T-Account Account Title Debit Credit LEFT SIDE

3-6 The T-Account Account Title Debit Credit RIGHT SIDE

3-7 Receipts are on the debit side. Payments are on the credit side. The balance is the difference between the debit and credit entries in the account. Debit and Credit Entries

3-8 ALE A = L + EASSETS Debit for Increase Credit for DecreaseEQUITIES Debit for Decrease Credit for IncreaseLIABILITIES Debit for Decrease Credit for Increase Debits and credits affect accounts as follows: Debit and Credit Entries

3-9 ALE A = L + E Debit balances Credit balances = In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits. Double Entry Accounting  The Equality of Debits and Credits

3-10 Let’s record selected transactions for JJ’s Lawn Care Service in the accounts.

 1 May: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Will Cash increase or decrease? Will Share Capital increase or decrease? Cash increases $8,000 with a debit. Share Capital increases $8,000 with a credit. 3-11

 2 May: JJ’s purchased a riding lawn mower for $2,500 cash. Will Cash increase or decrease? Will Tools & Equipment increase or decrease? Cash decreases $2,500 with a credit. Tools & Equipment increases $2,500 with a debit. 3-12

 8 May: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 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? Truck increases $15,000 with a debit. Cash decreases $2,000 with a credit. Notes Payable increases $13,000 with a credit. 3-13

 11 May: JJ’s purchased some repair parts for $300 on account. Will Tools & Equipment increase or decrease? Will Accounts Payable increase or decrease? Tools & Equipment increases $300 with a debit. Accounts Payable increases $300 with a credit. 3-14

 18 May: 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. Will Tools & Equipment increase or decrease? Will Accounts Receivable increase or decrease? Tools & Equipment decreases $150 with a credit. Accounts Receivable increases $150 with a debit. 3-15

3-16 2) THE JOURNAL It is a list in chronological order of all the transactions for a business. 1 Identify transaction from source documents. 2 Specify accounts affected. 3 Apply debit/credit rules. 4 Record transaction with description.

3-17 The Journal What does a journal entry include? – date of the transaction – title of the account debited – title of the account credited – amount of the debit and credit – description of the transaction – dollar signs are omitted

3-18 In an actual accounting system, transactions are initially recorded in the journal. The Journal

3-19 Posting Journal Entries to the Ledger Accounts Posting simply means updating the ledger accounts for the effects of the transactions recorded in the journal.

3-20 Posting Journal Entries to the Ledger Accounts

3-21 Posting Journal Entries to the Ledger Accounts

3-22 Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service. Posting Journal Entries to the Ledger Accounts

3-23 This ledger format is referred to as a running balance. Ledger Accounts After Posting

3-24 T accounts are simplified versions of the ledger account that only show the debit and credit columns. Ledger Accounts After Posting

3-25 Profit is not an asset; it is an increase in equity from profitable operations of the business. A LE A = L + E IncreaseDecrease As income is earned, either an asset is increased or a liability is decreased. Increase Profit always results in the increase of Equity What is Profit (Net Income)?

3-26 A L E A = L + E Retained Earnings Share Capital Retained Earnings The balance in the Retained Earnings account represents the profit of the corporation over the entire lifetime of the business, less all amounts which have been distributed to the shareholders as dividends.

3-27 The income statement summarizes the profitability of a business for a specified period of time. The Income Statement: A Preview

3-28 REVENUE and EXPENSES The price for goods sold and services rendered during a given accounting period. Increases equity. The costs of goods and services used up in the process of earning revenue. Decreases equity.

3-29 The Realization Principle: When To Record Revenue Realization Principle Revenue should be recorded at the time goods are sold and services are rendered.

3-30 The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up.

3-31 Debit and Credit Rules for Revenue and Expenses EQUITIES Debit for Decrease Credit for Increase Expenses decrease equity. Revenues increase equity. EXPENSES Credit for Decrease Debit for Increase REVENUES Debit for Decrease Credit for Increase

3-32 DIVIDENDS A dividend is a distribution of assets (usually cash) by a corporation to its stockholders. SIMILAR TO expenses; BUT, not an expense

3-33 EQUITIES Debit for Decrease Credit for Increase Payments to owners decrease equity. Owners’ investments increase equity. DIVIDENDS Credit for Decrease Debit for Increase Dividends SHARE CAPITAL Debit for Decrease Credit for Increase

3-34 Summary of Debit- Credit Rules for Revenues, Expenses and Dividends Owner’s Equity Decreases recorded by debits Increaes recorded by credits Expenses decrease O.E Revenue increases O.E Expenses are recorded by debits Revenue is recorded by credits Dividends reduce owners’ equity Dividends are recorded by debits

3-35 Let’s analyze the revenue and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction. Let’s analyze the revenue and expense transactions for JJ’s Lawn Care Service for the month of May. We will also analyze a dividend transaction.

 29 May: JJ’s provided lawn care services for a client and received $750 in cash. Will Cash increase or decrease? Will Sales Revenue increase or decrease? Cash increases $750 with a debit. Sales Revenue increases $750 with a credit. 3-36

 31 May: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Will Cash increase or decrease? Will Gasoline Expense increase or decrease? Cash decreases $50 with a credit. Gasoline Expense increases $50 with a debit. 3-37

 31 May: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Will Cash increase or decrease? Will Dividends increase or decrease? Cash decreases $200 with a credit. Dividends increase $200 with a debit. 3-38

3-39 3) TRIAL BALANCE 3) TRIAL BALANCE It is an internal document. It is a listing of all the accounts with their related balances. Proof of the equality of debit and credit balances.

3-40 DEBITS CREDITS Locating Trial Balance Errors What if it doesn’t balance ? Is the addition correct? Are all accounts listed? Are the balances listed correctly?

3-41 Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May.

3-42 All balances are taken from the ledger accounts on 31 May after considering all of JJ’s transactions for the month.

3-43 End of Chapter 3