recording business transactions

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Recording Business Recording Business TransactionsTransactions

Chapter 3

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The Role of Accounting The Role of Accounting RecordsRecords

Establishes accountability for assets and transactions.

Establishes accountability for assets and transactions.

Keeps track of routine business activities.

Keeps track of routine business activities.

Obtains detailed information about a particular transaction.

Obtains detailed information about a particular transaction.

Evaluates efficiency and performance within company.

Evaluates efficiency and performance within company.

Maintains evidence of a company’s business activities.

Maintains evidence of a company’s business activities.

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1) 1) TTHE LEDGERHE LEDGER

The entire group of accounts is kept

together in an accounting record

called a ledger.

The entire group of accounts is kept

together in an accounting record

called a ledger.

Cash

Accounts Payable

ShareCapital

Accounts are individual records showing increases

and decreases.

Accounts are individual records showing increases

and decreases.

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The Use of AccountsThe Use of Accounts

Increases are recorded on one

side of the T account, and decreases are

recorded on the other side.

Left or

Debit Side

Right or

Credit Side

Title of Account

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The T-AccountThe T-Account

Account Title

Debit Credit

LEFT SIDE

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The T-AccountThe T-Account

Account Title

Debit Credit

RIGHT SIDE

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Cash5/1 8,000 5/2 2,500

5/25 75 5/8 2,0005/29 750 5/28 150

5/31 50 5/31 4,125Bal.

Cash5/1 8,000 5/2 2,500

5/25 75 5/8 2,0005/29 750 5/28 150

5/31 50 5/31 4,125Bal.

Receipts are on the debit

side.

Payments are on the credit

side.

The balance is the difference between the debit and credit entries

in the account.

The balance is the difference between the debit and credit entries

in the account.

Debit and Credit EntriesDebit and Credit Entries

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AA = LL + EEASSETSASSETS

Debit for

Increase

Credit for

Decrease

EQUITIESEQUITIES

Debit for

Decrease

Credit for

Increase

LIABILITIESLIABILITIES

Debit for

Decrease

Credit for

Increase

Debits and credits affect accounts as follows:Debits and credits affect accounts as follows:

Debit and Credit EntriesDebit and Credit Entries

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AA = LL + EEDebit Debit

balancesbalancesCredit Credit

balancesbalances=In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.

In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.

Double Entry AccountingDouble Entry AccountingThe The Equality of Debits and CreditsEquality of Debits and Credits

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Let’s record selected

transactions for JJ’s Lawn

Care Service in the accounts.

1 May: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.

1 May: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.

Will Cash increase or decrease?

Will Share Capital increase or decrease?

Share Capital1/5 8,000

Cash1/5 8,000

Cash increases $8,000 with a debit.

Share Capital increases $8,000

with a credit.

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2 May: JJ’s purchased a riding lawn mower for $2,500 cash.

2 May: JJ’s purchased a riding lawn mower for $2,500 cash.

Will Cash increase or decrease?

Will Tools & Equipment increase

or decrease?

Tools & Equipment2/5 2,500

Cash1/5 8,000 2/5 2,500

Cash decreases $2,500 with a credit.

Tools & Equipment increases $2,500

with a debit.

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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.

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.

Will Truck increase or decrease?

Will Cash and Notes Payable

increase or decrease?

Truck8/5 15,000

Cash1/5 8,000 2/5 2,500

8/5 2,000

Notes Payable8/5 13,000

Truck increases $15,000 with a debit.

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11 May: JJ’s purchased some repair parts for $300 on account.

11 May: JJ’s purchased some repair parts for $300 on account.

Will Tools & Equipment increase

or decrease?

Will Accounts Payable increase or

decrease?

Tools & Equipment increases $300 with

a debit.

Tools & Equipment2/5 2.500

11/5 300

Accounts Payable11/5 300

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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.

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.

Will Tools & Equipment increase

or decrease?

Will Accounts Receivable increase

or decrease?

Tools & Equipment decreases $150 with

a credit.

Tools & Equipment2/5 2,500 18/5 150

11/5 300

Accounts Receivable18/5 150

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2) THE JOURNAL2) THE JOURNALIt 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.

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The The JournalJournalWhat 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

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In an actual accounting system, transactions are initially recorded in the

journal.

In an actual accounting system, transactions are initially recorded in the

journal.

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

2009

1 May Cash 8,000

Share Capital 8,000

Owners invest cash in the business.

The JournalThe Journal

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Posting Journal Entries to Posting Journal Entries to the Ledger Accountsthe Ledger Accounts

Posting simply means updating the ledger accounts for

the effects of the transactions

recorded in the journal.

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

2009

1 May Cash 8,000

Share Capital 8,000

Owners invest cash in the business.General LedgerCash

Date Debit Credit Balance20091 May 8,000 8,000

Posting Journal Entries to Posting Journal Entries to the Ledger Accountsthe Ledger Accounts

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

2009

1 May Cash 8,000

Share Capital 8,000

Owners invest cash in the business.General LedgerShare Capital

Date Debit Credit Balance20091 May 8,000 8,000

Posting Journal Entries to Posting Journal Entries to the Ledger Accountsthe Ledger Accounts

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

2009

2 May Tools & Equipment 2,500

Cash 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.

