The Accounting Cycle

Capturing Economic Events

Chapter 3

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3-1
The 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.
3-2
The Use of Accounts

Increases are
recorded on one Title of Account

side of the T Left Right

account, and or or
Debit Credit
decreases are Side Side
recorded on the
other side.

3-3
 Debit and Credit Entries
Cash
Cash
Receipts
are on
the debit
1/20
1/20 80,000
80,000 1/21
1/21 52,000
52,000 Payments
side.
1/26
1/26 600
600 1/22
1/22 6,000
6,000 creditare on the
side.
1/31
1/31 2,200
2,200 1/27
1/27 6,800
6,800
1/31
1/31 200
200
1/31
1/31 1,200
1,200
1/31
1/31 16,600
16,600 The
Thebalance
balanceis
isthe
the
difference
differencebetween
betweenthethe
debit
debitandandcredit
creditentries
entries
in
inthe
theaccount.
account.

3-4
Debit and Credit Entries
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

3-5
 Double Entry AccountingThe
Equality of Debits and 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.
3-6
 Let’s record
selected
transactions
for Overnight
Auto Service in
the accounts.

3-7
 January
January 20:
20: Michael
Michael McBryan
McBryan and
and his
his family
family
invested
invested $80,000
$80,000 in
in Overnight
Overnight Auto
Auto Service
Service and
and
received
received 8,000
8,000 shares
shares of
of stock
stock at
at $10
$10 per
per share.
share.

Capital Stock
increases $80,000
with a credit.

Cash Capital Stock

1/20 80,000 1/20 80,000

3-8

 Jan.
Jan. 21:
21: Overnight
Overnight purchased
purchased land
land for
for
$52,000
$52,000 cash.
cash.

Land increases
$52,000 with a debit.

Cash Land
1/20 80,000 1/21 52,000 1/21 52,000

3-9
 
 Jan.
Jan. 22:
22: Overnight
Overnight purchased
purchased aa garage
garage for
for
$36,000
$36,000 by
by paying
paying $6,000
$6,000 in
in cash
cash and
and issuing
issuing aa
note
note payable
payable for
for the
the remaining
remaining $30,000.
$30,000.

Building increases
$36,000 with a debit.

Cash
1/20 80,000 1/21 52,000
Building 1/22 6,000
1/22 36,000
Notes Payable
1/22 30,000

3-10
 Jan
Jan 23:
23: Overnight
Overnight Auto
Auto Service
Service purchased
purchased
tools
tools and
and equipment
equipment for
for $13,800
$13,800 on
on account.
account.

Tools & Equipment

increases $13,800
with a debit.

Tools & Equipment Accounts Payable

1/23 13,800 1/23 13,800

3-11

 Jan
Jan 24:
24: Overnight
Overnight sold
sold part
part of
of the
the tools
tools and
and
equipment
equipment to to Ace
Ace Towing
Towing for for $1,800,
$1,800, aa price
price
equal
equal to
to Overnight’s
Overnight’s cost.
cost. Ace Ace agrees
agrees to to pay
pay
Overnight
Overnight onon account
account in
in the
the future.
future.

Tools & Equipment Accounts Receivable

1/23 13,800 1/24 1,800 1/24 1,800

3-12
The 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
2015
Jan 20 Cash 80,000
Capital Stock 80,000
Owners invest cash in the business.
3-13
Posting Journal Entries to
the Ledger Accounts

Posting simply
means updating the
ledger accounts for
the effects of the
transactions
recorded in the
journal.
3-14
 Posting Journal Entries to
the Ledger Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2015
Jan 20 Cash 80,000
Capital Stock 80,000
General
Owners invest Ledger
cash in the business.
Cash
Date Debit Credit Balance
2015
Jan 20 80,000 80,000
3-15
 Posting Journal Entries to
the Ledger Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2015
Jan 20 Cash 80,000
Capital Stock 80,000
General
Owners invest Ledger
cash in the business.

Capital Stock
Date Debit Credit Balance
2015
Jan 20 80,000 80,000
3-16
Posting Journal Entries to
the Ledger Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2015
Jan 21 Land 52,000
Cash 52,000
Purchased land.

Let’s
Let’s see
see what
what the
the cash
cash account
account looks
looks like
like
after
after posting
posting the
the cash
cash portion
portion of
of this
this
transaction
transaction for
for Overnight
Overnight Auto
Auto Service.
Service.
3-17
Ledger Accounts After
Posting
General Ledger
Cash
Date Debit Credit Balance
2015
Jan 20 80,000 80,000
21 52,000 28,000

This ledger format is referred to as a

running balance.

3-18
Ledger Accounts After
Posting
General Ledger
Cash
Date Debit Credit Balance
2015
Jan 20 80,000 80,000
21 52,000 28,000

TT accounts
accounts areare simplified
simplified versions
versions of
of
the
the ledger
ledger account
account that
that only
only show
show the
the
debit
debit and
and credit
credit columns.
columns.
3-19
 What is Net 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

As income is earned, Net income

either an asset is always results in
increased or a liability is the increase of
decreased. Owners’ Equity
3-20
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.

3-21
The Income Statement: A
Preview

The
Theincome
incomestatement
statementsummarizes
summarizesthetheprofitability
profitability
of
ofaabusiness
businessfor
foraa specified
specifiedperiod
periodof
oftime.
time.
3-22
Accounting Periods
Time Period Principle
To provide users of
financial statements
with timely information,
net income is
measured for relatively
short accounting
periods of equal length.

