College Accounting, by Heintz and Parry Chapter 3: The Double Entry Framework

Eddie was surprised at how many transactions were occurring in his business, so he decided to use a more advanced method of accounting that he had learned about in class. He decided to use T-accounts. T-accounts look like a big T, and they give you a chance to list additions to an account on one side and subtractions on the other. The parts of a T-account are: Account Title Debit side Credit side (Debit means (Credit means “left”) “right”)

Eddie learned that what side of a balance sheet an account is on determines whether the debit (left) side or the credit (right) side is used for adding to the account. Because assets are on the left side of a balance sheet, you use the debit (left) side to add to your asset accounts. Liabilities and capital are on the right side of a balance sheet, so they increase on the credit (right) side. You can picture it like this: Assets = Liabilities + Capital debit credit debit credit debit credit + + +

There are 3 other types of accounts that don’t show up on a balance sheet: Drawing, Revenues and Expenses. Because these accounts are specific labels for increases and decreases in capital, their plus side is the side that would appropriately raise or lower capital. For example, withdrawals decrease capital, so the plus side for withdrawals should be the same as the minus side for capital, which is the debit side: Drawing debitcredit + Questions : 1) Using this logic, which side would be the plus side for revenues? 2) Which side would be the plus side for expenses?

Answers: 1) Revenues increase capital, so revenues go up on the credit side, just like capital. Revenues debit credit + 2) Expenses decrease capital, so they go up on the debit side: Expenses debit credit +

This means that three types of accounts go up on the debit (left) side, or you can think of them as +/- accounts: Assets, Withdrawals, and Expenses. The other three types go up on the credit (right) side, or are -/+ accounts: Capital, Liabilities, and Revenues. Thus, those of you who know the debit accounts are worthy of AWE, while those who also know the credit accounts are even CooLeR.

Eddie’s first transaction in November was to spend $120 to insure the instruments against theft or damage for one year. With t-accounts, the same rules apply: at least two accounts change, and the accounting equation stays in balance. In this case, the accounts involved are Cash and a new account called Prepaid Insurance. Because the insurance policy has a value for 1 full year, Prepaid Insurance is an asset account, like cash is. Questions: 1) Is cash increasing (+) or decreasing (-), and should it get a debit or a credit? 2) Is Prepaid Insurance increasing (+) or decreasing (-), and should it get a debit or a credit?

Answers: 1) Cash is decreasing, and assets decrease with a credit. 2) Prepaid Insurance is increasing, and assets increase with a debit. + Asset _ + Asset - debit Cash credit debit Prepaid Ins. credit Nov. 1 bal. 203 Nov Nov Note: we need to know where we were at the start of the month, so Eddie wrote in beginning balances.

Next, Eddie bought some supplies that he needed, things like heavy-duty tape (to keep people from tripping on cables) and letterhead. Because of his good credit rating, he got the $60 of supplies on account. As a result, he will set up another new asset account called Supplies. Questions: 1) Is the Supplies account increasing or decreasing, and will it get a debit or a credit? 2) What other account (discussed in Chapter 2) will be involved? What type of account (asset, revenue, etc.) is it? Is it increasing or decreasing? Will it get a debit or a credit?

Answers: 1) Supplies are increasing, and assets increase with a debit. 2) Accounts payable, a liability, is increasing, and liabilities increase with a credit. + Asset - - Liability + debit Supplies credit debit Accts. Payable credit Nov Nov. 1 bal. 300 Nov

The second gig for Eddie and the Losers wasn’t playing for relatives! It was for friends, specifically a fraternity where Eddie knew some guys. However, being friends, they asked Eddie if they could pay him three weeks after the gig. Since the fee was $300, he agreed. The gig went well, especially after the guy who kept yelling “Skynyrd” went home. A new t-account was needed, however: Accounts Receivable, an asset account which represents the right to receive money for a sale on account. Questions: Once again, figure out: Which two accounts changed? What type of accounts are they? Are they increasing or decreasing? Do they get debits or credits?

Answers: 1) Accounts Receivable, an asset account, is increasing, and assets increase with a debit. 2) Gig Revenue, a revenue account, is increasing, and revenues increase with a credit. + Asset - - Revenue + debit Accounts Rec. credit debit Gig Revenue credit Nov Nov. 1 bal. 225 Nov P.S. All of these transactions confirmed what Eddie learned in accounting class: that every transaction involves an equal dollar amount of debits and credits.

When November ended, Eddie didn’t do financial statements, but he did do a Trial Balance: a list of all accounts and their current balances. Doing a trial balance provides reasonable assurance that an equal amount of debits and credits were put into the t-accounts. To do a trial balance, you must calculate the balance of your t- accounts. This is done like this (using an example that has nothing to do with Eddie’s business): + Asset - debit Furniture credit Nov. 1 bal.220Nov Nov. 8450Nov “footings” Nov. 30 bal.430 difference between total debits and credits, listed on the larger side

The band’s Trial Balance: Eddie and the Losers Trial Balance For Month Ended November 30 DebitsCredits Cash 83 Accounts Receivable 300 Supplies 60 Prepaid Insurance 120 Musical Instruments 2200 Accounts Payable 360 Eddie O’Hare, Capital 2000 Eddie O’Hare, Drawing 12 Gig Revenue 525 Musician Wage Expense 80 Sound Equip. Rent Exp. 30 _____ ===== =====

As Eddie documented transactions in t-accounts, he developed two rules that helped him know which account got the debit and which got the credit: 1: Many transactions involve cash, so remember that cash in is a debit and cash out is a credit. 2: Of 6 types of accounts, 4 tend to get used on only one side: Drawing and Capital and Expenses get Revenues get B E I D T I S T S