1. Welcome Back
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2. Welcome Back
Time for Any Question
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4. CHAPTER # 02
REVIEW
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5. Analyzing Business Transactions
Chapter 02
Analyzing Business Transactions
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6. Analyzing Business Transactions
Section 1: Property and Financial Interest
Section Objectives
Record in equation form the financial effects of a business transaction.
Define, identify, and understand the relationship between asset, liability, and owner’s equity accounts.
Chapter 1 introduced accounting by (1) defining accounting, (2) describing accounting career opportunities, and (3) identifying users of financial information. Chapter 2 illustrates basic accounting procedures by analyzing the business transactions of a sole proprietorship in a service business. The first objective of the chapter is to record in equation form the financial effects of a business transaction.
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7. Steps to analyze the effect of a business transaction
1. Describe the financial event.
Identify the property.
Identify who owns the property.
Determine the amount of increase or decrease.
2. Make sure the equation is in balance.
Let’s start from the beginning. Carolyn Wells obtained the funds to start the business by withdrawing $100,000 from her personal savings account. The separate bank account helps Wells keep financial interest in the business separate from her personal funds.
When a business transaction occurs, it is analyzed to identify how it affects the equation property equals financial interest. This equation reflects the fact that in a free enterprise system, all property is owned by someone. The basic equation is Property (assets) = Financial Interest (creditor’s and owner’s). Property is anything of value the business “owns” (its assets) and financial interest represents what the business “owes” to its creditors or its owner.
Property (asset) = Financial Interest (creditors and owners)
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8. Assets, Liabilities, and Owner’s Equity
Define, identify, and understand the relationship between asset, liability, and owner’s equity accounts
Assets, Liabilities, and Owner’s Equity
QUESTION:
What are assets?
The second objective of chapter 2 is to define, identify, and understand the relationship between asset, liability, and owner’s equity accounts.
Accountants use special accounting terms when they refer to property and financial interests. For example, they refer to the property that a business owns as assets. The value of an asset is tied to its revenue-generating capacity.
Assets are property owned by a business.
ANSWER:
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9. Liabilities and Equity
QUESTION:
What are liabilities?
Liabilities are debts or obligations of a business
ANSWER:
QUESTION:
What is owner’s equity?
Owner’s equity is the term used by sole proprietorships. It is the financial interest of an owner of a business. It is also called proprietorship or net worth.
ANSWER:
Accountants refer to the debts or obligations of the business as liabilities. A good example of a liability is the Accounts Payable or debt the business incurred when it purchased equipment on account.
Owner’s Equity is the term used by accountants to keep track of the owner’s financial interest in the business.
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10. The Balance Sheet What is a Balance Sheet?
QUESTION:
What is a Balance Sheet?
A balance sheet is a formal report of the financial position of a business on a certain date. It reports the assets, liabilities, and owner’s equity of the business
ANSWER:
At regular intervals Carolyn reviews the status of the firm’s assets, liabilities and owner’s equity in a financial statement called a balance sheet.
The balance sheet shows the firm’s financial position on a given date. It reports the assets, liabilities, and owner’s equity of the business.
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11. The Balance Sheet
If we look at Wells’ Consulting Services’ balance sheet, which was prepared on November 30 after its first month of operations, we can see that the business has total assets of $103,500 and owes $3,500 to creditors. The owner’s financial interest in the business (Carolyn Wells, Capital) is $100,000.
Assets – the amount and types of property owned by the business
Liabilities – the amount owed to the creditors
Equity – the owner’s interest
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12. Property equals Financial Interest
Liabilities +
Owner’s Equity
Property
Assets
The balance sheet also shows the equality of the equation—Total assets of $103,500 = Total liabilities and owner’s equity of $103,500. Remember the financial equation we learned earlier: Property = Financial Interest.
Property equals Financial Interest
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13. Analyzing Business Transactions
Section 2: The Accounting Equation and Financial Statements
Section Objectives
The third objective of chapter 2 is to analyze the effects of business transactions on a firm’s assets, liabilities, and owner’s equity and record these effects in accounting equation form. In this section we will also learn how to prepare financial statements.
2-3 Analyze the effects of business transactions on a firm’s assets, liabilities, and owner’s equity and record these effects in accounting equation form.
2-4 Prepare an income statement.
