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Analyzing Business Transactions Using T Accounts

Transactions That Affect Revenue, Expenses, and Withdrawals Section Objectives Set up T accounts for revenue and expenses. Prepare a trial balance from T accounts. Prepare an income statement, a statement of owner’s equity, and a balance sheet. Develop a chart of accounts.

Revenue and Expense Accounts Page 67

Some owner’s equity accounts are classified as: Revenue Expense Separate accounts are used to record revenue and expense transactions. Page 67

Recording Revenue from Services Sold for Cash Page 67

Revenues increase owner’s equity. Decrease Side Increase Side 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. Page 67

Revenue Decrease Side Increase Side The right side of the revenue account shows increases and the left side shows decreases. Decreases in revenue accounts are rare but might occur because of corrections or transfers. Page 67

Carter Consulting Services During December the business earned $21,000 in revenue from clients who paid cash for bookkeeping, accounting, and consulting services. Page 67

Carter Consulting Services Which account is debited? Which account is credited? For what amount? For what amount? Page 68

Carter Consulting Services Cash Linda Carter, Capital 21,000 21,000 The preferred method is to keep revenue separate from the owner’s investment until the end of the investment period. Page 68

Carter Consulting Services Cash 21,000 Fees Income 21,000 Page 68

Reviewing the Effects of the Transactions Cash Fees Income Bal. 49,000 (m) 21,000 (n) 21,000 $21,000 (m) is entered on the left (increase) side of the asset account Cash. $21,000 (n) is entered on the right side of the Fees Income account. Page 68

Objective 4 Set up T accounts for revenue and expenses. Page 68

Recording Revenue from Services Sold on Credit Page 68

Accounts Receivable The accounts receivable account is used for charge customers. Accounts receivable is classified as an asset. Page 68

Business Transaction In December Carter Consulting Services earned $7,000 from various charge accounts clients. Analysis: (o) The asset account, Accounts Receivable, is increased by $7,000. (p) The revenue account, Fees Income, is increased by $7,000. Page 68

Left-Right Rules REVENUE ASSETS Page 68 Record increases

T-Account Presentation Which T account has an entry on the left? Which T account has an entry on the right? For what amount? For what amount? Page 68

T-Account Presentation Accounts Receivable Fees Income (o) 7,000 (p) 7,000 Page 68

Reviewing the Effects of the Transactions Accounts Receivable Fees Income (o) 7,000 (n) 21,000 (p) 7,000 REMEMBER REVENUE ACCOUNTS - Record decreases + Record increases Page 68

Recording Collections from Accounts Receivable Page 68

Business Transaction Charge account clients paid $3,000, reducing the amount owed to Carter Consulting Services. Analysis: (q) The asset account, Cash, is increased by $3,000. The asset account, Accounts Receivable, is decreased by $3,000. Page 68

Left-Right Rules ASSETS ASSETS Page 69 Record increases Record decreases Page 69

T-Account Presentation Which T account has an entry on the left? Which T account has an entry on the right? For what amount? For what amount? Page 69

T-Account Presentation Cash Accounts Receivable (q) 3,000 (r) 3,000 Page 69

Reviewing the Effects of the Transactions Cash Accounts Receivable Bal. 49,000 (m) 21,000 (q) 3,000 (o) 7,000 (r) 3,000 Remember: The revenue is not recorded when cash is collected from charge account clients. The revenue was recorded when the sales on credit were recorded. Page 69

Recording an Expense for Salaries Page 69

Expenses decrease owner’s equity. Decrease Side Increase Side Expense Revenue Increase Side Decrease Side Decrease Side Increase Side Expenses decrease owner’s equity. Decreases in owner’s equity appear on the left side of the T accounts. Page 69

Business Transaction In December Carter Consulting Services paid $5,000 in salaries. Analysis: (s) The asset account, Cash, is decreased by $5,000. (t) The expense account, Salaries Expense, is increased by $5,000. Page 69

Left-Right Rules EXPENSE ASSETS Page 69 Record increases Record decreases Page 69

T-Account Presentation Which T account has an entry on the left? Which T account has an entry on the right? For what amount? For what amount? Page 70

