Chapter Two T Accounts, Debits and Credits, Trial Balance, and Financial Statements

Performance Objectives Determine balances of T accounts having entries recorded on both sides of the accounts Present the fundamental accounting equation with the T account form, and label the plus and minus sides Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objectives Present the fundamental accounting equation with the T account form, and label the debit and credit sides Record directly in T accounts a group of business transactions involving changes in asset, liability, owner’s equity, revenue, and expense accounts for a service business Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objectives Prepare a trial balance Prepare: Income statement Statement of owner’s equity Balance sheet Recognize the effect of transpositions and slides on account balances Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objective 1 Determine balances of T accounts having entries recorded on both sides of the accounts Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. T Account Form Shaped like the letter T Two sides to the form One side for increases (+) to the account The other side for decreases (-) to the account 34,120 Copyright © Houghton Mifflin Company. All rights reserved.

Compare Account Column to T Account 34,120 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. T Accounts Footings The totals of the amounts listed on both sides of a T account recorded in small, penciled-in figures. 34,120 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. T Accounts Balance Record transactions for a period of time Subtract the smaller footing on one side from the larger footing on the other side Record the balance on the side having the larger footing 34,120 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. T Accounts Normal Balance The increase (plus) side of any T account. Normally, the footing on the increase (plus) side of an account will be larger than the footing on the decrease (minus) side of an account. 34,120 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. T Accounts Assets The plus side for assets is placed on the left The minus side is placed on the right Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. T Accounts Liabilities and owner’s equity These classifications are placed on the opposite side of the equals sign The plus and minus signs are therefore placed on the opposite sides of the T (switched around) Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. T Accounts Revenue and expenses are under the umbrella of owner’s equity Revenue increases owner’s equity Expenses decrease owner’s equity Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objective 2 Present the fundamental accounting equation with the T account form, and label the plus and minus sides Copyright © Houghton Mifflin Company. All rights reserved.

Fundamental Accounting Equation Copyright © Houghton Mifflin Company. All rights reserved.

Label the Plus and Minus Sides Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objective 3 Present the fundamental accounting equation with the T account form, and label the debit and credit sides Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Debits and Credits What does debit mean? Forget what you know about debit cards! Debit means left Debit is abbreviated “DR” What does credit mean? Forget what you know about credit cards! Credit means right Credit is abbreviated “CR” Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Debits and Credits Copyright © Houghton Mifflin Company. All rights reserved.

Fundamental Accounting Equation with Debits and Credits The amount placed on the debit side of one or more accounts MUST equal the amount placed on the credit side of another account or accounts Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Debits and Credits Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Drawing Account Drawing is placed under the umbrella of the Capital account Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objective 4 Record directly in T accounts a group of business transactions involving changes in asset, liability, owner’s equity, revenue, and expense accounts for a service business Copyright © Houghton Mifflin Company. All rights reserved.

Steps in Analyzing Transactions Which accounts are involved? Step 2 How should you classify the accounts? Asset Liability Capital Revenue Expenses Step 3 Are the accounts increased or decreased? Step 4 Which accounts are debited and which accounts are credited? Step 5 Balance the equations: DR = CR A = L + OE Copyright © Houghton Mifflin Company. All rights reserved.

Recording Business Transactions for a Service Business We will be recording business transactions for a company with the following details: Owner name: L. P. Arch Business name: Arch Copy Co. Business type: Sole proprietorship (one-person business) Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (a): Arch deposited $70,000 in a bank account in name of business. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (b): Bought equipment, paying cash, $33,000. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (c): Bought equipment on account from Melton Office Supply, $7,000. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (d): Paid Melton Office Supply, a creditor, $2,000. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (e): Arch invested her personal computer equipment having a fair market value of $6,200 in Arch Copy Co. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (f): Arch Copy Co. sold services for cash, $2,520. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (g): Paid rent for the month, $700. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (h): Bought supplies (toner and paper) on credit. These supplies are used immediately; therefore, they are recorded as an expense ($600). Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (i): Arch Copy Co. paid $360 for a one-year liability insurance policy. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (j): Received bill for newspaper advertising, $200. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (k): Arch Copy Co. completed a printing job and billed Walker Company $1,050 for services performed. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (l): Arch Copy Co. paid $1,800 to Melton Office Supply, its creditor, as part payment on account. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (m): Arch Copy Co. received and paid electric bill, $160. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (n): Arch Copy Co. paid on account $200 to City News for advertising. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (o): Arch Copy Co. paid wages of a part-time employee, $2,130. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (p): Bought additional equipment from Melton Office Supply, $3,520, paying $620 down with the remaining $2,900 on account. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (q): Arch Copy Co. received $850 cash on account from a credit customer. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (r): Arch Copy Co. received revenue from cash customers for the rest of the month, $4,220. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (s): Arch withdrew $2,500 in cash from the business for her personal use. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Footing Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Balances Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objective 5 Prepare a trial balance Copyright © Houghton Mifflin Company. All rights reserved.