Let’s see what the cash account looks like after posting the cash portion of this

transaction for JJ’s Lawn Care Service.

Posting Journal Entries to Posting Journal Entries to the Ledger Accountsthe Ledger Accounts

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General LedgerCash

Date Debit Credit Balance20091 May 8,000 8,000 2 2,500 5,500

This ledger format is referred to as a running balance.

This ledger format is referred to as a running balance.

Ledger Accounts After Ledger Accounts After PostingPosting

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General LedgerCash

Date Debit Credit Balance20091 May 8,000 8,000 2 2,500 5,500

T accounts are simplified versions of the ledger account that only show the

debit and credit columns.

T accounts are simplified versions of the ledger account that only show the

debit and credit columns.

Ledger Accounts After Ledger Accounts After PostingPosting

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Profit is not an asset; it is an increase in equity from profitable operations of the

business.

Profit is not an asset; it is an increase in equity from profitable operations of the

business.

A A = LL + EEIncrease Decrease

As income is earned, either an asset is

increased or a liability is decreased.

Increase

Profit always results in the increase of

Equity

What is ProfitWhat is Profit (Net (Net Income)Income)??

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A A = L L + EERetained EarningsRetained Earnings

ShareCapital

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.

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JJ's Lawn Care ServiceIncome Statement

For the Month Ended 31 May 2009

Sales Revenue 750$ Operating Expense: Gasoline Expense 50 Profit 700$

The income statement summarizes the profitability of a business for a specified period

of time.

The income statement summarizes the profitability of a business for a specified period

of time.

The Income Statement: A The Income Statement: A PreviewPreview

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RREVENUE and EXPENSESEVENUE 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.

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The The RealizationRealization Principle: Principle: When To Record RevenueWhen To Record Revenue

Realization PrincipleRevenue should be recorded at the time goods are sold and

services are rendered.

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The Matching Principle: The Matching Principle: When To Record ExpensesWhen To Record Expenses

Matching PrincipleExpenses should be

recorded in the period in which they

are used up.

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Debit and Credit Rules for Debit and Credit Rules for Revenue and ExpensesRevenue and Expenses

EQUITIES

Debit for

Decrease

Credit for

Increase

Expenses decrease

equity.

Revenues increase equity.

EXPENSES

Credit for

Decrease

Debit for

Increase

REVENUES

Debit for

Decrease

Credit for

Increase

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DIVIDENDSDIVIDENDS

• A dividend is a distribution of assets (usually cash) by a corporation to its stockholders.

• SIMILAR TO expenses; BUT, not an expense

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EQUITIES

Debit for

Decrease

Credit for

Increase

Payments to owners

decrease equity.

Owners’ investments

increase equity.

DIVIDENDS

Credit for

Decrease

Debit for

Increase

DividendsDividends

SHARE CAPITAL

Debit for

Decrease

Credit for

Increase

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Summary of Debit- Credit Summary of Debit- Credit Rules for Revenues, Expenses Rules for Revenues, Expenses

and Dividendsand DividendsOwner’s Equity

Decreases recorded by debits Increaes recorded by credits

Expenses decrease O.E Revenue increases O.E

Expenses are recorded by debits Revenue is recorded by credits

Dividends reduce owners’ equity

Dividends are recorded by debits

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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.

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.

29 May: JJ’s provided lawn care services for a client and received $750 in cash.

29 May: JJ’s provided lawn care services for a client and received $750 in cash.

Will Cash increase or decrease?

Will Sales Revenue increase or decrease?

Sales Revenue29/5 750

Cash increases $750 with a debit.

Cash1/5 8,000 2/5 2,500

29/5 750 8/5 2,000

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31 May: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.

31 May: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.

Will Cash increase or decrease?

Will Gasoline Expense increase or

decrease?

Gasoline Expense31/5 50

Cash decreases $50 with a credit.

Cash1/5 8,000 2/5 2,500

29/5 750 8/5 2,000 31/5 50

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31 May: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.

31 May: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.

Will Cash increase or decrease?

Will Dividends increase or decrease?

Dividends31/5 200

Cash decreases $200 with a credit.

Cash1/5 8,000 2/5 2,500

29/5 750 8/5 2,000 31/5 50 31/5 200

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3) 3) TTRIAL BALANCERIAL 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.

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DEBITS CREDITS

Locating Trial Balance Locating Trial Balance ErrorsErrors

What if it doesn’t balance ?Is the addition correct?Are all accounts listed?Are the balances listed correctly?

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Now, let’s look at the Trial Balance

for JJ’s Lawn Care Service for

the month of May.

Now, let’s look at the Trial Balance

for JJ’s Lawn Care Service for

the month of May.

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JJ's Lawn Care Service Unadjusted Trial Balance

31 May 2009Cash 3,925$ Accounts receivable 75 Tools & equipment 2,650 Truck 15,000 Notes payable 13,000$ Accounts payable 150 Share capital 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Total 21,900$ 21,900$

All balances are taken from the ledger accounts on 31 May after considering all of JJ’s transactions for the

month.

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End of Chapter 3End of Chapter 3