Chapter 3 The double-entry system

Discussion questions

– Another asset may have decreased

– A liability may have increased and/or shareholders’ equity may have increased.

a Not possible, since the right-hand side of the accounting equation will exceed the left-hand
side
b Possible (e.g. share capital issued to reduce debt)
c Not possible, since the left-hand side of the accounting equation will exceed the righthand side

– Assets normally have a debit balance, while liabilities and equity normally have a credit
balance. Revenues have a credit balance, and expenses have a debit balance.
– Therefore, some examples of asset accounts that normally have a debit balance are:
• cash
• accounts receivable
• inventory
• equipment
• land and buildings
• investments
• intangibles
• prepayments.
– Some liability accounts that normally have a credit balance are:
• accounts payable
• loan
• other payables (income tax, wages, etc.)
• revenue received in advance
 • loan
• provisions.
– Some equity accounts that normally have a credit balance are:
• share capital
• retained profits.
– Some revenue accounts that have a credit balance are:
• sales
• dividends received from investments
• other revenue.
– Some expense accounts that normally have a debit balance are:
• electricity expense
• income tax expense
• salaries and wages expense
• rent expense
• sundry expenses
• depreciation expense.

Accounting accumulates information about activities, and the financial statements are
prepared from the accounts that are produced as the information is accumulated. The
balance sheet and the income statement fit together, or articulate, because they are both
based on the double-entry accounting system. A set of accounts is created, which is in
balance. From these accounts are produced:
– the income statement, the bottom-line net profit after tax being transferred to
– the statement of retained profits, the bottom line ending retained profits being
transferred to
– the balance sheet, which summarizes all the accounts.
Thus, activities affecting profit affect the balance sheet through the double-entry system.
In particular, recognition of revenue and expense relies on the fact that a revenue causes a
change in the balance sheet, as does an expense.
Problem

1 A customer pays her account (i.e. an amount is received from a debtor).

2 Inventory is purchased on credit.
3 A company with a cash balance issues shares for cash.
4 A company with a bank overdraft issues shares for cash.
5 Inventory purchased on credit is returned to the supplier.
6 A company with a bank overdraft pays a supplier’s account.
7 A company pays a cash dividend.
1 Noncurrent asset DR
2 Noncurrent liability CR
3 Current asset DR
4 Shareholders’ equity CR
5 Current asset DR
6 Noncurrent liability CR
7 Current liability CR
8 Current asset DR
9 Noncurrent asset DR
10 Current liability CR
11 Noncurrent asset DR
12 Shareholders’ equity CR

Chapter 4 Record-keeping
Discussion questions

Specific transactions are recorded in the accounting records if they have the following
characteristics:
– Three fundamental economic and legal characteristics:
I Exchange: The event must involve an exchange of goods, money, financial instruments
(such as cheques), legal promises or other items of economic value.
II Past: The exchange must have happened, even if just seconds ago (financial accounting
is essentially a historical information system).
III External: The exchange must have been between the entity being accounted for and
someone else, such as a customer, an owner, a supplier, an employee, a banker or a tax
collector (the exchange must have been across the entity’s boundary, so to speak).
Two supplementary characteristics needed for accounting’s record-keeping:
I Evidence: There must be some documentation of what has happened (i.e. recorded on
paper or electronically).
II Dollars: The event must be measurable in dollars or the relevant currency unit in the
country where the transaction happens.

Journal entries are the first records of an accounting transaction in the accounting records.

A chart of accounts is a listing of the titles of all the accounts of an entity. Each account is
assigned a number. The number of account names listed in the chart of accounts is determined by
the number of accounts contained in the entity’s accounting records. The chart of accounts
includes every account used by an entity. The more detailed information the company wants, the
more accounts it will have.

A trial balance is a standard bookkeeping procedure to check whether certain errors have been
made in posting the journal entries to the ledger. It is a test to see whether total debits equal total
credits.
Problem
PROBLEM 4.3
Journal entries for simple transactions
The events listed below all took place on 21 June 2019. Provide the journal entry necessary to
record each event in the accounts of JKL Ltd for the year ended 30 June 2019. If no entry is
required, indicate this and give reasons. In most cases, an assumption is not necessary. If you feel
an assumption is necessary, however, state it.
1. A new general manager is hired at an annual salary of $140 000.
2. A loan is obtained from the bank for $20 000, repayable in two years ’ time.
3. A landscaper agrees to improve land owned by JKL Ltd. The agreed price for the
work is $2100 and work will commence in July 2019.
4. An order for $1300 of merchandise is received from a customer along with a cash
deposit of $400.
5. A $1200 insurance premium for coverage over the period from 1 July 2019 to 30 June
2020 is paid in cash.
6. JKL Ltd places an order for the purchase of inventories with a cost price of $2000.

PROBLEM 4.4
Identify transactions and write journal entries for them
Southward Stores Ltd is a general merchandise retailer operating in the suburbs. During a recent
month, the events listed below happened. For each event, decide whether it is an accounting
transaction. If it is an accounting transaction, state briefly why and record it in journal entry
form. Indicate where in the financial statements you wish each account to appear. If it is not an
accounting transaction, state briefly why it is not.
1. Southward borrowed $500 000 from the Commonwealth Bank. Payment is due in
three years, but the loan can be called on 10 days ’ notice if Southward fails to make any
of the monthly interest payments, which begin next month.
2. The company ordered inventory for resale, costing $300 000, to be delivered in 40
days, and sent a deposit of $10 000 with the order.
3. The company renewed its lease on the store premises, signing an agreement that
stipulated that, beginning in three months, the monthly rent would rise from $21 000 to
$23 000.
4. Southward was charged with unfair pricing of its main line of merchandise. News of
this sent the company ’ s shares (listed on the stock exchange) down in price from $10 to
$8.50 each. The company has one million shares issued, all publicly traded. 5. The
company declared a dividend of $0.50 cents per share, to be paid in one week, on each of
its one million issued shares. This news sent the company ’ s shares up by $0.40 each on
the stock exchange.
The trial balance will detect errors that result in the number of debits and credits posted being
different.
1. Would not be detected. The amount on invoice is incorrect, but the incorrect amount
from
the invoice was properly posted and then paid
2. Would be detected. Two accounts were credited and no account was debited, so debits
do
not equal credits
3. Would be detected. Debits do not equal credits
4. Would not be detected
5. Would be detected. Debits do not equal credits
6. Would not be detected
7. Would not be detected. Total debits equal total credits, for the two misstated items.
PROBLEM 3.10
The following transactions pertain to Rosewall Ltd for November 2018.
1 The company was incorporated, with shareholders investing $250 000 in cash.
2 Purchased $43 000 worth of inventory on credit.
3 Rent of $8000 was paid.
4 Made credit sales of $110 000 (COGS was $45 000).
5 Received the $2000 bill for an advertising campaign to promote the new company.
This amount will be paid in December.
6 Inventory was purchased for $27 000 cash.
7 Paid $30 000 of accounts payable. 8 Wages of $24 000 were paid (wages expense).
9 Received $45 000 from accounts receivable.
10 Sales commission was paid at the rate of 1 per cent of total monthly sales.
11 Purchased new machinery at a cost of $9000. Of this, $4000 was paid in cash with the
remainder to be paid in 15 months ’ time.
12 Owed employees $3500 in wages at the end of November.
13 Depreciation on the new equipment equalled $1000.
14 Interest of $6000 is owed by the bank at the end of November. It will be received in
January 2019.
15 Received $8000 from a client. Services to the client will be provided in December.
16 Several investors sold $20 000 of their shares to other investors. Show the effect of
each of the above transactions on the accounting equation.