3-23
Revenue and Expenses
The price for
goods sold
and services Increases
rendered during a owners’ equity.
given accounting
period.

The costs of
goods and Decreases
services used up owner’s equity.
in the process of
earning revenue.
3-24
 The Revenue Recognition
Principle: When To Record
Revenue
Revenue Recognition
Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.

3-25
 The Matching Principle:
When To Record Expenses

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

3-26
The Accrual Basis of
Accounting
Current Future
Accounting Period Accounting Period
Jan.
Jan. 1,
1, Dec.
Dec. 1,
1, Jan.
Jan. 1,
1, Dec.
Dec. 1,
1,
2015
2015 2015
2015 2016
2016 2016
2016

The
The income
income
Cash
Cash is
is received
received or
or But . . . statement
statement reports
reports
paid
paid here
here revenue
revenue oror expense
expense
here
here
OR
The
The income
income
statement
statement reports
reports But . . . Cash
Cash is
is received
received or
or
revenue
revenue or
or paid
paid here
here
expenses
expenses here
here
3-27
Debit and Credit Rules for
Revenue and Expenses
Expenses EQUITIES Revenues
decrease Debit Credit increase
owners’ for for owners’
equity. Decrease Increase equity.

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

3-28
 Dividends
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

3-29
 Let’s
Let’s analyze
analyze thethe
revenue
revenue and
and
expense
expense
transactions
transactions forfor
Overnight
Overnight Auto
Auto
Service
Service for
for the
the
month
month ofof February.
February.

We
We will
will also
also
analyze
analyze aa dividend
dividend
transaction.
transaction. 3-30
FEB.
FEB. 1:
1: Paid
Paid Daily
Daily Tribune
Tribune $360
$360 cash
cash for
for
newspaper
newspaper advertising
advertising to
to be
be run
run during
during February.
February.

Cash decreases
$360 with a credit.

Advertising Expense Cash

2/1 360 1/31 bal 16,600 2/1 360

3-31
FEB.
FEB. 2:
2: Purchased
Purchased radio
radio advertising
advertising from
from KRAM
KRAM to
to be
be
aired
aired in
in February.
February. The
The cost
cost was
was $470,
$470, payable
payable within
within 30
30
days.
days.

Accounts payable
increases $470 with
a credit.

Advertising Expense Accounts Payable

2/1 360 1/31 bal 7,000
2/2 470
2/2 470

3-32
FEB.
FEB. 4:
4: Purchased
Purchased various
various supplies
supplies for
for $1,400,
$1,400,
payable
payable within
within 30
30 days.
days. The
The supplies
supplies are
are expected
expected to
to
be
be used
used over
over the
the next
next 33 to
to 44 months.
months.

Accounts payable
increases $1,400
with a credit.

Shop Supplies Accounts Payable

2/4 1,400 1/31 bal 7,000
2/2 470
2/4 1,400

3-33
 FEB
FEB 15:
15: Overnight
Overnight collected
collected $4,980
$4,980 cash
cash for
for
repairs
repairs made
made to
to vehicles
vehicles of
of Airport
Airport Shuttle
Shuttle
Service.
Service.

Cash increases
$4,980 with a debit.

Cash Repair Service Revenue

1/31 bal 16,600 2/1 360 1/31 bal. 2,200
2/15 4,980 2/15 4,980

3-34
 FEB
FEB 28:
28: Overnight
Overnight billed
billed Harbor
Harbor Cab
Cab Co.
Co. $5,400
$5,400
for
for maintenance
maintenance and
and repair
repair services
services provided
provided in
in
February,
February, with
with payment
payment toto be
be received
received by
by March
March 10.
10.

Accounts Receivable Repair Service Revenue

1/31 bal 1,200 1/31 bal. 2,200
2/28 5,400
2/15 4,980
2/28 5,400
3-35
 FEB
FEB 28:
28: Overnight
Overnight paid
paid employee’s
employee’s wages
wages
earned
earned in
in February,
February, $4,900.
$4,900.

Cash decreases
$4,900 with a credit.

Wages Expense Cash

1/31 bal. 1,200 1/31 bal 16,600 2/1 360
2/15 4,980 2/28 4,900
2/28 4,900

3-36
 FEB
FEB 28:
28: Overnight
Overnight recorded
recorded aa $1,600
$1,600 utility
utility bill
bill
for
for February.
February. The
The entire
entire amount
amount isis due
due March
March
15.
15.

Accounts Payable
increases $1,600
with a credit.

Utilities Expense Accounts Payable

1/31 bal. 200 1/31 bal 7,000
2/28 1,600 2/2 470
2/4 1,400
2/28 1,600
3-37
 FEB
FEB 28:
28: Overnight
Overnight Auto
Auto Services
Services declares
declares and
and
pays
pays aa dividend
dividend of
of 40
40 cents
cents per
per share
share to
to the
the owners
owners
of
of its
its 8,000
8,000 shares
shares of
of capital
capital stock—a
stock—a total
total of
of $3,200.
$3,200.

Cash decreases
$3,200 with a credit.

Dividends Cash
1/31 bal. - 1/31 bal 16,600 2/1 360
2/28 3,200 2/15 4,980 2/28 4,900
2/28 3,200

3-38
Now,
Now, let’s
let’s look
look at
at
the
the Trial
Trial Balance
Balance
for
for Overnight
Overnight
Auto
Auto Service
Service for
for
the
the month
month of of
February.
February.

3-39
All balances are taken from the ledger accounts on Feb 28 after
considering all of Overnight’s transactions for the month.
3-40