Gary A. Porter and Curtis L. Norton Using Financial Accounting Information: The Alternative to Debits and Credits Fifth Edition Gary A. Porter and Curtis L. Norton Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

External and Internal Events External events: interaction between entity and outside environment Internal events: interaction within an entity LO1

Source Documents Evidence needed in an accounting system to record Purchase Invoice Sales Invoice Evidence needed in an accounting system to record transactions Checks Cash Register Tape Receiving Document Shipping Document Payroll Records LO2

Issue Capital Stock for Cash January Transactions for Glengarry Health Club Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash Capital Stock $100,000 = $ 100,000 The accounting equation must always remain in balance LO3 3

Purchase of Property in Exchange for Note Payable Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Land Note Payable $50,000 = $200,000 Building $150,000 Increase on left of equal sign has corresponding increase on right 4

Purchase of Equipment on Account Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Equip. Accts. Pay. $20,000 = $20,000 At least two accounts affected by every transaction 5

Effect of Revenue and Expenses on Retained Earnings Statement of Retained Earnings Income Statement Revenue – Expenses = Net Income (loss) Beg. R/E + Net Income (or – Net Loss) – Dividends = End. R/E 7

Sell Monthly Memberships on Account Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Accts. Rec. Membership Revenue $15,000 = $15,000 Revenues increase retained earnings 6

Revenues increase retained earnings Sell Court Time Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash Court Revenue $5,000 = $5,000 Revenues increase retained earnings 6

Payment of Wages and Salaries Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash Wages Expense ($10,000) = ($10,000) Expenses decrease retained earnings 8

Expenses also decrease assets or Payment of Utilities Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash Utilities Expense ($3,000) = ($3,000) Expenses also decrease assets or increase liabilities 8

Collection of Accounts Receivable Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash $4,000 = (no change in Liab. or R/E) Accts. Rec. ( $4,000) Assets were traded: accounts receivable for cash 10

Dividends directly reduce Payment of Dividends Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash Retained Earnings ($2,000) = ($2,000) Dividends directly reduce retained earnings 10

Cumulative Effect of Transactions for Glengarry Health Club Assets = Liabilities + Stockholders’ Equity Sold stock + $100,000 = + $100,000 Bought prop. with note + 200,000 = + $200,000 Bought equip. on acct. + 20,000 = + 20,000 Sold memberships + 15,000 = + 15,000 Sold court time + 5,000 = + 5,000 Paid wages – 10,000 = – 10,000 Paid utilities – 3,000 = – 3,000 Collected A/R + 4,000 = (no change in Liabilities + OE) – 4,000 Paid dividends – 2,000 = – 2,000 + $325,000 = + $220,000 + $105,000 11

Glengarry Health Club Balance Sheet January 31, 2007 Assets Cash $ 94,000 Accts. Rec. 11,000 Equipment 20,000 Building 150,000 Land 50,000 Total assets $325,000 Liabilities and Stock. Equity Accounts payable $ 20,000 Notes payable 200,000 Capital stock 100,000 Retained earnings 5,000 Total liabilities and stock. equity $325,000

Glengarry Health Club Income Statement For the Month Ended January 31, 2007 Revenues: Memberships $15,000 Court fees 5,000 $20,000 Expenses: Salaries and wages $10,000 Utilities 3,000 13,000 Net income $ 7,000 Net increase to retained earnings

Sample Chart of Accounts 100–199 ASSETS 100–109: Cash 101: Checking Account 102: Savings Account 110–119: Receivables 111: Accounts Receivable 120–129: Prepaid Assets 121: Cleaning Supplies 122: Prepaid Insurance 130–139: Property, Plant, and Equipment 131: Land 132: Building 200–299 LIABILITIES 200–209: Short-Term Liabilities 201: Accounts Payable 202: Wages Payable 300–399 STOCK. EQUITY 301: Preferred Stock 302: Common Stock 303: Retained Earnings 400–499 REVENUES 500–599 EXPENSES

General Ledger Cash A/R +400 File or book that contains one page +100 –50 A/R +400 –100 Cash: +100 –50 File or book that contains one page (or entry) for each account LO4