T-Account Presentation Salaries Expense Cash (t) 5,000 (s) 5,000 Page 70

Reviewing the Effects of the Transactions Salaries Expense Cash (t) 5,000 Bal. 49,000 (m) 21,000 (q) 3,000 (s) 5,000 REMEMBER EXPENSE ACCOUNTS + Record increases - Record decreases Page 70

Recording an Expense for Utilities Page 70

Business Transaction Carter Consulting Services issued a check for $600 to pay the utilities bill. Analysis: (u) The asset account, Cash, is decreased by $600. (v) The expense account, Utilities Expense, is increased by $600. Page 70

Left-Right Rules EXPENSE ASSETS Page 70 Record increases Record decreases Page 70

T-Account Presentation Which T account has an entry on the left? Which T account has an entry on the right? For what amount? For what amount? Page 71

T-Account Presentation Utilities Expense Cash (v) 600 (u) 600 Page 71

Reviewing the Effects of the Transactions Utilities Expense Cash (v) 600 Bal. 49,000 (m) 21,000 (q) 3,000 (s) 5,000 (u) 600 Page 71

The Drawing Account Page 71

What is a drawing account? QUESTION: What is a drawing account? A drawing account is a special type of owner’s equity account set up to record the owner’s withdrawal of cash from the business. ANSWER: Page 71

Drawing decreases owner’s equity. Decrease Side Increase Side Expense Revenue Increase Side Decrease Side Decrease Side Increase Side Drawing Increase Side Decrease Side Drawing decreases owner’s equity. Decreases in owner’s equity appear on the left side of the T accounts. Page 71

Business Transaction Linda Carter wrote a check to withdraw $3,000 cash for personal use. Analysis: (w) The asset account, Cash, is decreased by $3,000. (x) The owner’s equity account, Linda Carter, Drawing, is increased by $3,000. Page 71

Left-Right Rules DRAWING ACCOUNT ASSETS Page 71 Record increases Record decreases Page 71

T-Account Presentation Which T account has an entry on the left? Which T account has an entry on the right? For what amount? For what amount? Page 71

T-Account Presentation Linda Carter, Drawing Cash (x) 3,000 (w) 3,000 Page 71

Reviewing the Effects of the Transactions Linda Carter, Drawing Cash (x) 3,000 Bal. 49,000 (m) 21,000 (q) 3,000 (s) 5,000 600 (w) 3,000 Page 72

The Rules of Debit and Credit Page 72

A debit is an entry on the left side of an account. QUESTION: What is a debit? A debit is an entry on the left side of an account. ANSWER: Page 72

A credit is an entry on the right side of an account. QUESTION: What is a credit? A credit is an entry on the right side of an account. ANSWER: Page 72

What is a double-entry system? QUESTION: What is a double-entry system? A double-entry system is an accounting system that involves recording the effects of each transaction as debits and credits. ANSWER: Page 72

Any Account DEBIT SIDE CREDIT SIDE Left Side Right 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. Page 72

Double-entry Accounting Every transaction must have at least two parts: Debit Credit Page 72

Rules for Debits and Credits Asset Accounts Liability Accounts Owner’s Capital Account Debit Credit + - Increase Decrease Side Side (Normal Bal.) Debit Credit - + Decrease Increase Side Side ( Normal Bal.) Debit Credit - + Decrease Increase Side Side ( Normal Bal.) Owner’s Drawing Account Revenue Accounts Expense Accounts Debit Credit + - Increase Decrease Side Side (Normal Bal.) Debit Credit - + Decrease Increase Side Side (Normal Bal.) Debit Credit + - Increase Decrease Side Side (Normal Bal.) Page 72

The Trial Balance Page 73

Prepare a trial balance from T accounts. Objective 5 Prepare a trial balance from T accounts. Page 73

QUESTION: What is a trial balance? A trial balance is a statement to test the accuracy of total debits and credits after transactions have been recorded. ANSWER: Page 73

Complete the trial balance in six steps. Enter the trial balance heading showing the company name, report title, and closing date for the accounting period. List the account names in the same order as they appear on the financial statements. Assets Liabilities Owner’s Equity Revenue Expenses Page 73

Complete the trial balance in six steps. 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. Page 73

Carter Consulting Services 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 120,000 64,400 12,000 80,000 3,000 28,000 5,000 600 35,000 6,000 4,000 2,000 Carter Consulting Services Trial Balance December 31, 2004 Page 74

