3. CHAPTER THREE ASSET, LIABILITY, AND OWNER’S EQUITY ACCOUNTS

4. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-3 1. Set up T accounts. 2. Enter opening balances in T accounts. 3. Record debits and credits in asset, liability, and owner’s equity accounts. 4. Foot and balance the accounts. 5. Prove the fundamental accounting equation. ASSET, LIABILITY, AND OWNER’S EQUITY ACCOUNTS Objectives:

5. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-4 The Form of Accounts The simplest form of an account looks like the letter “T” and is therefore called a T account. The left side is the debit side. The right side is the credit side.

6. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-5 Opening Accounts for the Balance Sheet Items For assets, the beginning balance is on the left side, or debit side. For liabilities and owner’s equity, the beginning balances are on the right hand side, or credit side.

7. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-6 Recording Changes in Accounts For asset accounts, increases are entered on the debit side. Decreases are entered on the credit side. For liabilities and owner’s equity accounts, increases are entered on the credit side. Decreases are entered on the debit side.

8. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-7 Finding the Balances of Accounts Each side of the account is added. The smaller balance is subtracted from the larger balance. The difference is the account balance. The account balance is recorded on the balance side in pencil. This is known as a pencil footing.

9. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-8 Using Account Balances to Prove the Accounting Equation Once the account balances have been computed they can be used to prove the accounting equation. assets = liabilities + owner’s equity.

10. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-9 Accounting Terminology Account Account Balance Debit Credit General Ledger Pencil Footing Source Document

11. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-10 Chapter Summary A separate account is kept for every asset, liability, and owner’s equity item in a business. The accounts are used to record the increases and decreases caused by daily transactions. All accounts together are known as the general ledger.

12. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-11 Chapter Summary (continued) Two things must be considered when analyzing and recording each part of a business transaction: 1. The type of account affected (asset, liability, or owner’s equity). 2. Whether an increase or a decrease is involved.

13. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-12 Chapter Summary (continued) The left side of an account is the debit side. The right side of an account is the credit side.

14. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-13 Chapter Summary (continued) Increases in assets are recorded as debits. Decrease in assets are recorded as credits.

15. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-14 Chapter Summary (continued) Increases in liabilities and in owner’s equity are recorded as credits. Decreases in liabilities and in owner’s equity are recorded as debits.

16. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-15 Chapter Summary (continued) An account balance is the difference between the total debits and the total credits in an account. A total or balance written in small pencil figures is called a pencil footing.

17. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-16 Chapter Summary (continued) To foot or pencil-foot a column of figures means to total the figures.

18. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-17 1. The “T” in T account stands for transaction. 2. Beginning balances for assets are on the debit side of the account. 3. Liabilities and owner’s equity accounts both have debit balances. Topic Quiz Answer the following true/false questions: TRUE FALSE

19. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-18 Investigating on the Internet Sources of information about accounts and account balances can be accessed on many corporate websites. Search for a website of a business that shows a financial report and study how the report addresses their accounts.

20. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-19 (Return to Topic Quiz) 1. The “T” in T account stands for transaction. FALSE It is because an account looks like the letter “T.”

21. McGraw-Hill/Irwin Accounting Fundamentals, 7/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 3-20 (Return to Topic Quiz) 3. Liabilities and owner’s equity accounts both have debit balances. FALSE Liabilities and owner’s equity accounts have credit balances.