3-1 Skyline College Chapter 3. 3-2 The Accounting Equation ASSETS The property a business owns...

3-1

Skyline College

Chapter

3

3-2

The Accounting EquationThe Accounting Equation

ASSETSThe property a business owns

LIABILITIESThe debts of the business

OWNER’SEQUITY

The owner’s financialinterest in the business

=

+

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Accounts help to:

analyze,

record,

classify,

summarize,

and report financial information.

Advantages of Accounts

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Classification of Accounts Asset Accounts Asset accounts show the property a business owns.

Liability Accounts Liability accounts show the debts of the business.

Owner’s Equity Accounts Owner’s equity accounts show the owner’s financial interest in the business.

Classification is a means of identifying each account: asset, liability, or owner’s equity.

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= +

T Accounts

ASSETS

+ Record

Increases

LEFT SIDE

-Record

Decreases

RIGHT SIDE

LIABILITIES

-Record

Decreases

LEFT SIDE

+ Record

Increases

RIGHT SIDE

OWNER’S EQUITY

-Record

Decreases

LEFT SIDE

+ Record

Increases

RIGHT SIDE

A T account is a type of diagram, used to analyze the effects of a business transaction.

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Cash

+ Record

Increases

LEFT SIDE

-Record

Decreases

RIGHT SIDE

Assets appear on the left side of the accounting equation.

Cash is an asset.

Cash increases appear on the left side of the Cash T account.

Decreases are shown on the right side.

Asset Account

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Liabilities & Capital Accounts

Jason Taylor, Capital

- Record

Decreases

LEFT SIDE

+Record

Increases

RIGHT SIDE

Owner’s equity appears on the right side of the accounting equation (Assets = Liabilities + Owner’s Equity).

Increases appear on the right side of the T account.

Decreases appear on the left side.

Capital is an owner’s equity account.

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Effects of Business Transactions

1. Analyze the financial event.

Use these steps to analyze the effects of the business transactions:

2. Apply the left-right rules for each account affected.

3. Make the entry in T-account form.

Identify the accounts affected.

Classify the accounts affected.

Determine the amount of increase or decrease for each account.

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Business Transaction

Jason Taylor withdrew $90,000 from personal savings and deposited it in the new business checking account for JT’s Consulting Services.

Analysis:

(a) The asset account, Cash, is increased by $90,000.

(a) The owner’s equity account, Jason Taylor, Capital, is increased

by $90,000.

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Left-Right Rules

ASSETS OWNER’S EQUITY

Record increases

+

Record increases

+

LEFT Increases to asset accounts are recorded on the left side of the T account.

RIGHT Increases to owner’s equity accounts are recorded on the right side of the T account.

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T-Account Presentation

For what amount? For what amount?

Which T account has an entry on the left?

Which T account has an entry on the right?

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+(a) 90,000

+(a) 90,000

Cash Jason Taylor, Capital


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JT’s Consulting Services issued a $10,000 check to purchase a computer and other equipment.

Analysis:

(b) The asset account, Equipment, is increased by $10,000.

(b) The asset account, Cash, is decreased by $10,000.

Record a cash purchase of Equipment

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Left-Right Rules

ASSETS

Record increases

+

Record decreases

-

ASSETS


RIGHT Decreases to asset accounts are recorded on the right side of the T account.

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Equipment

+ (b) 10,000

Cash

-(b) 10,000


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Reviewing the Effects of the Transactions

The Cash account shows two transactions. The initial investment by the owner (a) The cash purchase of equipment (b)

Equipment

+ (b) 10,000

Cash

-(b) 10,000

+ (a) 90,000

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Liabilities are amounts a business owes its creditors.

They appear on the right side of the accounting equation (Assets = Liabilities + Owner’s Equity).

Liabilities

Recall that when a purchase is made on account, a liability is created.

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The firm bought office equipment for $12,000 on account from Office Plus.

Analysis:

(c) The asset account, Equipment, is increased by $12,000.

(c) The liability account, Accounts Payable, is increased by $12,000.