Understanding Trial Balance Errors Page 74

Some common errors in a trial balance are: 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 Page 74

Finding Trial Balance Errors Page 74

Carter Consulting Services 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 122,000 120,000 64,400 12,000 80,000 3,000 28,000 5,000 600 35,000 6,000 4,000 2,000 Carter Consulting Services Trial Balance December 31, 2004 1. Check the arithmetic. Page 74

Carter Consulting Services 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 120,000 64,400 12,000 80,000 3,000 28,000 5,000 600 35,000 6,000 4,000 2,000 Carter Consulting Services Trial Balance December 31, 2004 1. Check the arithmetic. Page 74

Carter Consulting Services Check that the correct account balances were transferred to the correct trial balance columns. 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 116,000 120,000 60,400 12,000 80,000 3,000 28,000 5,000 600 35,000 6,000 4,000 2,000 Carter Consulting Services Trial Balance December 31, 2004 64,400 ACCOUNT ____________________________ ACCOUNT NO. ________ DATE DESCRIPTION POST REF. DEBIT CREDIT BALANCE Nov. 30 Dec. 31 2004 Bal. forward J2 21,000 3,000 5,000 600 49,000 70,000 73,000 68,000 67,400 Cash 101 Page 74

Carter Consulting Services Check that the correct account balances were transferred to the correct trial balance columns. 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 120,000 64,400 12,000 80,000 3,000 28,000 5,000 600 35,000 6,000 4,000 2,000 Carter Consulting Services Trial Balance December 31, 2004 64,400 ACCOUNT ____________________________ ACCOUNT NO. ________ DATE DESCRIPTION POST REF. DEBIT CREDIT BALANCE Nov. 30 Dec. 31 2004 Bal. forward J2 21,000 3,000 5,000 600 49,000 70,000 73,000 68,000 67,400 Cash 101 Page 74

Carter Consulting Services Check the arithmetic used to compute the account balances. Carter Consulting Services Trial Balance December 31, 2004 64,400 ACCOUNT ____________________________ ACCOUNT NO. ________ DATE DESCRIPTION POST REF. DEBIT CREDIT BALANCE Nov. 30 Dec. 31 2004 Bal. forward J2 21,000 3,000 5,000 600 49,000 70,000 73,000 68,000 67,400 46,400 Cash 101 Due to a math error, the wrong balance was transferred from the general ledger account. ACCOUNT NAME DEBIT CREDIT Cash 46,400 Accounts Receivable 4,000 Supplies 2,000 Prepaid Rent 6,000 Equipment 35,000 Accounts Payable 12,000 Linda Carter, Capital 80,000 Linda Carter, Drawing 3,000 Fees Income 28,000 Salaries Expense 5,000 Utilities Expense 600 102,000 120,000 Page 74 Totals

Carter Consulting Services Check the arithmetic used to compute the account balances. 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 120,000 64,400 12,000 80,000 3,000 28,000 5,000 600 35,000 6,000 4,000 2,000 Carter Consulting Services Trial Balance December 31, 2004 64,400 ACCOUNT ____________________________ ACCOUNT NO. ________ DATE DESCRIPTION POST REF. DEBIT CREDIT BALANCE Nov. 30 Dec. 31 2004 Bal. forward J2 21,000 3,000 5,000 600 49,000 70,000 73,000 68,000 67,400 Cash 101 Page 74

Carter Consulting Services Cash 49,000 21,000 3,000 Utilities Expense 600 5,000 Carter Consulting Services Trial Balance December 31, 2004 64,400 ACCOUNT ____________________________ ACCOUNT NO. ________ DATE DESCRIPTION POST REF. DEBIT CREDIT BALANCE Nov. 30 Dec. 31 2004 Bal. forward J2 21,000 3,000 5,000 600 2,000 49,000 70,000 73,000 68,000 67,400 63,400 Cash 101 ACCOUNT NAME DEBIT CREDIT Cash 63,400 Accounts Receivable 4,000 Supplies 2,000 Prepaid Rent 6,000 Equipment 35,000 Check that each transaction was recorded correctly in the accounts by tracing the amounts to the analysis of the transaction. Accounts Payable 12,000 Linda Carter, Capital 80,000 Linda Carter, Drawing 3,000 Fees Income 28,000 Salaries Expense 5,000 Utilities Expense 600 119,000 120,000 Page 74 Totals

