Recording Business Transactions Chapter 3 McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. 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. 3-2 1) THE LEDGER Cash Accounts Payable Share Capital Accounts are individual records showing increases and decreases. The entire group of accounts is kept together in an accounting record called a ledger. 3-3 The Use of Accounts Increases are recorded on one side of the T account, and decreases are recorded on the other side. Title of Account Left or Debit Side Right or Credit Side 3-4 The T-Account Account Title Debit Credit LEFT SIDE 3-5 The T-Account Account Title Debit Credit RIGHT SIDE 3-6 Debit and Credit Entries Receipts are on the debit side. 5/1 5/25 5/29 5/31 Bal. Cash 8,000 5/2 2,500 Payments are credit 75 5/8 2,000 on the side. 750 5/28 150 5/31 50 4,125 The balance is the difference between the debit and credit entries in the account. 3-7 Debit and Credit Entries Debits and credits affect accounts as follows: A = L + E ASSETS LIABILITIES EQUITIES Debit Credit for for Increase Decrease Debit Credit for for Decrease Increase Debit Credit for for Decrease Increase 3-8 Double Entry AccountingThe Equality of Debits and Credits 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. 3-9 Let’s record selected transactions for JJ’s Lawn Care Service in the accounts. 3-10 1 May: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. Will Cash Cash increases increase $8,000 or decrease? with a debit. Cash 1/5 8,000 Will Share Share Capital Capital increases increase$8,000 or with decrease? a credit. Share Capital 1/5 8,000 3-11 2 May: JJ’s purchased a riding lawn mower for $2,500 cash. Will Cash Cash decreases increase $2,500 or decrease? with a credit. Cash 1/5 8,000 2/5 2,500 Tools Will & Tools Equipment & Equipment increases increase $2,500 or with decrease? a debit. Tools & Equipment 2/5 2,500 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. Truck increases Will Truck increase $15,000 with a debit. or decrease? Truck 8/5 15,000 Cash decreases Will Cash and $2,000 with a credit. Notes Payable Notes Payable increase or increases $13,000 decrease? with a credit. Cash 1/5 8,000 2/5 2,500 8/5 2,000 Notes Payable 8/5 13,000 3-13 11 May: JJ’s purchased some repair parts for $300 on account. Tools Will & Tools Equipment & Equipment increases $300 increase with or decrease? a debit. Accounts Will Accounts Payable increases Payable increase $300 with or decrease? a credit. Tools & Equipment 2/5 2.500 11/5 300 Accounts Payable 11/5 300 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. Tools Will & Tools Equipment & decreases Equipment$150 increase with or adecrease? credit. Tools & Equipment 2/5 2,500 18/5 150 11/5 300 Accounts Will Accounts Receivable Receivable increases $150 increase with or decrease? a debit. Accounts Receivable 18/5 150 3-15 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. 3-16 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 3-17 The Journal In an actual accounting system, transactions are initially recorded in the journal. GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2009 1 May Cash Share Capital 8,000 8,000 Owners invest cash in the business. 3-18 Posting Journal Entries to the Ledger Accounts Posting simply means updating the ledger accounts for the effects of the transactions recorded in the journal. 3-19 Posting Journal Entries to the Ledger Accounts GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2009 1 May Cash 8,000 Share Capital 8,000 Owners General invest cash in the business. Ledger Date 2009 1 May Cash Debit Credit 8,000 Balance 8,000 3-20 Posting Journal Entries to the Ledger Accounts GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2009 1 May Cash 8,000 Share Capital 8,000 Owners General invest cash in the business. Ledger Date 2009 1 May Share Capital Debit Credit 8,000 Balance 8,000 3-21 Posting Journal Entries to the Ledger Accounts GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2009 2 May Tools & Equipment Cash 2,500 2,500 Purchased lawn mower. Let’s see what the cash account looks like after posting the cash portion of this transaction for JJ’s Lawn Care Service. 