Prepare a Trial Balance List the account balances in two columns Left column = Debits Right column = Credits List the accounts in the same order as the chart of accounts First the balance sheet accounts Then the income statement accounts Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Trial Balance A trial run to prove that DR = CR If DR = CR, then A = L + OE Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Trial Balance Not a financial statement Don’t use dollar signs Use a single underline under the list of figures to be added Use a double underline under column totals Copyright © Houghton Mifflin Company. All rights reserved.

Summarizing means preparing financial statements Accounting Process of: Analyzing Classifying Recording Summarizing Interpreting business transactions Summarizing means preparing financial statements Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objective 6 Prepare Income statement Statement of owner’s equity Balance sheet Copyright © Houghton Mifflin Company. All rights reserved.

All Financial Statements Summarize useful financial information for users of accounting information: Owners/investors Managers Creditors Government agencies Copyright © Houghton Mifflin Company. All rights reserved.

All Financial Statements Have a three-line title Who: Name of the company (or owner) What: Title of financial statement When: Period of time or date Income Statement Or Statement of OE Balance Sheet Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Income Statement Total Revenue – Total Expenses = Net Income (or Net Loss) Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Income Statement Answers the questions How profitable was the company over the past period? How much net income did the entity earn? Revenues – Expenses Net Income Copyright © Houghton Mifflin Company. All rights reserved.

What the Income Statement Tells Us Is the business profitable? What is the net income? Revenue > Expenses What is the net loss? Expenses > Revenue Copyright © Houghton Mifflin Company. All rights reserved.

Income Statement—Also Known As Statement of income and expenses Profit and loss statement Results of operations Copyright © Houghton Mifflin Company. All rights reserved.

Net Income—Also Known As Profit Earnings Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Net Income Use the net income figure on the income statement to complete the statement of owner’s equity Copyright © Houghton Mifflin Company. All rights reserved.

Statement of Owner’s Equity Beg. Bal. Capital + Investments + Net Income (or - Net Loss) – Drawing = Ending Capital Copyright © Houghton Mifflin Company. All rights reserved.

Statement of Owner’s Equity Prepared after you finish the income statement Answers the questions How did the owner’s equity change over the last period? How and why did the Capital account change? Provides ending Capital amount for use on the balance sheet 00 Copyright © Houghton Mifflin Company. All rights reserved.

Additional Investment in the Company Can you invest assets other than cash? Tools? Trucks? Equipment? Yes! They must be recorded at their fair market value (what they would be sold for on the open market) Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Balance Sheet Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Balance Sheet Answers the questions What is the entity’s financial position on the last day of the period? What assets, liabilities, and equities does the entity have on the last day of the period? Uses the ending capital figure shown on the statement of owner’s equity Resembles a snapshot—shows a point in time Be careful of the date! Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Balance Sheet List accounts in the same order as the chart of accounts Why? Listed in order of liquidity Liquidity: How quickly it can be turned into cash Report Form Balance Sheet presentation where Assets are above Liabilities and Owner’s Equity Copyright © Houghton Mifflin Company. All rights reserved.

Errors Exposed by the Trial Balance DR ≠ CR? Arithmetic error Trial balance columns added correctly? Accounts added correctly? Half an entry DR without a CR? Example: If Trial Balance is off by $100, did you record the DR without the CR? DR ≠ CR? Both sides of an entry on one side (two DRs) Example: If the Trial Balance is off by $200, divide by 2 to get $100 and look for transactions for the amount $100 ($100 DR to Cash and $100 DR to Revenue) Recording amounts incorrectly Look back to original receipt, source document, or problem Copyright © Houghton Mifflin Company. All rights reserved.

Errors Exposed by the Trial Balance When DR = CR, there can still be an error if you: Forgot to record a transaction Recorded the transaction twice Recorded the transaction for an incorrect amount Recorded the amount in the incorrect account Copyright © Houghton Mifflin Company. All rights reserved.

How Do You Find the Errors? Pay careful attention as you record transactions. Look to see if a normal balance was placed in the wrong column. Re-add the columns. Check to see if account totals were transferred correctly. Recalculate the footings and balances in the accounts. Copyright © Houghton Mifflin Company. All rights reserved.

Performance Objective 7 Recognize the effect of transpositions and slides on account balances Copyright © Houghton Mifflin Company. All rights reserved.

Transpositions and Slides Transposition error Digits have been transposed (switched around) Slide error The decimal point in an amount has been misplaced “Slide the decimal place” Copyright © Houghton Mifflin Company. All rights reserved.