Carter Consulting Services Cash 49,000 21,000 Utilities Expense 600 5,000 Carter Consulting Services Trial Balance December 31, 2004 3,000 64,400 ACCOUNT ____________________________ ACCOUNT NO. ________ DATE DESCRIPTION POST REF. DEBIT CREDIT BALANCE Nov. 30 Dec. 31 2004 Bal. forward J2 21,000 3,000 5,000 600 49,000 70,000 73,000 68,000 67,400 Cash 101 ACCOUNT NAME DEBIT CREDIT Cash 64,400 Accounts Receivable 4,000 Supplies 2,000 Prepaid Rent 6,000 Equipment 35,000 Check that each transaction was recorded correctly in the accounts by tracing the amounts to the analysis of the transaction. Accounts Payable 12,000 Linda Carter, Capital 80,000 Linda Carter, Drawing 3,000 Fees Income 28,000 Salaries Expense 5,000 3,000 64,400 Utilities Expense 600 120, 000 120,000 Page 74 Totals

Financial Statements Page 75

Prepare an income statement, a statement of owner’s equity, Objective 6 Prepare an income statement, a statement of owner’s equity, and a balance sheet. Page 75

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 Linda Carter, Capital account, computed on the statement of owner’s equity, is used on the balance sheet. Page 75

Page 75 CARTER CONSULTING SERVICES Income Statement Month Ended December 31, 2004 Revenue Fees Income 28,000.00 Expenses Salaries Expense 5,000.00 Utilities Expense 600.00 Total Expenses 5,600.00 Net Income 22,400.00 CARTER CONSULTING SERVICES Statement Of Owner’s Equity Month Ended December 31, 2004 Linda Carter, Capital, Dec. 1, 2004 80,000.00 Net Income for December 22,400.00 Less Withdrawals for December 3,000.00 Increase in Capital 19,400.00 Linda Carter, Capital, Dec. 31, 2004 99,400.00 CARTER CONSULTING SERVICES Balance Sheet December 31, 2004 ASSETS LIABILITIES Cash 64,400.00 Accounts Payable 12,000.00 Accounts Receivable 4,000.00 Supplies 2,000.00 Prepaid Rent 6,000.00 OWNER’S EQUITY Equipment 35,000.00 Linda Carter, Capital 99,400.00 Total Assets 111,400.00 Total Liabilities and Owner’s Equity 111,400.00 Page 75

Chart of Accounts Page 75

Develop a chart of accounts. Objective 7 Develop a chart of accounts. Page 75

What is a chart of accounts? QUESTION: What is a chart of accounts? A chart of accounts is a list of the accounts used by a business to record its financial transactions. ANSWER: Page 75

Chart of Accounts Each account has a number and a name. The balance sheet accounts are listed first, followed by the income statement accounts. The account number is assigned based on the type of account. Page 75

CARTER CONSULTING SERVICES 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 Linda Carter, Capital Statement of Owner’s Equity Account 302 Linda Carter, Drawing Income Statement Accounts 400-499 REVENUE 401 Fees Income 500-599 EXPENSES 511 Salaries Expense 514 Utilities Expense CARTER CONSULTING SERVICES Chart of Accounts Account Number Account Name Page 77

Permanent and Temporary Accounts Page 76

What is a permanent account? QUESTION: What is a permanent account? A permanent account is an account that is kept open from one accounting period to the next. ANSWER: Page 76

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. Page 76

What is a temporary account? QUESTION: What is a temporary account? A temporary account is an account whose balance is transferred to another account at the end of an accounting period. ANSWER: Page 77

Temporary accounts are: Drawing Revenue Expenses Page 76

Complete the following sentences: R E V I W Complete the following sentences: A special type of owner’s equity account set up to record the owner’s withdrawal of cash from the business is called a(n) _______________. drawing account An entry in the left side of an account is a(n) _____. debit An entry on the right side of an account is a(n) ______. credit

Complete the following sentences: R E V I W Complete the following sentences: An accounting system that involves recording the effects of each transaction as debits and credits is called a(n) __________________. double-entry system A statement to test the accuracy of total debits and credits after transactions have been recorded is called a(n) ___________. trial balance A list of accounts used by a business to record its financial transactions is called a(n) _______________. chart of accounts

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