2-5 Prepare a statement of owner’s equity and a balance sheet.
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14. The Fundamental Accounting Equation
QUESTION:
What is the fundamental accounting
equation?
ANSWER:
The fundamental accounting equation is the relationship between assets and liabilities plus owner’s equity.
In accounting terms the firm’s assets must equal the total of its liabilities and owner’s equity. We use the fundamental accounting equation to ensure that this relationship is in place.
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15. The Fundamental Accounting Equation
In accounting terms the firm’s assets must equal the total of its liabilities and owner’s equity.
This equality can be expressed in equation form as:
Assets = Liabilities Owner’s Equity
The entire accounting process of analyzing, recording and reporting business transactions is based on the fundamental accounting equation.
This equality can be expressed in equation form. The relationship between assets and liabilities plus owner’s equity is called the fundamental accounting equation. All business transactions are recorded with this accounting equation in mind. It must always remain in balance.
If any two parts of the equation are known, the third part can be determined.
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16. Revenues What is revenue?
QUESTION:
What is revenue?
ANSWER:
A revenue is an inflow of money or other assets that results from the sales of goods or services or from the use of money or property. It is also called income.
When a business performs a service or sells a product it generates revenue. Wells’ Consulting Services earns revenue by performing accounting and bookkeeping services for its clients.
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17. Expenses What is an expense?
QUESTION:
What is an expense?
ANSWER:
An expense is an outflow of cash, use of other assets, or incurring of a liability.
Expenses on the other hand, involve the outflow of money, the use of other assets, or the incurring of a liability. Expenses include the costs of any materials, labor, supplies, and services used to produce revenue.
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18. Prepare an Income Statement
QUESTION:
What is an income statement?
ANSWER:
An income statement is a formal report of business operations covering a specific period of time. It is also called a profit and loss statement or a statement of income and expenses.
Earlier in the chapter, we looked at one financial statement called the balance sheet which showed total assets, total liabilities or debts, and total owner’s equity. In objective 4 of the chapter, we are going to look at another financial statement of the business which is called the income statement.
Unlike the balance sheet which is dated on a specific date, the income statement is for a period of time such as a month, a quarter, or a year and it is the first financial statement prepared for an accounting period. The income statement shows the revenue earned and the expenses incurred for that specified period of time. You may hear it referred to as a profit and loss statement or a statement of income and expenses.
If total revenue is greater than total expenses, then the difference is called “net income.” However, if during the period expenses are greater then total revenue, then the difference is a net loss.
In the rare case when revenue and expenses are equal, the firm is said to break even.
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19. The income statement has Wells’ Consulting Services
a three-line heading
The third line shows that the report covers operations over a period of time
Wells’ Consulting Services
Income Statement
Month Ended December 31, 2016
Revenue
Fees Income $47,000.00
Expenses
Salaries Expense $8,000.00
Utilities Expense
Total Expenses ,650.00
In preparing a formal income statement for a business, the heading contains three lines: Who, What, When. The top line contains the name of the business. The second line shows the name of the financial statement and the third line called the date line, describes the period of time for which the financial statement covers. This financial statement is only for one month’s worth of revenues and expenses.
Net Income $ 38,350.00
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20. The income statement reports revenue Wells’ Consulting Services
Month Ended December 31, 2016
Revenue
Fees Income $47,000.00
Expenses
Salaries Expense 8,000.00
Utilities Expense
Total Expenses ,650.00
Under the heading of Revenues, there is only one listed revenue account—Fees Income. For the month of December, total Fees Income was $47,000.
Net Income $ 38,350.00
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21. The income statement also reports expenses Wells’ Consulting Services
Month Ended December 31, 2016
Revenue
Fees Income $47,000.00
Expenses
Salaries Expense 8,000.00
Utilities Expense
Total Expenses ,650.00
Below the Revenue section is the Expenses section. All expenses are listed individually and then totaled. For the month of December, total expenses are $8,650.
Net Income $ 38,350.00
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22. Wells’ Consulting Services Income Statement
The result is net income or net loss for the period
Wells’ Consulting Services
Income Statement
Month Ended December 31, 2016
Revenue
Fees Income $47,000.00
Expenses
Salaries Expense 8,000.00
Utilities Expense
Total Expenses ,650.00
For the month of December, Wells’ Consulting Services earned $47,000 of revenues and had total expenses of $8,650. The difference of $38,350 is the net income for the month. (If the expenses would have been more than the revenues, the bottom line of the Income Statement would have been a Net Loss.)