Recording a Credit Purchase

of Equipment

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Left-Right Rules

ASSETS LIABILITY

Record increases

+

Record increases

+


RIGHT Increases to liability accounts are recorded on the right side of the T account.

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Equipment

+ (c) 12,000

Accounts Payable

+(c) 12,000


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The Equipment account shows two transactions. The purchase of equipment for cash (b) The purchase of equipment on credit (c)

+(b) 10,000

(c) 12,000


Equipment Accounts Payable

+(c) 12,000

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JT’s Consulting Services issued a check for $3,000 to Office Supplies Inc. to purchase office supplies.

Analysis:

(d) The asset account, Supplies, is increased by $3,000.

(d) The asset account, Cash, is decreased by $3,000.

Recording a Cash Purchase

of Supplies

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Left-Right Rules

ASSETS ASSETS

Record increases

+

Record decreases

-



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Supplies

+(d) 3,000

Cash

-(d) 3,000


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The Cash account shows three transactions: The initial investment by the owner (a) The cash purchase of equipment (b) The cash purchase of supplies (d)

Supplies

+(d) 3,000

Cash

- (b) 10,000 (d) 3,000

+(a) 90,000

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JT’s Consulting Services issued a check in the amount of $5,000 to Office Plus.

Analysis:

(e) The asset account, Cash, is decreased by $5,000.

(e) The liability account, Accounts Payable, is decreased by $5,000.

Recording a Payment to a Creditor

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Left-Right Rules

LIABILITY ASSETS

Record decreases

-

Record decreases

-

LEFT Decreases to liability accounts are recorded on the left side of the T account.


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Accounts Payable

-(e) 5,000

Cash

- (e) 5,000


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+ (a) 90,000

Cash

(d) 10,000

(h) 3,000

(i) 5,000

+(b) 12,000

Accounts Payable

-(e) 5,000

The Cash account shows four transactions: Initial investment (a) Equipment purchase (b) Supplies purchase (d) Payment on account (e)

-

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+

(a) 90,000

Cash

(b) 10,000

(d) 3,000

(e) 5,000

+(c) 12,000

Accounts Payable

-(e) 5,000

The Accounts Payable account shows two transactions: Credit purchase of equipment (c) Payment to creditor (e)

-

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Business Transactions

JT’s Consulting Services issued a check for $7,000 to pay rent for the months of December and January.

Analysis:

(f) The asset account, Prepaid Rent, is increased by $7,000.

(f) The asset account, Cash, is decreased by $7,000.

Recording Prepaid Rent

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Left-Right Rules

ASSETS ASSETS

Record increases

+

Record decreases

-



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Prepaid Rent

+(f) 7,000

Cash

- (f) 7,000


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-(b) 10,000 (d) 3,000 (e) 5,000 (f) 7,000

+ (a) 90,000

The Cash account shows five transactions: Initial investment (a) Equipment purchase (b) Supplies purchase (d) Payment on account (e) Advance rent payment (f)

Prepaid Rent

+ (f) 7,000

Cash

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An account balance is the difference between the amounts recorded on the two sides of an account.

Account Balances

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Calculating the Account Balance

1. Compute the totals of each side of the T account.

2. Subtract the smaller total from the larger total. The result is the account balance.

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the total of those entries is the account balance.

an account contains entries on only one side,

that amount is the balance.an account shows only one amount,

the balance is recorded on the left side.the total on the left side is larger,

the balance is recorded on the right side.the total on the right side is larger than the total on the left side,

Recording Account Balances

IF THEN

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Account Balance

Cash

+ (a) 90,000

-(b) 10,000(d) 3,000(e) 5,000(f) 7,000

Bal. 65,000

(90,000 – 25,000 = 65,000)

25,00090,000

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Account balances for Carter Consulting Services

ASSETS = LIABILITIES + OWNER’S EQUITY Cash Accounts Payable Jason Taylor, Capital (a) 90,000 (b) 10,000 (e) 5,000 (c) 12,000 (a) 90,000 (d) 3,000

