Chapter THE ACCOUNTING

3 CYCLE:
Capturing Economic Events

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The Role of Accounting Records
Establishes accountability for
assets and transactions.

Keeps track of routine

business activities.

Obtains detailed information

about a particular transaction.

Evaluates efficiency and © The McGraw-Hill Companies, Inc., 2002

McGraw-Hill/Irwin
 The Ledger
Accounts are
Cash individual records
showing increases
Accounts
and decreases.
Payable
The entire group of
Capital accounts is kept
together in an
Stock accounting record
called a ledger.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The Use of Accounts

Increases are Title of

recorded on one Account
side of the T- Left Right
account, and or or
Debit Credit
decreases are Side Side
recorded on the
other side.

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 Let’s see how
debits and credits
are recorded in the
Cash account for
JJ’s Lawn Care
Service.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Debit and Credit Entries
Cas
5/1 h
8,000 5/2 2,500
Receipts Payments
are on 5/25 75 5/8 2,000 are on
the debit 5/29 750 5/28 150 the credit
side. side.
5/31 50
5/31 4,125 The balance is the
Bal. difference between
the debit and
credit entries in
the account.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Debit and Credit Rules
Debits and credits affect accounts as
follows:

A = L + OE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit for
for for for for for
Increa Decrea Decrease Increase Decrease
se se Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Double Entry Accounting  The
Equality of Debits and Credits

A = L + OE
=
Debit Credit
balances balances

In the double-entry accounting system,

every transaction is recorded by
equal dollar amounts of debits and
credits.
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 Let’s record
selected
transactions for
JJ’s Lawn Care
Service in the
accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Will Capital Stock

Will Cash increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Capital Stock
Cash increases
increases $8,000
$8,000 with a debit.
with a credit.

Cash Capital Stock

5/1 5/1
8,000 8,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Will Tools &

Will Cash increase
Equipment
or decrease?
increase or
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Tools & Equipment

Cash decreases
increases $2,500
$2,500 with a credit.
with a debit.

Cash Tools & Equipment

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 May 8: JJ’s purchased a $15,000 truck.
JJ’s paid $2,000 down in cash and issued a
note payable for the remaining $13,000.

Will Cash and

Notes Payable
Will Truck increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 May 8: JJ’s purchased a $15,000 truck.
JJ’s paid $2,000 down in cash and issued a
note payable for the remaining $13,000.

Cash decreases
$2,000 with a credit.
Truck increases
Notes Payable
$15,000 with a
increases $13,000
debit.
with a credit.
Cash
5/1 5/2 2,500
Truck 8,000
5/8 5/8 2,000
15,000 Notes Payable
5/8
13,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 May 11: JJ’s purchased some repair parts
for
$300 on account.

Will Tools & Will Accounts

Equipment increase Payable increase or
or decrease? decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Tools & Equipment Accounts Payable

increases $300 with increases $300 with
a debit. a credit.

Tools & Equipment Accounts Payable

5/2 2,500 5/11
5/11 300 300

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 May 18: 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 & Will Accounts

Equipment increase Receivable increase
or decrease? or decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 May 18: 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.

Tools & Equipment Accounts Receivable

decreases $150 with increases $150 with
a credit. a debit.

Tools & Equipment Accounts Receivable

5/2 2,500 5/18 150 5/18
5/11 300 150

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 The Journal

In an actual accounting system, transactions

are initially recorded in the journal.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

2003
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Posting Journal Entries to the Ledger
Accounts

Posting
involves
copying
information
from the
journal to the
ledger
accounts.
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 Posting Journal Entries to the Ledger
Accounts
GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

2003
May 1 Cash 8,000
Capital Stock 8,000
General Ledger
Owners invest cash in the
business. Cash
Date Debit Credit Balance
2003
May 1 8,000 8,000
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M /Irwin The McGraw-Hill Com

 Posting Journal Entries to the Ledger
Accounts
GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

2003
May 1 Cash 8,000
Capital Stock 8,000
General Ledger
Owners invest cash in the
business. Capital Stock
Date Debit Credit Balance
2003
May 1 8,000 8,000
cGraw-Hill © panies, Inc., 2002

M /Irwin The McGraw-Hill Com

 Posting Journal Entries to the Ledger
Accounts
GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

2003
May 2 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.
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 Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2003
May 1 8,000 8,000
2 2,500 5,500

This ledger format is referred to as a

running balance (as opposed to simple
T accounts).
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 What is Net Income?
Net income is not an asset  it’s an increase
in owners’ equity from profits of the
business.

A = L +
OE
Either (or both) of these
Increase
effects occur as netDecrease
income
. . . but this is
Increase
what “net income”
is earned . . . really means.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Retained Earnings

A = L + OE
Capital Retained
Stock
Earnings

The balance in the Retained Earnings account represents

the total net income of the corporation over the entire
lifetime of the business, less all amounts which have
been distributed to the stockholders as dividends.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Revenue and Expenses
The price for
goods sold
and services Increases
rendered during a owner’s equity.
given accounting
period.

The costs of
goods and Decreases
services used up owner’s equity.
in the process
of earning
McGraw-Hill/Irwin revenue. © The McGraw-Hill Companies, Inc., 2002
 The Realization Principle: When
To Record Revenue

Realization Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The Matching Principle:When To
Record Expenses

Matching Principle
Expenses should be
recorded in the
period in which they
are used up.

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 Debits and Credits for Revenue and
Expense
Expenses EQUITIES Revenues
decrease Debit Credit increase
owner’s for for owner’s
equity. Decrease Increase equity.

EXPENSES REVENUES
Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Investments by and Payments to
Owners
Payments to Owners’
EQUITIES
owners investments
decrease Debit Credit increase
for for
owners’ Decrease Increase owners’
equity. equity.

DIVIDENDS CAPITAL STOCK

Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Will Sales Revenue

Will Cash increase
increase or
or decrease?
decrease?

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

Sales Revenue
Cash increases
increases $750 with
$750 with a debit.
a credit.

Cash Sales Revenue

5/1 8,000 5/2 2,500 5/29
5/29 750 5/8 2,000 750

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Will Gasoline
Will Cash increase
Expense increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Gasoline Expense
Cash decreases $50
increases $50 with a
with a credit.
debit.

Cash Gasoline Expense

5/1 8,000 5/2 2,500 5/31
5/29 750 5/8 2,000 50
5/31 50

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Will Dividends
Will Cash increase
increase or
or decrease?
decrease?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Cash decreases Dividends increase

$200 with a credit. $200 with a debit.

Cash Dividends
5/1 8,000 5/2 2,500 5/31
5/29 750 5/8 2,000 200
5/31 50
5/31 200

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 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 All balances
Unadjusted Trial Balance are taken from
May 31, 2003
the ledger
Cash $ 3,925
accounts on
Accounts receivable 75 May 31 after
Tools & equipment 2,650 considering all
Truck 15,000 of JJ’s
Notes payable $ 13,000 transactions
Accounts payable 150 for the month.
Capital stock 8,000
Dividends 200 Proves equality
Sales revenue 750 of debits and
Gasoline expense 50
credits.
Total $ 21,900 $ 21,900

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The Accounting Cycle

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Prepare after closing Journalize and Prepare Prepare adjusted

trial balance. post closing financial trial balance.
McGraw-Hill/Irwin entries. © The McGraw-Hill Companies, Inc., 2002
 End of Chapter 3

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002