Net Income $ 38,350.00
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23. A Statement of Owner’s Equity
Prepare a Statement of Owner’s Equity and Balance Sheet
A Statement of Owner’s Equity
Carolyn Wells, Capital, December 1, 2016
Net Income for December
Less Withdrawals for December
Increase in Capital
Carolyn Wells, Capital, December 31, 2016
Wells’ Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2016
$100,000.00
33,350.00
$133,350.00
$38,350.00
5,000.00
Note that the statement of owner’s equity has a three-line heading: who, what, and when. Let’s take a look at this statement on a line item by line item basis:
The first line is the amount of the owner’s capital at the start of the period.
The next line is net income which caused owner’s equity to go up. If there had been a net loss reported on the income statement, then the net loss would have caused a decrease in owner’s equity.
Withdrawals by the owner are a decrease to owner’s equity.
The total of changes in equity is reported on the line “Increase in Capital” or (“Decrease in Capital”). This is the difference between the net income and the withdrawals.
The last line of the statement of owner’s equity is the capital balance at the end of the period. 37
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24. Wells’ Consulting Services
The Balance Sheet
Wells’ Consulting Services
Balance Sheet
December 31, 2016
Assets
Cash ,350.00
Accounts Receivable , Supplies ,500.00
Prepaid Rent ,000.00
Equipment ,000.00
Total Assets ,850.00
Liabilities
Accounts Payable ,500.00
Owner’s Equity
Carolyn Wells, Capital ,350.00
Total Liabilities and Owner’s Equity ,
In preparing a balance sheet, remember the three line heading: who, what and when.
The when (date) line on the balance sheet is only good for one day but the other two financial statement date lines show a period of time. Put another way, the income statement and the statement of owner’s equity are like a movie covering a period of time but the balance sheet is only a snap shot of one day.
Note that the ending capital balance from the statement of owner’s equity is also used to prepare the balance sheet. Dollar signs are omitted when financial statements are prepared on paper with ruled columns.
A single line shows that the amounts above it are being added or subtracted.
A double line indicates final amounts for the column or section of a
report.
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25. The Importance of Financial Statements
Business managers and owners use the balance sheet and the income statement to control current operations and plan for the future.
Creditors, prospective investors, governmental agencies, and others are interested in the profits of the business and in the asset and equity structure.
Preparing financial statements is one of the accountant’s most important jobs. Each day millions of business decisions are made based on the information in financial statements.
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26. Financial statements are prepared in a specific order:
1st Income Statement
2nd Statement of Owner’s equity
3rd Balance Sheet
Financial statements are always prepared in a certain order.
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27. Analyzing Business Transactions Using T Accounts
Chapter 03
Analyzing Business Transactions Using T Accounts
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28. Analyzing Business Transactions Using T Accounts
Section 1: Transactions That Affect Assets, Liabilities, and Owner’s Equity
Section Objectives
Chapter 2 illustrated basic relationships in the accounting equation and showed how to prepare financial statements. Chapter 3 introduces tools accountants use to analyze business transactions, as well as the chart of accounts. In the first objective of the chapter we will learn how to set up T accounts for all assets, liabilities, and owner’s equity accounts.
3-1 Set up T accounts for assets, liabilities, and owner’s equity.
3-2 Analyze business transactions and enter them in the accounts.
3-3 Determine the balance of an account.
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29. The Accounting Equation
ASSETS
The property a
business owns
LIABILITIES
The debts of
the business = +
OWNER’S
EQUITY
The owner’s financial
interest in the business
The accounting equation is one tool for analyzing the effects of business transactions. However, businesses do not record transactions in equation form. Instead, businesses establish separate records, called accounts for assets, liabilities, and owner’s equity. Accounts are written records of the assets, liabilities, and owner’s equity of a business. Use of accounts helps owners and staff analyze, classify, record, summarize, and report financial information.
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30. 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.
Accounts are recognized by their classification as assets, liabilities, or owner’s equity.
