1 The Simple Ledger ________________ is a page specifically designed to record the changes in each individual item affecting the financial position. ________________ is a group or file of accounts. _______________ can be prepared in different ways. The accounts can be prepared on cards to form a card ledger. Important Features of Ledger Accounts 1. Each individual balance sheet item is given its own specially divided page with the name of the item at the top. Each of these pages is called an account. 2. The dollar figure for each item is recorded in the account on the first line. This is the beginning value for the account. 3. It is especially important to record the dollar figure on the correct side of the account. For any item, the correct side is the side on which the item itself would appear on a simple balance sheet. Observe that for each of the assets accounts, the dollar amount is placed on the left side of the account page. For each of the liability accounts and the owner’s equity account, the dollar amount is placed on the right side of the account page. 4. The ledger and the balance sheet both show financial position, although in different ways. If you have a ledger, a balance sheet can be prepared from it. If you have a balance sheet, a ledger can be prepared from it. Debits and Credit Theory: The theory of accounting using ledger accounts is based entirely on the understanding that every account page has two distinct sides. DEBIT is the word associated with the LEFT SIDE of an account. CREDIT is the word associated with the right side of an account. In accounting terms, debit means left and credit means right!!! The Rules of Debit and Credit: For each type of account, record increases on its beginning value side and decrease on the other side. 2 Type of Accounts Asset Accounts Liability and Owner’s Equity Beginning Value Side Debit Increases Debit Decreases Credit Credit Credit Debit Applying the Rules of Debit and Credit: Transaction 1: Paris Hilton Ltd. purchases $300 worth of make-up supplies from Titan Make-up and Beauty, to be paid later. Analysis: When analyzing a transaction, you should use a transaction analysis sheet. This sheet provides a place to organize your thoughts about the transaction. Step 1: In column (A), write down the names of the accounts that are affected by the transaction. Account name A, L, OE Increase or Decrease Debit or Credit Amount Supplies A/P Titan Makeup Step 2: In column (B), write down whether each of these accounts is an asset, a liability, or the capital account. In this example: Account name A, L, OE Supplies A/P Titan Makeup Asset Liability Increase or Decrease Debit or Credit Amount Step 3: In column (C), write down whether the accounts are to be increased or decreased. In this example: Account name A, L, OE Supplies A/P Titan Makeup Asset Liability Increase or Decrease + + Debit or Credit Amount 3 Step 4: In column (D), write down whether the accounts are be debited or credited. Apply the rule given in the previous section: To increase an asset, you debit the account, to increase a liability, you credit the account. In this example: Account name A, L, OE Supplies A/P Titan Makeup Asset Liability Increase or Decrease + + Debit or Credit Amount DR CR Step 5: In Column (E), write in the amounts by which the accounts are increased or decreased in this example. Account name A, L, OE Supplies A/P Titan Makeup Asset Liability Increase or Decrease + + Debit or Credit Amount DR CR 300300- This final step completes what is known as the accounting entry for the transaction. An accounting entry may be defined as all of the changes in the accounts caused by one business transaction, expressed in terms of debits and credits. An accountant would express the accounting entry for transaction 1 in the following way: Debit Supplies and Credit A/P Titan Makeup, $300. Notice that the Debit is stated FIRST. The credited account is stated SECOND. Another Example: Transaction 2: A used limo costing $20 000 is purchased from Paris Hilton Ltd. A cash payment of $10 000 is made at the time of the purchase and the balance is by paid at a later date. Account name A, L, OE Debit or Credit Amount Asset Liability Increase or Decrease + - Limo Cash DR CR 20 000 10 000 A/P –Paris Hilton Liability + CR 10 000 4 Double-Entry System of Accounting: Whenever a transaction occurs, changes must be made in the accounts. For each transaction, all of the account changes together must balance. They are known as the accounting entry for the transaction. Introducing T-Accounts: Instead of using the transaction analysis sheet, there is another way to handle a transaction which will give the same results, that is, by using T-Accounts. A T-Account is shaped like a “T” and has two sides just like the balance sheet: Account Title Left side Debit Right Side Credit Debit is the accounting term used for the ____________________ side of the account. Credit is the accounting term used for the ____________________side of the account. Rules for T-Accounts: Assets Since assets are located on the left side of the balance sheet, the beginning balance of an asset is recorder on the left or debit side of its account. Liabilities and owner’s equity Since liabilities and owner’s equity are located on the right side of the balance sheet, the beginning balance of an liability and owner’s equity is recorded on the right or credit side of its account. 