Processing Accounting Information The Transaction Effects Equation Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Shows how transactions are analyzed into account names and accounting equation categories for use in recording transactions Shows how the balance sheet and the income statement are affected by the transactions

Appendix: Accounting Tools: Double-Entry System

Representation of one account in the general ledger The T Account Account Name Debits are entered on left Credits are entered on right Representation of one account in the general ledger LO5 17

The T Account Account Name 400 dr. 900 cr. 500 cr. Debits and credits are netted to obtain balance in account 500 cr. 17

Debits/Credits and the Accounting Equation STOCK- HOLDERS’ EQUITY Dr. Cr. + – + LIABILITIES Dr. Cr. – = ASSETS Dr. Cr. + – Opposite sides of the accounting equation are increased/decreased in an opposite way

Link Between Revenues and Retained Earnings Cr. Both accounts are increased with credits – + Revenues increase retained earnings (part of stockholders’ equity) REVENUES Dr. Cr. – +

Link Between Expenses and Dividends and Retained Earnings Retained earnings is decreased with debits DR. CR. – + Expenses and dividends decrease retained earnings DR. CR. EXPENSES AND DIVIDENDS + – Use debits to record(increase) expenses and dividends

Normal Account Balances Debit Credit Assets Expenses Dividends Liabilities Stockholders’ Equity Revenues all increased with debits all increased with credits 22 21

Transactions and T Accounts Cash Capital Stock (1) 100,000 100,000 (1) (1) Issue capital stock for cash 3 22

Transactions and T Accounts Land (2) 50,000 Note Payable Building 200,000 (2) (2) 150,000 (2) Purchase property in exchange for note payable 3 23

Transactions and T Accounts Equipment Accounts Payable (3) 20,000 20,000 (3) (3) Purchase equipment on account 3 24

(4) Sell monthly memberships on account Transactions and T Accounts Accounts Receivable Membership Revenue (4) 15,000 (4) 15,000 (4) Sell monthly memberships on account 3 25

Transactions and T Accounts Cash Court Fee Revenue (1) 100,000 (5) 5,000 (5) 5,000 T Accounts reflect current and previous postings to the account for each period (5) Sell court time

(6) Pay employees wages for the month (7) Pay utilities for the month Transactions and T Accounts Wage Expense Cash (6) 10,000 (1) 100,000 (5) 5,000 10,000 (6) 3,000 (7) Utilities Expense (7) 3,000 (6) Pay employees wages for the month (7) Pay utilities for the month 3 25

Transactions and T Accounts (8) Collection of accounts receivable Cash (1) 100,000 (5) 5,000 Accounts Receivable 10,000 (6) 3,000 (7) (4) 15,000 4,000 (8) (8) 4,000 (8) Collection of accounts receivable 3 24

Transactions and T Accounts Cash (1) 100,000 (5) 5,000 Dividends 10,000 (6) 3,000 (7) (9) 2,000 (8) 4,000 2,000 (9) (9) Pay dividends 3 24

Determine the Balance of the T Accounts Cash Accounts Receivable 10,000 (6) 3,000 (7) (4) 15,000 4,000 (8) (1) 100,000 (5) 5,000 11,000 2,000 (9) (8) 4,000 Retained Earnings 94,000 (9) 2,000 15,000 (4) 5,000 (5) 18,000 3 26

Posting from Journal Transactions are entered in: And then posted to: Ledger Accounts Cash Capital Stock And then posted to: Journal (via journal entries): Dr. Cr. Cash 100,000 Capital Stock 100,000 To record the issuance of 10,000 shares LO6

Glengarry Health Club Trial Balance January 31, 2007 Debits Credits Cash Accounts Receivable Equipment Building Land Accounts Payable Notes Payable Capital Stock Membership Revenue Court Fee Revenue Wage Expense Utility Expense Dividends Totals $ 94,000 11,000 20,000 150,000 50,000 $ 20,000 200,000 100,000 15,000 5,000 10,000 3,000 2,000 $340,000 $340,000 LO7

End of Chapter 3