Asset accounts show the property a business owns. Liability accounts show the debts of the business. Owner’s equity accounts show the owner’s financial interest in the business.
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31. Set up T accounts for assets, liabilities and owner’s equity= +
ASSETS
+ Record
Increases LEFT SIDE -
Record
Decreases
RIGHT SIDE
LIABILITIES
LEFT SIDE
Increases RIGHT SIDE
OWNER’S EQUITY
Objective one is to set up T-accounts for assets, liabilities, and owner’s equity accounts. Accountants use T accounts to analyze transactions. A T-account consists of a vertical line and a horizontal line that resembles the letter T. T- accounts are helpful when analyzing transactions.
Above are examples of T accounts for assets, liabilities, and owner’s equity. Using T accounts simplifies recordkeeping by grouping all transactions of a particular type together. Note that Assets are on the left side of the accounting equation, to increase any asset account you have to record the $ amount on the left side of the T account. Since Liabilities and Owner’s Capital are on the right side of the accounting equation, to increase those accounts you would record the $ amount on the right side of the T account.
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32. Effects of Business Transactions
Analyze business transactions and enter them in the accounts
Effects of Business Transactions
Steps to analyze the effects of the business
transactions:
Analyze the financial event.
Identify the accounts affected.
Classify the accounts affected.
Determine the amount of increase or decrease for each account.
Objective two is to analyze business transactions and enter them in the accounts. Take a look at the three steps shown and keep them in mind as we go through the transactions. Now that we know the rules regarding increasing and decreasing asset, liability and the owner’s capital account, let’s record some transactions.
Apply the left-side-right side rules for each account affected.
Make the entry in T-account form.
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33. Initial Investment
Carolyn Wells withdrew $100,000 from personal savings and deposited it in the new business checking account for Wells’ Consulting Services.
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.
Cash
Carolyn Wells, Capital
Let’s consider the initial investment of an owner. For this transaction, lets assume that Carolyn Wells withdrew $100,000 from personal savings and deposited it in the new business checking account for Wells’ Consulting Services.
Remember that assets are on the left side of the accounting equation so to increase them we would record the entry on the left. Because owner’s equity is on the right side of the accounting equation, to increase them we would record the entry on the right side of the T account.
Analysis:
(a) The asset account, Cash, is increased by $100,000.
(a) The owner’s equity account, Carolyn Wells, Capital, is increased by $100,000.
Since investments cause cash to go up, we would record the $100,000 cash increase on the left side of the Cash T account. Since the investment causes the owner’s capital account to go up, we would record the $100,000 investment on the right side of the Capital account.
Remember that debits must always equal credits! ALWAYS!
(a) 100,000
(a) 100,000
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34. Business Transaction
Wells’ Consulting Services issued a $5,000 check to purchase a computer and other equipment.
Analysis:
(b) The asset account, Equipment, is increased by $5,000.
(b) The asset account, Cash, is decreased by $5,000.
Equipment
Cash
Our next transaction is when the business purchased equipment for cash.
Wells’ Consulting Services issued a $5,000 check to purchase a computer and other equipment.
Analysis:
(b) The asset account, Equipment, is increased by $5,000.
(b) The asset account, Cash, is decreased by $5,000.
Since equipment is going up, we would record the $5,000 equipment increase on the left side of the Equipment T account. Since the check causes the Cash account to go down, we would record the $5,000 outlay of cash on the right side of the Cash account.
(b) 5,000
(b) 5,000
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35. Purchase of Equipment on Account
The firm bought office equipment for $6,000 on account from Office Plus. Analysis:
(c) The asset account, Equipment, is increased by $6,000.
(c) The liability account, Accounts Payable, is increased by $6,000.
Equipment
Accounts Payable
The next transaction we need to record is the purchase of equipment for credit. This time the purchase is on account. Remember when a business buys something “on account” it means that they are agreeing to pay later. Buying something on account causes debts of the firm to go up. Liabilities are amounts a business owes its creditors. They appear on the right side of the accounting equation: (Assets = Liabilities + Owner’s Equity).
Equipment is an asset, and so we show the increase on the left hand side of the T account with a debit. The increase to accounts payable, a liability account is shown with an entry on the right hand of the T account with a credit . As always, debits must equal credits.
