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
3.1 The
The Role
Role of
ofAccounting
Accounting Records
Records
Establishes
Establishesaccountability
accountabilityfor
for
assets
assetsand
andtransactions.
transactions.
Keeps
Keepstrack
trackof
ofroutine
routine
business
businessactivities.
activities.
Obtains
Obtainsdetailed
detailedinformation
information
about
aboutaaparticular
particulartransaction.
transaction.
Evaluates
Evaluatesefficiency
efficiencyand
and
performance
performancewithin
withincompany.
company.

Maintains
Maintainsevidence
evidenceof
of
company’s
company’sbusiness
businessactivities.
activities.
 The
The Ledger
Ledger

Accounts
Accounts are
are
Cash individual
individual records
records
showing
showing increases
increases
Accounts
and
and decreases.
decreases.
Payable
The
The entire
entire group
group of
of
Capital accounts
accounts is is kept
kept
Stock together
together in in an
an
accounting
accounting record
record
called
called aa ledger.
ledger.
 The
The Use
Use of
ofAccounts
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
Let’s see
see how
how
debits
debits and
and credits
credits
are
are recorded
recorded inin the
the
Cash
Cash account
account for
for
AG
AG Lawn
Lawn Care
Care
Service.
Service.
 Debit
Debit and
and Credit
Credit Entries
Entries
Cash
Cash
Receipts
5/1
5/1 8,000
8,000 5/2
5/2 2,500
2,500 Payments
are on 5/25
5/25 75
75 5/8
5/8 2,000
2,000 are on the
the debit 5/29 750
side.
5/29 750 5/28
5/28 150
150 credit
side.
5/31
5/31 50
50
5/31
5/31 4,125
4,125 The
Thebalance
balanceis
isthe
the
Bal.
Bal. difference
differencebetween
between
the
thedebit
debitand
andcredit
credit
entries
entriesin
inthe
the
account.
account.
 3.2
3.2 Debit
Debit and
and Credit
Credit Rules
Rules
Debits
Debits and
and credits
credits affect
affect accounts
accounts as
as
follows:
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
3.3 Double
Double Entry
EntryAccountingThe
AccountingThe
Equality
Equality of
of Debits
Debits and
and Credits
Credits

A = L + OE
=
Debit Credit
balances balances

In
In the
the double-entry
double-entry accounting
accounting system,
system,
every
every transaction
transaction is
is recorded
recorded by
by equal
equal
dollar
dollar amounts
amounts of
of debits
debits and
and credits.
credits.
 Let’s record
selected
transactions for
AG Lawn Care
Service in the
accounts.

 May
May 1:1: Abel
Abel Gidey
Gidey and
and his
his family
family invested
invested Br.
Br.
8,000
8,000 in
in AG’s
AG’s Lawn
Lawn Care
Care Service
Service and
and received
received 800
800
shares
shares ofof stock.
stock.

Will Capital Stock

Will Cash increase
increase or
or decrease?
decrease?

 May
May 1:1: Abel
Abel Gidey
Gidey and
and his
his family
family invested
invested Br.
Br.
8,000
8,000 in
in AG’s
AG’s Lawn
Lawn Care
Care Service
Service and
and received
received 800
800
shares
shares ofof stock.
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
May 2:2: AG
AG Lawn
Lawn Care
Care Service
Service purchased
purchased aa
riding
riding lawn
lawn mower
mower for
for Br.
Br. 2,500
2,500 for
for cash.
cash.

Will Tools &

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

Tools & Equipment

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

Tools & Equipment

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

Will Cash and

Will Truck increase Notes Payable
or decrease? increase or
decrease?

 May
May 8:
8: AG
AG purchased
purchased aa Br.
Br. 15,000
15,000 truck.
truck. AG
AG
paid
paid Br.
Br. 2,000
2,000 down
down inin cash
cash and
and issued
issued aa note
note
payable
payable for
for the
the remaining
remaining Br.
Br. 13,000.
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
May 11:
11: AG
AG purchased
purchased some
some repair
repair parts
parts for
for
Br.
Br. 300
300 on
on account.
account.

Will Tools & Will Accounts

Equipment increase Payable increase or
or decrease? decrease?