(e) 5,000 Bal. 7,000 Bal 90,000 (f) 7,000 Bal. 65,000

Supplies SUMMARY OF ACCOUNT BALANCES (d) 3,000

ASSETS = LIABILITIES + OWNER’S EQUITY Bal 3,000 Prepaid Rent 65,000 7,000 90,000 3,000 (f) 7,000 7,000 Bal 7,000 22,000 Equipment 97,000 = 7,000 + 90,000 (b) 10,000 (c) 12,000

Bal. 22,000

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Some owner’s equity accounts are classified as: Revenue Expense

Separate accounts are used to record revenue and expense transactions.

Revenue and Expense Accounts

Owner’s Equity

Decrease

Side

Increase

Side

Revenue

Decrease

Side

Increase

Side

Revenues increase owner’s equity. Increases in owner’s equity appear on the right side of the T account.

Therefore, increases in revenue appear on the right side of revenue T accounts.

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The right side of the revenue account shows increases and the left side shows decreases.

Revenue

Decrease

Side

-

Increase

Side

+

Decreases in revenue accounts are rare but might occur because of corrections or transfers.

During December the business earned $26,000 in revenue from clients who paid cash for bookkeeping, accounting, and consulting services.

JT’s Consulting Services

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JT’s Consulting Services

Which account is debited?

For what amount?

Which account is credited?

For what amount?


Cash

+Bal. 65,000(g) 26,000

Fees Income

+(g) 26,000

$26,000 (g) is entered on the left (increase) side of the asset account Cash.

$26,000 (g) is entered on the right side of the Fees Income account.

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Accounts ReceivableAccounts Receivable

The accounts receivable account is used for charge customers.

Accounts receivable is classified as an asset.

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In December JT’s Consulting Services earned $9,000 from various charge accounts clients.

Analysis:

(h) The asset account, Accounts Receivable, is increased by $9,000.

(h) The revenue account, Fees Income, is increased by $9,000.

Record Revenue from Services Sold

on Credit

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Left-Right Rules

ASSETS REVENUE

Record increases

+

Record increases

+

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Accounts Receivable

+ (h) 9,000

Fees Income

+(h) 9,000

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Accounts Receivable

+(h) 9,000

Fees Income

+(g) 26,000


REVENUE ACCOUNTS

+Record

increases

REMEMBER

-Record

decreases

(h) 9,000

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Analysis:

(i) The asset account, Cash, is increased by $4,000.

(i) The asset account, Accounts Receivable, is decreased by $4,000.


Charge account clients paid $4,000, reducing theamount owed to JT’s Consulting Services.

Recording Collections from

Accounts Receivable

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Left-Right Rules

ASSETS ASSETS

Record increases

+

Record decreases

-

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Cash

+(i) 4,000

Accounts Receivable

-(i) 4,000

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Remember:

The revenue was recorded when the sales on credit were recorded. . . not. . .

when cash is collected.

Cash

Bal. 65,000 (g) 26,000

Accounts Receivable

-(i) 4,000

+(h) 9,000


(i) 4,000

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Expenses decrease owner’s equity.

Owner’s Equity

Decrease Side Increase Side

Revenue


Expense

Increase Side Decrease Side

Decreases in owner’s equity appear on the left side of the T accounts.

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In December JT’s Consulting Services paid $7,000 in salaries.

Analysis:

(j) The asset account, Cash, is decreased by $7,000.

(j) The expense account, Salaries Expense, is increased by $7,000.

Recording an Expense for Salaries

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Left-Right Rules

EXPENSE

Record increases

+

ASSETS

Record decreases

-

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Salaries Expense

+(j) 7,000

Cash

-(j) 7,000


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+Bal. 65,000 (g) 26,000(h) 4,000

Salaries Expense

+(j) 7,000

Cash

-(j) 7,000

EXPENSE ACCOUNTS

-Record

decreases

REMEMBER

+Record

increases


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JT’s Consulting Services issued a check for $500 to pay the utilities bill.