(c) 6,000
(c) 6,000
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36. Purchase of Supplies for Cash
Wells’ Consulting Services issued a check for $1,500 to Office Delux Inc. to purchase office supplies.
Analysis:
(d) The asset account, Supplies, is increased by $1,500.
(d) The asset account, Cash, is decreased by $1,500.
Supplies
Cash
Our next transaction for the purchase of office supplies can also be recorded using T accounts. Since Supplies is going up, and it is an asset, we will increase this account on the left. Cash is the other account affected. It is also an asset, so we would decrease it by an entry on the right side of the T account.
(d) 1,500
(d) 1,500
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37. Payment of a Liability
Wells’ Consulting Services issued a check in the amount of $2,500 to Office Plus.
Analysis:
(e) The asset account, Cash, is decreased by $2,500.
(e) The liability account, Accounts Payable, is decreased by $2,500.
Accounts Payable
Cash
(e) 2,500
(e) 2,500
Recall that the firm purchased equipment earlier on account. It is now paying part of that liability by issuing a check to the vendor, Office Plus.
Remember that assets are on the left side of the accounting equation so to increase them we would record the entry on the left. However, since this transaction involves a decrease in an asset account, we need to record the entry on the right side of the asset account. Because liabilities are on the right side of the accounting equation, to increase them we would record the entry on the right side of the T account. However, in this transaction, since we want to decrease the liability account, we need to record the dollar amount on the left side of the T account. Since Accounts Payable is going down, we will decrease it by entering a $2,500 entry on the left side of the T account. Since the Cash account is going down by the same amount, we will enter the $2,500 amount in the right side of the Cash T account.
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38. Prepayment of Rent
Wells’ Consulting Services issued a check for $8,000 to pay rent for the months of December and January.
Analysis:
(f) The asset account, Prepaid Rent, is increased by $8,000.
(f) The asset account, Cash, is decreased by $8,000.
Prepaid Rent
Cash
(f) 8,000
(f) 8,000
When the business pays for two or more months of rent in advance, they are exchanging one asset, Cash, for another asset, Prepaid Rent. Remember that assets are on the left side of the accounting equation so to increase them we would record the entry on the left. Since we also want to decrease a different asset account, we need to record the entry on the right side of that asset account.
Since the Prepaid Rent account is going up, we will increase it by entering a $8,000 entry on the left side of the T account. Since the Cash account is going down by the same amount, we will enter the $8,000 amount in the right side of the Cash T account,
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39. Determine the balance of an account
An account balance is the difference between the amounts recorded on the two sides of an account.
A footing is a small pencil figure written at the base of an amount column showing the sum of the entries in the column.
Objective three shows us how to determine the balance of a T account. An account balance is the difference between the amounts recorded on the two sides of an account. It can be computed at any time.
When we “foot” a column, this means to add down and write the total at the bottom of the column. Subtract the smaller of the two totals from the larger of the two totals– the result is the account balance.
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40. Recording Account Balances IF
THEN
the total on the right side is larger than the total on the left side,
the balance is recorded on the right side.
the total on the left side is larger,
the balance is recorded on the left side.
an account shows only one amount,
When we determine the balance of an account, we add both sides of the T account and then subtract the smaller side from the larger side. The difference is the “balance” of the account.
Calculating account balances simply means adding up or “footing” the total of both sides of the T-account. Use footings for columns that have more than one entry. Then subtract the smaller total from the larger total. The result is the account balance. You will see a demonstration of this in the next slide.
This table shows the possible balance alternatives that could exist in an account.
that amount is the balance.
an account contains entries on only one side,
the total of those entries is the account balance.
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41. Computing the Account Balance
Cash
100,000
(b) 5,000
(d) 1,500
(e) 2,500
(f) 8,000
17,000
Footing
To determine the balance of the Cash account, we would add (foot) the total of the right side, which equal $17,000. Since this side is smaller than the left side, we would subtract the $17,000 from the larger $100,000 left side. The difference is a left side balance of $83,000 in the Cash account.
