CHAPTER

THE ACCOUNTING
THREE CYCLE:
Capturing Economic Events
PART I DISCUSSION POINTS:
The Role of Accounting Records
Debit and Credit Rules
Double Entry AccountingThe Equality of Debits and Credits
The Journal – A Book of Original Entry
Posting Journal Entries to the Ledger Accounts
What is Net Income?
Retained Earnings
Revenue and Expenses
The Realization Principle: When To Record Revenue
The Matching Principle: When To Record Expenses
Debits and Credits for Revenue and Expense
Investments by and Payments to Owners
Summary of the Accounting Cycle
3.1 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

performance within company.

Maintains evidence of
company’s business activities.
 The Ledger

Accounts are
Cash individual records
showing increases
Accounts
and decreases.
Payable
The entire group of
Capital accounts is kept
Stock together in an
accounting record
called a ledger.
 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.
 Let’s see how
debits and credits
are recorded in the
Cash account for
AG Lawn Care
Service.
 Debit and Credit Entries
Cash
Receipts
5/1 8,000 5/2 2,500
Payments
are on 5/25 75 5/8 2,000 are on the
the debit 5/29 750 5/28 150 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.
 3.2 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
Increase Decrease Decrease Increase Decrease Increase
 3.3 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.
 Let’s record
selected
transactions for
AG Lawn Care
Service in the
accounts.
May 1: Abel Gidey and his family invested Br.
8,000 in AG’s Lawn Care Service and received 800
shares of stock.

Will Capital Stock

Will Cash increase
increase or
or decrease?
decrease?
 May 1: Abel Gidey and his family invested Br.
8,000 in AG’s Lawn Care Service and received 800
shares of stock.

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

Cash Capital Stock

5/1 8,000 5/1 8,000
 May 2: AG Lawn Care Service purchased a
riding lawn mower for Br. 2,500 for cash.

Will Tools &

Will Cash increase
Equipment increase
or decrease?
or decrease?
 May 2: AG Lawn Care Service purchased a
riding lawn mower for Br. 2,500 cash.

Tools & Equipment

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

Cash Tools & Equipment

5/1 8,000 5/2 2,500 5/2 2,500
May 8: AG Lawn Care Service purchased a Br.
15,000 truck. AG paid Br. 2,000 down in cash
and issued a note payable for the remaining Br.
13,000.

Will Cash and

Will Truck increase Notes Payable
or decrease? increase or
decrease?
 May 8: AG purchased a Br. 15,000 truck. AG
paid Br. 2,000 down in cash and issued a note
payable for the remaining Br. 13,000.

Cash decreases Br.

2,000 with a credit.
Truck increases Br.
Notes Payable
15,000 with a debit.
increases Br.
13,000 with a credit.
Cash
5/1 8,000 5/2 2,500
Truck
5/8 2,000
5/8 15,000
Notes Payable
5/8 13,000
May 11: AG purchased some repair parts for
Br. 300 on account.

Will Tools & Will Accounts

Equipment increase Payable increase or
or decrease? decrease?
 May 11: AG purchased some repair parts for
Br. 300 on account.

Tools & Equipment Accounts Payable

increases Br. 300 increases Br. 300
with a debit. with a credit.

Tools & Equipment Accounts Payable

5/2 2,500 5/11 300
5/11 300
May 18: AG Lawn Care Service sold half of the
repair parts to ABC Lawns for Br. 150, a price
equal to AG’s cost. ABC Lawns agrees to pay
AG within 30 days.

Will Tools & Will Accounts

Equipment increase Receivable increase
or decrease? or decrease?
 May 18: AG Lawn Care Service sold half of the
repair parts to ABC Lawns for Br.150, a price
equal to AG’s cost. ABC Lawns agrees to pay
AG within 30 days.