Analysis:

(k) The asset account, Cash, is decreased by $500.

(k) The expense account, Utilities Expense, is increased by $500.

Recording an Expense for Utilities

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Left-Right Rules

EXPENSE

Record increases

+

ASSETS

Record decreases

-

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Utilities Expense

+(k) 500

Cash

-(k) 500

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Utilities Expense

+(k) 500

Cash

-(j) 7,000

+Bal. 65,000 (g) 26,000(h) 4,000

(k) 500


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A drawing account is a temporary owner’s equity account set up to keep track of the owner’s withdrawals from the business during the period.

The Drawing Account

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Drawing decreases owner’s equity.

Owner’s Equity

Decrease Side

-

Increase Side

+

Revenue


Expense

Increase Side Decrease Side

Drawing

Increase Side

+

Decrease Side

-

Decreases in owner’s equity appear on the left side of the T accounts.

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Jason Taylor wrote a check to withdraw $4,000 cash for personal use.

Analysis:

(l) The asset account, Cash, is decreased by $4,000.

(l) The owner’s equity account, Jason Taylor, Drawing, is increased by $4,000.


The Drawing Account

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Left-Right Rules

DRAWING ACCOUNT

Record increases

+

Record decreases

-

ASSETS

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Jason Taylor, Drawing

+ (l) 4,000

Cash

-(l) 4,000

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(j) 7,000(k) 500

+Bal. 65,000 (g) 26,000(i) 4,000


+(l) 4,000

Cash

(l) 4,000


-

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Any Account

Left Side

DEBIT

Right Side

CREDITDEBITSIDE

CREDIT

SIDE

Accountants refer to the left side of an account as the debit side instead of saying the left side.

The right side of the account is called the credit side.

The Rules of Debit and Credit

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A double-entry system is an accounting system that involves recording the effects of each transaction as debits and credits.

Double-Entry System

Debit Credit

Every transaction must have at least two parts:

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Debit Credit + - Increase Decrease Side Side (Normal Bal.)

Debit Credit - +

Decrease Increase Side Side ( Normal Bal.)

Debit Credit - +

Decrease Increase Side Side ( Normal Bal.)

Debit Credit + - Increase Decrease Side Side

(Normal Bal.)

Debit Credit - +

Decrease Increase Side Side (Normal Bal.)

Debit Credit + -

Increase Decrease Side Side (Normal Bal.)

Rules for Debits and Credits Asset Accounts Liability Accounts Owner’s Capital Account

Owner’s Drawing Account Revenue Accounts Expense Accounts

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A trial balance is a statement to test the accuracy of total debits and credits after transactions have been recorded.

Debit balances = Credit Balances

The Trial Balance

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1. Enter the trial balance heading showing the company name, report title, and closing date for the accounting period.

2. List the account names in the same order as they appear on the Chart of Accounts (financial statements). Assets

Liabilities

Owner’s Equity

Revenue

Expenses

Complete the trial balance

in six steps.

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3. Enter the ending balance of each account in the appropriate Debit or Credit column.

4. Total the Debit column.

5. Total the Credit column.

6. Compare the total debits with the total credits.

Complete the trial balance

in six steps.

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DEBIT CREDIT

ACCOUNT NAME

Cash

Accounts Receivable

Supplies

Prepaid Rent

Equipment


Accounts Payable


Fees Income

Salaries Expense

Utilities Expense

Totals 132,000 132,000

83,500

7,000

90,000

4,000

35,000

7,000 500

22,0007,000

5,000

3,000

JT’s Consulting ServicesTrial Balance

December 31, 2007

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Adding trial balance columns incorrectly

Recording only half a transaction – for example, recording a debit but not recording a credit, or vice versa

Recording both halves of a transaction as debits or credits rather than recording one debit and one credit

Recording an amount incorrectly from a transaction

Recording a debit for one amount and a credit for a different amount

Making an error when calculating the account balances

Some common errors in a trial balance are:

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DEBIT CREDIT

ACCOUNT NAME

Cash

Accounts Receivable

Supplies

Prepaid Rent

Equipment


Accounts Payable


Fees Income

Salaries Expense

Utilities Expense

Totals 132,000 130,000

83,500

7,000

90,000

4,000

35,000

7,000 500

22,0007,000

5,000

3,000


December 31, 2007 1. Check the arithmetic.