Bal. 83,000
(100,000 – 17,000)
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42. Summary of Account Balances
ASSETS = LIABILITIES OWNER’S EQUITY
Cash Accounts Payable Carolyn Wells, Capital
(a) 100,000 (b) 5, ( e) 2, (c) 6, (b) 100,000
(d) 1, Bal. 3,500
(e) 2,500
(f) ,000
Bal. 83, ,000
Supplies
SUMMARY OF ACCOUNT BALANCES
(d) 1,500
ASSETS = LIABILITIES + OWNER’S EQUITY
Prepaid Rent , , ,000
1,500
(f) 8, ,000
11,000
Equipment
103, = , ,000
(b) 5,000
(c) 6,000
Bal. 11,000
Account balances for Carter Consulting Services
Here is a visual presentation of the T accounts and their balances at the end of the month. Notice that the total of all the asset account balances equal the total of the liabilities and owner’s equity. $103,500 = $103,500. As you look at this slide, notice which side of the account the balance is on. All accounts have a “normal” balance. This is the side that receives the increase.
You will notice that assets have a normal left side balance, or debit. Liabilities have a normal right side balance, or credit. And the owner’s equity account, specifically capital, has a normal right side or credit balance. It’s important to recognize that all accounts have “normal balances.”
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43. Analyzing Business Transactions Using T Accounts
Section 2: Transactions That Affect Revenue, Expenses, and Withdrawals
Section Objectives
Section 2 of this chapter shows us how to record revenue, expense and withdrawal transactions into T accounts. The fourth objective of the chapter explains how to set up T accounts for these additional accounts. Let’s get started.
3-4 Set up T accounts for revenue and expenses.
3-5 Prepare a trial balance from T accounts.
3-6 Prepare an income statement, a statement of owner’s equity, and a balance sheet.
3-7 Develop a chart of accounts.
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44. T-Account for Revenue 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.
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45. Revenue
Decrease
Side _
Increase
Side +
The right side of the revenue account shows increases and the left side shows decreases.
To increase a revenue account, we would credit the account. If we would want to decrease the account we would do the opposite, so we would debit the account.
Decreases in revenue accounts are rare but might occur because of corrections or transfers.
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46. Recording Revenue from Services Sold for Cash
Set up T accounts for revenues and expenses
Recording Revenue from Services Sold for Cash
Cash
Fees Income
Bal. 83,000 (g) 36,000
(g) 36,000
The next transaction will be to record revenue from services sold for cash. Take a moment to review the transaction.
$36,000 is entered on the left (increase) side of the asset account Cash.
$36,000 is entered on the right side of the Fees Income account.
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47. Recording Revenue from Services Sold on Credit
In December, Wells’ Consulting Services earned $11,000 from various charge account clients.
Analysis:
(h) The asset account, Accounts Receivable, is increased by $11,000.
(h) The revenue account, Fees Income, is increased by $11,000.
Let’s consider the transactions where Wells’ earns $11,000 from various charge account clients. Since we have completed the work and earned the money, we increase or debit our Accounts Receivable for $11,000. We also increase our Fees Income account by recording a credit for $11,000.
Accounts Receivable
Fees Income
(h) 11,000
(h) 11,000
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48. Receipt of Payments on Account
Charge account clients paid $6,000, reducing the amount owed to Wells’ Consulting Services.
Analysis:
The asset account, Cash, is increased by $6,000.
(i) The asset account, Accounts Receivable, is decreased by $6,000.
Cash
Accounts Receivable
Wells’ Consulting collected some of the money owed by its customers. Let’s see how to record this transaction in our T accounts. Both of the accounts utilized are assets. One asset, cash, is going up, so it is shown with a debit. The other asset, accounts receivable, is going down, so it is shown with a credit.
Here is the transaction which has been entered into both of the affected accounts. Cash is debited by $6,000 and Accounts Receivable is credited by $6,000.
(i) 6,000
(i) 6,000
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49. Expenses Owner’s Equity _ + Expense Revenue + _ _ +
Decrease Side _
Increase Side +
Expense
Revenue
Increase Side +
Decrease Side _
Decrease Side _
Increase Side +
As the business incurs expenses it causes total owner’s equity to go down. Remember, since owner’s equity is on the right side of the accounting equation, to decrease total owner’s equity, we need to record the entry on the left side of the Expenses T account.
Expenses decrease owner’s equity.
Decreases in owner’s equity appear on the left side of the T accounts.
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50. Payment of Salaries
In December, Wells’ Consulting Services paid $8,000 in salaries.
Analysis:
(j) The asset account, Cash, is decreased by $8,000.