Tools & Equipment Accounts Receivable

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

Tools & Equipment Accounts Receivable

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

In an actual accounting system, transactions

are initially recorded in the journal.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2013
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.
3.4 Posting Journal Entries to the Ledger
Accounts

Posting
involves
copying
information
from the
journal to the
ledger
accounts.
 (Posting Journal Entries, Cont’d)

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2013
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest cash Ledger
in the business.
Cash
Date Debit Credit Balance
2013
May 1 8,000 8,000
 (Posting Journal Entries, Cont’d)

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2013
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest cash Ledger
in the business.
Capital Stock
Date Debit Credit Balance
2013
May 1 8,000 8,000
 (Posting Journal Entries, Cont’d)

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2013 1
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
AG Lawn Care Service.
 Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2013
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).
 3.5 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
Increase Decrease Increase

Either (or both) of these . . . but this is

effects occur as net income what “net income”
is earned . . . really means.
 3.6 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.
 3.7 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 revenue.
 3.8 The Realization Principle: When To
Record Revenue

Realization Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.
 3.9 The Matching Principle: When To
Record Expenses

Matching Principle  The Matching Principle

dictates that in order to
Expenses should be report the true value of
net income (or net loss),
recorded in the the expenses actually
period in which they incurred in the process of
are incurred (used generating revenue
should be matched in the
up, expired or same period in which the
consumed) revenues are realized.
 3.10 Debits and Credits for Revenue and
Expense

Expenses OWNER’S EQUITY Revenues

decrease Debit Credit increase
owner’s for for owner’s
equity. Decrease Increas equity.
e

EXPENSES REVENUES
Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase
 3.11 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
Let’s analyze the
revenue, and
expense
transactions for
AG Lawn Care
Service for the
month of May.
We will also
analyze a dividend
transaction.
May 29: AG provided lawn care services for a
client and received Br. 750 in cash.

Will Sales Revenue

Will Cash increase
increase or
or decrease?
decrease?
  May 29: AG provided lawn care services for a
client and received Br. 750 in cash.

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

Cash Sales Revenue

5/1 8,000 5/2 2,500 5/29 750
5/29 750 5/8 2,000
May 31: AG purchased gasoline for the lawn
mower and the truck for Br. 50 cash.

Will Gasoline
Will Cash increase
Expense increase or
or decrease?
decrease?
  May 31: AG purchased gasoline for the lawn
mower and the truck for Br. 50 cash.

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

Cash Gasoline Expense

5/1 8,000 5/2 2,500 5/31 50
5/29 750 5/8 2,000
5/31 50
May 31: AG Lawn Care paid Abel Gidey and
his family a Br. 200 dividend.

Will Dividends
Will Cash increase
increase or
or decrease?
decrease?
  May 31: AG Lawn Care paid Abel Gidey and
his family a Br. 200 dividend.

Cash decreases Br. Dividends increase

200 with a credit. Br. 200 with a debit.

Cash Dividends
5/1 8,000 5/2 2,500 5/31 200
5/29 750 5/8 2,000
5/31 50
5/31 200
 3.12 A Trial Balance

 However, a trial balance that

What is a trial balance? is in balance doesn’t provide
After all entries in the journal have a complete accuracy of the
been posted to the ledger accounts, the records. It provides only the
account balance for each item has been mathematical equality of
determined and the equality of debits & debits and credits in the
credits should be checked. This is done ledger.
through the preparation of a trial
balance. Now, let’s look at
The proof of the equality of debits &
credits in the ledger is called a trial the Trial Balance
balance. The total debits and credits in for AG Lawn Care
the trial balance should be equal.
Service for the
month of May.
 AG Lawn Care Service All balances
Unadjusted Trial Balance are taken from
May 31, 2013 the ledger
accounts on
Cash Br. 3,925
Accounts receivable 75 May 31 after
Tools & equipment 2,650 considering all
Truck 15,000 of AG’s
Notes payable Br. 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 Br. 21,900 Br21,900
 3.13 Summary of 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.
entries. statements.