3-22 Ledger Accounts After Posting Date 2009 1 May 2 General Ledger Cash Debit Credit 8,000 2,500 Balance 8,000 5,500 This ledger format is referred to as a running balance. 3-23 Ledger Accounts After Posting Date 2009 1 May 2 General Ledger Cash Debit Credit 8,000 2,500 Balance 8,000 5,500 T accounts are simplified versions of the ledger account that only show the debit and credit columns. 3-24 What is Profit (Net Income)? Profit is not an asset; it is an increase in equity from profitable operations of the business. A = L + E Increase Decrease As income is earned, either an asset is increased or a liability is decreased. Increase Profit always results in the increase of Equity 3-25 Retained Earnings A = L + E 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. 3-26 The Income Statement: A Preview JJ's Lawn Care Service Income Statement For the Month Ended 31 May 2009 Sales Revenue Operating Expense: Gasoline Expense Profit $ 750 $ 50 700 The income statement summarizes the profitability of a business for a specified period of time. 3-27 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. 3-28 The Realization Principle: When To Record Revenue Realization Principle Revenue should be recorded at the time goods are sold and services are rendered. 3-29 The Matching Principle: When To Record Expenses Matching Principle Expenses should be recorded in the period in which they are used up. 3-30 Debit and Credit Rules for Revenue and Expenses Expenses decrease equity. EQUITIES Debit Credit for for Decrease Increase Revenues increase equity. EXPENSES REVENUES Debit Credit for for Increase Decrease Debit Credit for for Decrease Increase 3-31 DIVIDENDS • A dividend is a distribution of assets (usually cash) by a corporation to its stockholders. • SIMILAR TO expenses; BUT, not an expense 3-32 Dividends Payments to owners decrease equity. EQUITIES Debit Credit for for Decrease Increase DIVIDENDS Debit Credit for for Increase Decrease Owners’ investments increase equity. SHARE CAPITAL Debit Credit for for Decrease Increase 3-33 Summary of Debit- Credit Rules for Revenues, Expenses and Dividends Owner’s Equity Decreases recorded by debits Expenses decrease O.E Expenses are recorded by debits Dividends reduce owners’ equity Dividends are recorded by debits Increaes recorded by credits Revenue increases O.E Revenue is recorded by credits 3-34 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. 3-35 29 May: JJ’s provided lawn care services for a client and received $750 in cash. Will Cash Cash increases increase $750 or decrease? with a debit. Cash 1/5 8,000 2/5 2,500 29/5 750 8/5 2,000 Will Sales Sales Revenue Revenue increases increase $750 or with decrease? a credit. Sales Revenue 29/5 750 3-36 31 May: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. Cash Will Cash decreases increase $50 or with decrease? a credit. Cash 1/5 8,000 2/5 2,500 29/5 750 8/5 2,000 31/5 50 Gasoline Will Gasoline Expense Expense increasesincrease $50 withor a decrease? debit. Gasoline Expense 31/5 50 3-37 31 May: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend. Will Cash Cash decreases increase $200 or decrease? with a credit. Cash 1/5 8,000 2/5 2,500 29/5 750 8/5 2,000 31/5 50 31/5 200 Will Dividends Dividends increase increase or $200 with a debit. decrease? 31/5 Dividends 200 3-38 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. 3-39 Locating Trial Balance Errors What if it doesn’t balance ? Is the addition correct? Are all accounts listed? Are the balances listed correctly? DEBITS CREDITS 3-40 Now, let’s look at the Trial Balance for JJ’s Lawn Care Service for the month of May. 3-41 JJ's Lawn Care Service Unadjusted Trial Balance 31 May 2009 Cash $ 3,925 Accounts receivable 75 Tools & equipment 2,650 Truck 15,000 Notes payable $ Accounts payable Share capital Dividends 200 Sales revenue Gasoline expense 50 Total $ 21,900 $ 13,000 150 8,000 750 21,900 All balances are taken from the ledger accounts on 31 May after considering all of JJ’s transactions for the month. 3-42 End of Chapter 3 3-43