(j) The expense account, Salaries Expense, is increased by $8,000.
Salaries Expense
Cash
Let’s see how to record a business expense in the T accounts.
Remember, as the business incurs expenses it causes total owner’s equity to go down. Since owner’s equity is on the right side of the accounting equation, to decrease owner’s equity, we would record the dollar amount on the left side or debit side of the expense T account.
Remember that assets are on the left side of the accounting equation so to decrease them we would put the entry on the right or credit side of the account.
We know that Cash is the asset account which needs to be credited for the $8,000 check written. Salaries Expense is the owner’s equity expense account effected for the same amount so we need to debit it for $8,000.
(j) 8,000
(j) 8,000
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51. Payment of Utilities
Wells’ Consulting Services issued a check for $650 to pay the utilities bill.
Analysis:
(k) The asset account, Cash, is decreased by $650.
(k) The expense account, Utilities Expense, is increased by $650.
Utilities Expense
Cash
Let’s see how expenses are recorded. Remember, as the business incurs expenses it causes total owner’s equity to go down. Since we incurred the expense, we increase or debit our Utilities Expense account for $650. Cash is going down, so we credit Cash for $650.
(k)650
(k) 650
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52. Owner’s Withdrawals Owner’s Equity _ + Expense Revenue + _ _ +
Decrease
Side _
Increase
Side +
Expense
Revenue
Increase
Side +
Decrease
Side _
Decrease
Side _
Increase
Side +
Owner Drawing
Recall that drawings are not expenses of the business but part of the owner’s financial investment which he/she is pulling out of the business for personal use. A drawing account is a special type of owner’s equity account set up to record the owner’s withdrawal of cash (or other assets) from the business.
As the owner withdraws resources for personal use, it causes total owner’s equity to go down. Remember, since owner’s equity is on the right side of the accounting equation, to decrease total owner’s equity we need to record the entry on the left side of the Drawing T account. The Drawing account acts like an expense account – it is increased with a debit and thus it DECREASES owner’s equity.
Increase
Side +
Decrease
Side _
Drawing decreases owner’s equity.
Decreases in owner’s equity appear on the left side of the T accounts.
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53. The Owner Withdraws Funds
Carolyn Wells wrote a check to withdraw $5,000 cash for personal use.
Analysis:
(l) The asset account, Cash, is decreased by $5,000.
(l) The owner’s equity account, Carolyn Wells, Drawing, is increased by $5,000.
Carolyn Wells, Drawing
Cash
Let’s record this withdrawal. . . Remember, as the owner withdraws funds for personal use, it causes total owner’s equity to go down. Since owner’s equity is on the right side of the accounting equation, to decrease owner’s equity we would record $5,000 on the left side or debit side of the Drawing T account. Remember that assets are on the left side of the accounting equation so to decrease them we would record the entry on the opposite side or credit side of the Cash account. Carolyn Wells, Drawing is debited for $5,000 and Cash is credited for $5,000.
(l) 5,000
(l) 5,000
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54. The Rules of Debit and Credit
A debit is an entry on the left side of an account.
A credit is an entry on the right side of an account.
A double-entry system is an accounting system that involves recording the effects of each transaction as debits and credits in separate accounts.
Every transaction in a Double entry accounting system has at least one debit and one credit.
The total of the debits and credits recorded in the separate accounts must be EQUAL.
We have been mentioning debit (left) as we discuss T accounts. Have you noticed this? Debit just means left side of the T account. Credit means right side of the T account.
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55. 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.
We will be using the terms Debit and Credit from now on to describe how a transaction affects an account.
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56. Rules for Debits and Credits
Here are the rules for all asset, liability and owner’s equity accounts. It is important that you study this slide and refer to it often when studying. These are fundamental rules for accounting students to learn.
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57. Prepare a trial balance from T accounts
Use the proper heading to include who, what, and when information.
List the accounts in chart of account order or in the same order as they appear in the financial statement.
Enter the ending balance of each account in the appropriate Debit or Credit column.
Total the Debit column.
Total the Credit column.
Compare the column totals. They should be equal.
Our fifth objective is to prepare a trial balance using the balances in our T accounts. A trial balance is a report to test the accuracy of total debits and credits after transactions have been recorded. A Trial Balance just tells us whether total debits equal total credits. You can review the six steps shown.