5 Test your knowledge In the following list, there are three asset accounts, two liability accounts, and one capital account. In the t-accounts below, write each title on a t-account, enter its beginning value on the proper side, and write a note to indicate the side on which the account increase and the side on which it decreases. The first one has been done for you. A/R Titan Ltd____ 1000 increase decrease Accounts: A/R Titan Minnie Mouse, Capital Equipment ______________ ______________ 1 000 13 150 7 500 Cash 7 000 A/P—Donald Duck 350 A/P—Mickey Mouse 2 000 _________________ ___________________ _________________ _______________ 6 Calculating the Balance of an Account To calculate the balance of a T-Account, two steps are performed as follows: Step 1: Add the two sides of the account separately. Use tiny pencil figures to write down these two subtotals beneath the last item on each side. These tiny totals are called pin totals or pencil footings. Step 2: Subtract the smaller total from the larger total. Write the result beside or beneath the larger of the two pin totals from Step 1. Circle this final amount. The circled amount is the dollar value of the account. The side on which it is recorded indicates the type of balance it is, DR or CR. The account balance gives the dollar value of an account and shows whether it is a DR or CR value. Exceptional Account Balances An account that would normally have a debit balance ends up with the credit balance, or vise versa. Opposite balances are not necessarily the results of mistakes, although that possibility should be checked out. For example: Suppose that Donald Trump, a customer, owes us $50. Suppose also that he sends a cheque for $55 in has payment. His account will end up with a credit balance of $5, even though he is a customer and normally has a debit balance. The account balance is correct. It shows that the business owes Donald Trump $5. The account is temporarily a liability account. Other transactions can bring exceptional balances as well. Consider the following: * You overpay an account payable *A customer with no account balance returns unsatisfactory merchandise for credit *You return goods for credit to a supplier with whom you have no account balance. 7 Trial Balance Fill in the organizer on the following terms from Page 98. Term Definition Trial Balance In Balance Out of Balance Taking off a trial balance Method of taking off a Trial Balance: To take off a Trial Balance, proceed as follows: Step 1: List all the accounts and their balance. Leave room for a three-line heading. Step 2: Place the debit balances in a debit column and the credit balances in a credit column. Step 3: Add up the two columns. Step 4: See if the two column totals are the same. Only if the two column totals are the same can you consider your ledger work to be correct. Step 5: Write a heading at the top. A heading is necessary on the trial balance. It must show the name of the individual or business, the title “Trial Balance,” and the date. 8 Importance of the Trial Balance: It is important for an accountant to have the ledger in balance. The work is not accurate if the ledger is not in balance. A ledger out of balance is a certain sign that at least one error has been made in accounts. A good accountant does not rest until all errors are found and correct. Trial Balance out of Balance: There is a four-step procedure to follow if you can find a ledger that does not balance. The steps are: Step 1: Re-add the trial balance columns. Step 2: Check the figures from the ledger against those of the trial balance. Make sure that none are missing, none are on the wrong side, and none are for the wrong amount. Step 3: Recalculate the account balance. Step 4: Check that there is a balanced accounting entry in the accounts for each transaction. Errors in Trial Balance: Testing your knowledge question The accountant for Mr. Titan Magical Pownall, owner of a dog grooming service and dog sitting business in Markham Ontario prepared a trial balance at the end of December 2007. When Mr. Titan Magical Pownall examined the trial balance, he noticed that the Doggie Goodies Co had a debit balance of $400. Mr. Titan Magical Pownall remembered depositing a cheque received from Doggie Goodies for that amount. He wants to know why a debit balance still exists on the record. Give three different explanations of how this could happen. Interpreting the Balance of an Account. Example: A debit balance in the cash account tells you there is money in the bank. 9 The Bank Account The Account you know as “Cash” will now be referred to as “Bank”. Businesses do not deal in cash these days, so “Bank” is a more appropriate term. Buying and Selling on Credit Short-term credit – Usually 30 days a customer will have to pay their bill. This gives them a chance to inspect goods, return them if necessary. This is a common practice. On Account – This term is used in 4 different ways 1. If you buy something on credit (not paid for at the time of purchase), this is called a “purchase on account”. 2. If you sell something on credit (not paid for at the time the item is sold), this is called “sale on account”, 3. Money paid out to someone you owe (a creditor) to decrease the amount owing is known as a “payment on account”. 4. Money received from a debtor to reduce the amount owed, is called “receipt on account”.