Chapter 3

Summary Of How To Increase Account Balances With Debits and Credits

Debits increase assets, expenses, and dividends Credits increase liabilities, equities, and revenues

Destination Accounts

Debits increase these accounts Asset accounts, dividend accounts, and expense accounts

Accounting Information System

Designed to handle the nature of the company's business, size of the company, volume of transaction data, the types of transactions occurring, and the information needs or demands of management Designed to record its transactions in a manner that shows what's received equals what's given

Accounts

Each company makes a chart of accounts that identifies the accounts it uses and/or tracks Each account is given a unique name that represents one specific asset, liability, equity, dividend, revenue, or expense Companies keep track of the amount in each account by maintaining a running balance of each account listed in its chart of accounts Company changes the balance of its accounts by recording transactions in its journal and then posting the journal entries to its ledger

Effect of Transactions on the Accounting Equation

Each transaction has a dual effect on the accounting equation and that it remains in balance

Accounting Cycle 1. Identify and Analyze Transactions

Each transaction produces a source document that summarizes information about the transaction Identifying and analyzing source documents leads to understanding the transactions that occurred, including the parties and amounts involved in it

Accounting Cycle 3. Transfer Journal Entries to the Ledger

Posting accumulates the debit and credit effects of journalized transactions in the individual accounts

Posting

Process of transferring journal entries to the ledger, including debiting and crediting account balances

Beginning Retained Earnings

+ revenue - expenses - dividends = ending retained earnings

Accounting Cycle Steps

1) Identify and analyze transactions 2) Record transactions in the journal (journalizing transactions) 3) Transfer the journal entries to the ledger (posting to the ledger) 4) Prepare a trial balance (unadjusted trial balance) 5) Journalize and post the adjusting entries 6) Prepare an adjusted trial balance (2nd trial balance) 7) Prepare the financial statements 8) Journalize and post the closing entries 9) Prepare a post-closing trial balance (3rd trial balance)

Dividend Element

AKA cash dividends Stock dividends

Revenue Element

AKA sales Sales revenue, service revenue, interest revenue

Accounting Equation

AKA the basic accounting equation Assets = liabilities - equity Think property = claims on the property Some accounts are assets while others are liabilities or equities Must balance meaning the company's total assets must equal the sum of its total liabilities and equity Every transaction affects 2+ account balances and the accounting equation must remain in balance after each transaction

Double-Entry Accounting Rules

Accounting equation must remain in balance so it must balance for the sum of all transactions Debits = credits so the aggregate of all accounts with debit balances must equal the aggregate of all accounts with credit balances Debits increase assets Revenues increase equity; expenses and dividends decrease equity

Accounting Cycle

Accounting information systems use a series of steps known as the accounting cycle

Liabilities

Accounts payable, notes payable, unearned revenue, salaries payable

Trial Balance

After journalizing and posting transactions to the ledger (but before preparing financial statements), prepare the first of 3 trial balances Lists the company accounts and their balances at the end of the period Purpose of the trial balance is to prove, verify, and confirm that the sum of debit balances equals the sum of credit balances

How Debits and Credits Affect Accounts

Assets are increased by debits and decreased by credits Given transaction could increase assets and increase liabilities and/or equity Since assets increase with debits, and debits must equal credits then liabilities must increase with credits (and decrease with debits) Revenues increase income and retained earnings; revenues increase in the same manner as retained earnings (equity) so revenues increase with credits and decrease with debits Expenses and dividends decrease retained earnings; expenses and dividends increase in the opposite manner as retained earnings so expenses and dividends increase with debits (and decreases with credits)

Examples of Transactions

Buying inventory from a supplier Selling inventory to customer Paying employee's their wages Borrowing money from a bank

Summary Of How To Decrease Account Balances With Debits and Credits

Debits decrease liabilities, equities, and revenues Credits decrease assets, expenses, and dividends

Debits and Credits

Can be abbreviated Dr. and Cr. Companies record transactions by adjusting the balances of accounts affected by the transaction Increase or decrease the balances to reflect the economic effects of the transaction Accounting uses the account names (based on the chart of accounts) and a shorthand (code system) involving debits and credits Every transaction recorded in the journal and ledger debits an account and credits a different account such that debits equal credits Change the balance of the account

Retained Earnings

Can be further expanded by partitioning it into components that affect it Revenues increase retained earnings Expenses and dividends decrease it

Assets

Cash, inventory, accounts receivable, prepaid insurance, equipment, buildings, patents, trademarks

Equities

Common stock and retained earnings

Expenses Element

Cost of goods sold, salaries expense, rent expense, insurance expense, tax expense

Creation Accounts

Credits increase these accounts Equity accounts, liability accounts, and revenue accounts

Acronyms and Short Cuts for Debits and Credits

DEAD CLIC "Debit: Expense, Asset, and Dividends "Credit: Liability, Income, Capital" Income includes revenue accounts and gain accounts Capital includes equity accounts (common stock and retained earnings) DEALER "Dividends, Expenses, Assets, Liabilities, Equity, Revenue" Generally the creation or source of an economic benefit is recorded by credit a source account (to increase it) and the economic benefit's destination is recorded by debiting a destination account (to increase it)

Unadjusted Trial Balance

First trial balance

Events Not Recorded in Journal or Ledger

Hiring an employee. This can lead to the employee earning a wage and the company paying and recording the payment of the wage and those will be transactions that the company records Discussing new products with potential customers. This might lead to future sales, and any future sales will be transactions that the company records.