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58. The Trial Balance
This is what a Trial balance looks like. Notice that total debits equal total credits.
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59. Errors 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 the incorrect amount for a transaction
Recording a debit for one amount and a credit for a different amount
Mathematical errors in calculating account balances
Forgetting to carry over an account balance to the Trial Balance
Sometimes our trial balance does not balance. Review the common errors in a trial balance. If you discover that your trial balance has an error, you can try re-footing it to check for math errors. You should insure that the correct balances from the account were transferred over to the correct debit or credit balance. (If you know what “normal balances” are, this will assist you in locating errors.) You can look to see if a transposition error or slide error occurred. Sometimes just double checking your work will disclose the error. Refer to the textbook section on “Finding Trial Balance errors” for more guidance on this topic.
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60. Prepare an income statement, a statement of owner’s equity, and a balance sheet
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 Carolyn Wells, Capital account, computed on the statement of owner’s equity, is used on the balance sheet.
Objective 6 shows us how to use the trial balance to create our financial statements. We use the information from our trial balance to prepare our financial statements.
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61. Wells’ CONSULTING SERVICES
Income Statement
Month Ended December 31, 2016
Revenue
Fees Income ,000.00
Expenses
Salaries Expense 8,000.00
Utilities Expense
Total Expenses ,650.00
Net Income ,350.00
Wells’ CONSULTING SERVICES
Statement Of Owner’s Equity
Month Ended December 31, 2016
Carolyn Wells, Capital, Dec. 1, ,000.00
Net Income for December ,350.00
Less Withdrawals for December ,000.00
Increase in Capital ,350.00
Carolyn Wells, Capital, Dec. 31, ,350.00
Once the income statement is finished you can do the statement of owner’s equity and use the ending balance of the Carolyn Wells, Capital account to complete the balance sheet.
Wells’ CONSULTING SERVICES
Balance Sheet
December 31, 2016
ASSETS LIABILITIES
Cash , Accounts Payable ,500.00
Accounts Receivable ,000.00
Supplies ,500.00
Prepaid Rent , OWNER’S EQUITY
Equipment , Carolyn Wells, Capital ,350.00
Total Assets , Total Liabilities and Owner’s Equity ,850.00
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62. Develop a chart of accounts
Each account has a number and a name.
The Balance Sheet accounts are listed first, followed by the Statement of Owner’s Equity accounts, ending with the income statement accounts.
The account number is assigned based on the type of account.
Each account should have a number assigned to its title (name)
Balance Sheet accounts are listed before income statement accounts.
Our last objective is to develop a chart of accounts. This is simply a list of all of the accounts that you use to do the record keeping in your business. Account numbers give more meaning to the chart of accounts. See an example of a numbering system for a chart of accounts on the next page.
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63. Accounts that begin with a 1 are assets
Accounts that begin with a 1 are assets. Numbers that begin with a 2 are liabilities, etc. Notice that spaces between account numbers allow you to ADD new accounts or make other changes to your chart of accounts as time passes.
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64. Permanent and Temporary Accounts
A permanent account is an account that is kept open from one accounting period to the next.
A temporary account is an account whose balance is transferred to another account at the end of an accounting period. A temporary account is “zeroed out” at the end of the accounting period.
Let’s now introduce the concept of permanent and temporary accounts before we end this chapter. Permanent accounts continue to exist from one accounting period to the next. Assets, liabilities and the owner’s capital account are permanent accounts. Another name for permanent accounts is REAL accounts.
Temporary accounts only have a balance for one accounting period. Their balance is not carried over to the next accounting period. Examples of temporary accounts are revenues, expenses, and drawing. Another name for temporary accounts is NOMINAL accounts.
We have covered many important rules in accounting. You may wish to review this chapter one more time before continuing on with the next one.
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65. Happiness is having all homework up to date
Homework assignment
Using Connect – 5 Questions for 50 Points for Chapter 03.
Log in Connect web site and do “Connect Orientation” for 10 Points
Quiz # 01 is due at home; today till 09/13 at 11:59 PM.
Prepare chapter 4 “The General Journal and General Ledger.”
Happiness is having all homework up to date
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66. Thank you and See You Next Week at the Same Time, Take Care
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