 May
May 11:
11: AG
AG purchased
purchased some
some repair
repair parts
parts for
for
Br.
Br. 300
300 on
on account.
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
May 18:
18: AG
AG Lawn
Lawn Care
Care Service
Service sold
sold half
half of
of
the
the repair
repair parts
parts to
to ABC
ABC Lawns
Lawns for
for Br.
Br. 150,
150, aa
price
price equal
equal to
to AG’s
AG’s cost.
cost. ABC
ABC Lawns
Lawns agrees
agrees toto
pay
pay AGAG within
within 3030 days.
days.

Will Tools & Will Accounts

Equipment increase Receivable increase
or decrease? or decrease?
 May
May 18:
18: AG
AG Lawn
Lawn Care
Care Service
Service sold
sold half
half of
of
the
the repair
repair parts
parts to
to ABC
ABC Lawns
Lawns for
for Br.150,
Br.150, aa
price
price equal
equal to
to AG’s
AG’s cost.
cost. ABC
ABC Lawns
Lawns agrees
agrees to to
pay
pay AGAG within
within 3030 days.
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
The Journal
Journal

In
In an
an actual
actual accounting
accounting system,
system, transactions
transactions
are
are initially
initially recorded
recorded in
in the
the journal.
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
3.4 Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

Posting
involves
copying
information
from the
journal to the
ledger
accounts.
 (Posting
(Posting Journal
Journal Entries,
Entries, Cont’d)
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
(Posting Journal
Journal Entries,
Entries, Cont’d)
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
(Posting Journal
Journal Entries,
Entries, Cont’d)
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
Let’s see
see what
what the
the cash
cash account
account lookslooks like
like after
after
posting
posting the
the cash
cash portion
portion of
of this
this transaction
transaction forfor
AG
AG Lawn
Lawn Care
Care Service.
Service.
 Ledger
LedgerAccounts
AccountsAfter
After Posting
Posting
General Ledger
Cash
Date Debit Credit Balance
2013
May 1 8,000 8,000
2 2,500 5,500

This
This ledger
ledger format
format is
is referred
referred to
to as
as aa
running
running balance
balance (as
(as opposed
opposed to to simple
simple
TT accounts).
accounts).
 3.5
3.5 What
What isis Net
Net Income?
Income?

Net
Net income
income is
is not
not an asset it’s
an asset it’s an
an increase
increase in
in
owners’
owners’ equity
equity from
from profits
profits of
of the
the business.
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
3.6 Retained
Retained Earnings
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
3.7 Revenue
Revenue and
and Expenses
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
3.8 The
The Realization
Realization Principle:
Principle: When
When To
To
Record
Record Revenue
Revenue

Realization Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.
 3.9
3.9 The
The Matching
Matching Principle:
Principle: When
When To
To
Record
Record Expenses
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
3.10 Debits
Debits and
and Credits
Credits for
for Revenue
Revenue and
and
Expense
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
3.11 Investments
Investments by
by and
and Payments
Payments to
to
Owners
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
Let’s analyze
analyze the
the
revenue,
revenue, and
and
expense
expense
transactions
transactions forfor
AG
AG Lawn
Lawn Care
Care
Service
Service for
for the
the
month
month ofof May.
May.
We
We will
will also
also
analyze
analyze aa dividend
dividend
transaction.
transaction.

 May
May 29:
29: AG
AG provided
provided lawn
lawn care
care services
services for
for aa
client
client and
and received
received Br.
Br. 750
750 in
in cash.
cash.

Will Sales Revenue

Will Cash increase
increase or
or decrease?
decrease?
 
 May
May 29:
29: AG
AG provided
provided lawn
lawn care
care services
services for
for aa
client
client and
and received
received Br.
Br. 750
750 in
in cash.
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
May 31:
31: AG
AG purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
mower
mower and
and the
the truck
truck for
for Br.
Br. 50
50 cash.
cash.

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

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

Gasoline Expense
5/31 50

 May
May 31:
31: AGAG Lawn
Lawn Care
Care paid
paid Abel
Abel Gidey
Gidey and
and
his
his family
family aa Br.
Br. 200
200 dividend.
dividend.

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

Cash decreases Br. Dividends increase

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

Dividends
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,
The proof of the equality of debits & Now, let’s
let’s look
look at
at
credits in the ledger is called a trial the
the Trial
Trial Balance
Balance
balance. The total debits and credits in for
for AG
AG Lawn
Lawn Care
Care
the trial balance should be equal.
Service
Service for
for the
the
month
month of of May.
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.