Credit Balances

If the credits recorded in an account exceed the debits Liabilities, equities, and revenue accounts are increased by credits Normally have credit balances

Debit Balance

If the debits recorded in an account exceed the credits Assets, expenses, and dividends are increased by debits, they normally have debit balances

Source Document

Includes receipt, bill, deposit slip

Accounting

Information system that identifies, records, and communicates the economic events of an organization to interested users to permit informed judgements and decisions by the users of the information

Accounting Cycle 2. Record Transactions in the Journal

Journal is the summary of a company's transactions in chronological order Each journal entry discloses the accounting effects of one transaction Journal entries record the effects of transactions on specific accounts' balances using debits and credits When journalizing a transaction, record the names of accounts being debited above the names of accounts being credited, and indent the names of accounts being credited

Debit

Means left Increase assets, expenses, and dividends Does not mean increase or decrease

Credit

Means right Increase liabilities, equities, and revenues

Announce an intention to close an unprofitable line of business in 6 months Journalize?

No

Call a supplier and place an order where payment will be due within 30 days after receiving goods being ordered Journalize?

No

Ledger

Record of each account tracked or maintained by a company that tracks each account's dollar balance and changes in their dollar balances as caused by transactions Like a collection of chapters where each chapter tells the story of one account Where the company summarizes the balance in each account Book that includes each account used by the company and it's used to track the balance of each account by debiting and crediting accounts as described in the journals

Journal

Record of each transaction in chronological order Like a diary that describes each transaction one at a time in the order in which they occur Events that change account balances must be journalized Journalizing and posting is how account balances are changed

Expanding the Accounting Equation

Sometimes expanded by partitioning equity into paid-in capital (common stock) and retained earnings

Double-Entry Accounting

System of recording transactions where every journal entry changes the balance of at least 2 accounts such that the change to one account requires a corresponding or opposite entry to a different account Constantly keeps the accounting equation in balance and it keeps debits equal to credits

T-Account

Top line is the account's title, identifies the account by name Beneath the title, there are 2 columns Left-side column is the debit column which is where debits to the account are recorded Right-side column is called the credit column and it's where credits to the account are recorded Often represented even more simply (without explicitly writing debit and/or credit as column headings)

Accounting Transactions

Trades (exchanges) between parties that have economic effects on each party's assets, liabilities, equity, revenue, expenses, and/or dividends Records transaction in 2 books known as the journal and the ledger Company's accounting information system analyzes each transaction to identify which accounts are affected and how much each account is affected and whether the amount increases the account's balance or decreases it Some economic events are not transactions and they do not affect the company's accounts so they are not recorded in the company's journal or ledger

Accounting Cycle 4. Prepare a Trial Balance

Trial balance lists the company's accounts and the accounts' balances as of a particular point in time Trial balance list accounts in the order they appear in the ledger: assets, liabilities, stockholders' equity, dividends, revenues, expenses Purpose of the trial balance is to prove, verify, and confirm that the sum of debit balances in accounts equals the sum of credit balances in accounts If total debits do not equal total credits then a recording error must have occurred. Fix the errors before step 5

Describing Accounts in the Ledger Using as T-Accounts

Users of accounting information sometimes examine one account, including its beginning balance, increases, decreases, and its ending balance Each account is often represented with a T-shape

Journal-Entry

When a transaction is recorded in the journal it's recording Company identifies the accounts affected by name (cash, inventory, etc) and identifies the amount in dollars

Financial Statement

Where the companies track the dollar value balances of several accounts Track the changes in the account balances Report account balances on financial statement to summarize company's financial performance (income) and position (net worth)

Limitations of a Trial Balance

Will balance even if certain errors exist in the accounting records Following errors do not cause the trial balance to be out of balance: 1. Transaction was not journalized in the journal 2. Journal entry was not posted to the ledger 3. Transaction was journalized more than once or posted more than once 4. Incorrect accounts were used to journalize or post the transaction 5. Offsetting errors are made in recording 2+ transactions

Buy a computer Journalize?

Yes

Collect cash from a customer for services your company will provide in the near future Journalize?

Yes

Pay rent Journalize?

Yes