Finding Trial Balance Errors

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DEBIT CREDIT

ACCOUNT NAME

Cash

Accounts Receivable

Supplies

Prepaid Rent

Equipment

Linda Carter, Capital

Accounts Payable

Linda Carter, Drawing

Fees Income

Salaries Expense

Utilities Expense

Totals 122,000 132,000

73,500

7,000

90,000

4,000

35,000

7,000 500

22,0007,000

5,000

3,000


December 31, 2007

64,400

ACCOUNT ____________________________ ACCOUNT NO. ________

DATE DESCRIPTIONPOST REF. DEBIT CREDIT DEBIT CREDIT

BALANCE

Nov. 30

Dec. 31

Dec. 31

Dec. 31

Dec. 31

Dec. 31

2004

Bal. forward

J2

J2

J2

J2

J2

21,000

3,000

5,000

600

3,000

49,000

70,000

73,000

68,000

67,400

83,500

Cash 101

2. Check that the correct account balances were transferred to the correct trial balance columns.

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After the trial balance is prepared, the financial statements are prepared.

Net income from the income statement is used on the statement of owner’s equity.

The ending balance of the Jason Taylor, Capital account, computed on the statement of owner’s equity, is used on the balance sheet.

Financial Statements

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JT’s CONSULTING SERVICES Balance Sheet December 31, 2007 ASSETS LIABILITIESCash 83,500.00 Accounts Payable 7,000.00Accounts Receivable 5,000.00Supplies 3,000.00Prepaid Rent 7,000.00 OWNER’S EQUITYEquipment 22,000.00 Jason Taylor, Capital 113,500.00Total Assets 120,500.00 Total Liabilities and Owner’s Equity 120,500.00

JT’s CONSULTING SERVICES Statement Of Owner’s Equity Month Ended December 31, 2007 Jason Taylor, Capital, Dec. 1, 2007 90,000.00 Net Income for December 27,500.00 Less Withdrawals for December 4,000.00 Increase in Capital 23,500.00 Jason Taylor, Capital, Dec. 31, 2007 113,500.00

JT’s CONSULTING SERVICES Income Statement Month Ended December 31, 2007Revenue Fees Income 35,000.00Expenses Salaries Expense 7,000.00 Utilities Expense 500.00 Total Expenses 7,500.00Net Income 27,500.00

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A chart of accounts is a list of the accounts used by a business to record its financial transactions.

Chart of Accounts

Each account has a number and a name.

The account number is assigned based on the type of account.

The balance sheet accounts are listed first, followed by the income statement accounts.

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Balance Sheet Accounts 100-199 ASSETS 101 Cash 111 Accounts Receivable 121 Supplies 137 Prepaid Rent 141 Equipment 200-299 LIABILITIES 202 Accounts Payable

300-399 OWNER’S EQUITY 301 Jason Taylor, Capital Statement of Owner’s Equity Account 302 Jason Taylor, Drawing Income Statement Accounts 400-499 REVENUE 401 Fees Income 500-599 EXPENSES 511 Salaries Expense 514 Utilities Expense

JT’s CONSULTING SERVICES

Chart of Accounts Account Number Account Name

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Permanent accounts are: Assets

Liabilities

Owner’s capital

The permanent accounts appear on the balance sheet at the end of an accounting period.

The balances of these accounts are then carried forward to start the new accounting period.

Permanent Accounts

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A temporary account is an account whose balance is transferred to another account at the end of an accounting period.

Temporary Accounts

Temporary accounts are: Drawing

Revenue

Expenses

3-1 Skyline College Chapter 3. 3-2 The Accounting Equation ASSETS The property a business owns...

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