Transpositions and Slides Finding an error Divide the difference between two trial balance totals by 2, or multiply by 2. See if the result matches a transaction amount. Errors divisible by 9: If an error exists and the amount of difference between the totals of the trial balance is evenly divisible by 9, the error consists of either a transposition or a slide or both. Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem We will be recording business transactions for a company with the following details: Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (a): Nelson deposited $43,000 in a bank account in the name of business. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (b): Bought truck, paying cash, $23,000. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (c): Bought camper shell for truck on account from Louie's Trucks & Campers, $2,500. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (d): Paid Louie's Trucks & Campers, a creditor, $1,500. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (e): Nelson invested his own personal computer equipment, having a fair market value of $3,400, in WindSport Boomerang & Kite Demos. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (f): Nelson and employee performed boomerang & kite demo for Girl Scouts and received cash, $2,500. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (g): Paid rent for the month, $700. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Assets = Liabilities + Owner's Equity + Revenue – Expenses + – – + – + – + + – Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash Accounts Payable R. P. Nelson, Capital Income from Demos Wages Expense + – – + – + – + + – Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit a) 43,000 b) 23,000 d) 1,500 c) 2,500 a) 43,000 f) 2,500.0 f) 2,500 d) 1,500 h) 600 e) 3,400 g) 700 Rent Expense + – R. P. Nelson, Drawing Debit Credit + - g) 700 Debit Credit Supplies Expense + – Debit Credit h) 600 Advertising Expense Accounts Receivable + – + – Debit Credit Debit Credit Traveling Expense + – Prepaid Insurance Debit Credit + – Debit Credit Transaction (h): WindSport B&K Demos bought supplies (toner and paper) on credit. These supplies are used immediately so they are recorded as an expense ($600). Equipment + – Debit Credit b) 23,000 c) 2,500 e) 3,400 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Assets = Liabilities + Owner's Equity + Revenue – Expenses + – – + – + – + + – Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash Accounts Payable R. P. Nelson, Capital Income from Demos Wages Expense + – – + – + – + + – Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit a) 43,000 b) 23,000 d) 1,500 c) 2,500 a) 43,000 f) 2,500 f) 2,500 d) 1,500 h) 600 e) 3,400 g) 700 Rent Expense i) 2,000 + – R. P. Nelson, Drawing Debit Credit + - g) 700 Debit Credit Supplies Expense + – Debit Credit h) 600 Advertising Expense Accounts Receivable + – + – Debit Credit Debit Credit Traveling Expense + – Prepaid Insurance Debit Credit + – Debit Credit i) 2,000 Transaction (i): WindSport B & K Demos paid $2,000 for a one-year liability insurance policy. Equipment + – Debit Credit b) 23,000 c) 2,500 e) 3,400 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Assets = Liabilities + Owner's Equity + Revenue – Expenses + – – + – + – + + – Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash Accounts Payable R. P. Nelson, Capital Income from Demos Wages Expense + – – + – + – + + – Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit a) 43,000 b) 23,000 d) 1,500 c) 2,500 a) 43,000 f) 2,500 f) 2,500 d) 1,500 h) 600 e) 3,400 g) 700 j) 200 Rent Expense i) 2,000 + – R. P. Nelson, Drawing Debit Credit + - g) 700 Debit Credit Supplies Expense + – Debit Credit h) 600 Advertising Expense Accounts Receivable + – + – Debit Credit Debit Credit j) 200 Traveling Expense + – Prepaid Insurance Debit Credit + – Debit Credit i) 2,000 Transaction (j): WindSport B & K Demos received an advertising bill from City News for advertising, $200. Equipment + – Debit Credit b) 23,000 c) 2,500 e) 3,400 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (k): Nelson and employee performed boomerang & kite demo for Boy Scouts and earned income on account ("sold services on account"), $2,500. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (l): WindSport B & K Demos paid $1,000 to Louie's Trucks & Campers, its creditor, as final payment on account. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (m): WindSport B & K Demos received and paid the gas card bill, $160 (Traveling Expense). Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (n): WindSport B & K Demos pays $200 on account to City News for advertising. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (o): WindSport B & K Demos pays wages for a part-time employee, $1,030. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (p): WindSport B&K Demos buys a trailer from Louie's Trucks & Campers for $2,120, paying $620 down with the remaining $1,500 on account (Equipment, A/P, and Cash accounts). Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (q): WindSport B & K Demos receives $850 cash on account from a credit customer. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (r): WindSport B & K Demos receives revenue from cash customers for the rest of the month, $4,220. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Transaction (s): Nelson withdraws $2,500 in cash from the business for his personal living costs. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Footing Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Balances Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Trial Balance Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Income Statement Copyright © Houghton Mifflin Company. All rights reserved.

Statement of Owner’s Equity Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Balance Sheet Copyright © Houghton Mifflin Company. All rights reserved.