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Acct 2210 Chp 3 The Double-Entry Accounting System (including Debit & Credit Notation) McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Describe business events using debit/credit terminology. 3-1 Debit/Credit Terminology Claims Assets Debit Credit + - = Liabilities Debit Credit - + + Equity Debit Credit - + In every transaction, the total dollar value of all debits equals the total dollar value of all credits. 3-2 LO 2 Record transactions in T-accounts and show their effect on financial statements. 3-3 Double-Entry Accounting Let’s see how debits and credits work by looking at transactions for Collins Brokerage Services. 3-4 Collins Brokerage Services began the period with the following balances: $5,000 in cash, $4,000 in common stock, and $1,000 in retained earnings. Assets Cash Debit Credit Bal. 5,000 = Liabilities + Equity Common Stock Debit Credit 4,000 Bal. Assets = Cash 5,000 = Liab. n/a Ret. Earn. Debit Credit 1,000 Bal. + Equity Comm. Stk. Ret. Earn. + 4,000 + 1,000 3-5 Event 1: Collins acquired $25,000 from the issue of common stock. 1. Increase assets (cash). Asset Source Transaction 2. Increase equity (common stock). Assets Cash Debit Credit + 25,000 Assets = 25,000 = Liab. n/a = + + Equity 25,000 Liabilities + Revenue - Expenses n/a n/a Equity Common Stock Debit Credit + 25,000 = = Net Income n/a Cash Flow 25,000 FA 3-6 Event 2: Collins purchased $850 of supplies on account. 1. Increase assets (supplies). 2. Increase liabilities (accounts payable). Assets Supplies Debit Credit + 850 Assets = 850 = Liab. + 850 + = Equity n/a Asset Source Transaction Liabilities + Accounts Payable Debit Credit + 850 Revenue - Expenses = n/a n/a = Equity Net Income n/a Cash Flow n/a 3-7 Event 3: Collins collected $1,800 as an advance to provide future services over a one-year period starting March 1. 1. Increase assets (cash). Asset Source Transaction 2. Increase liabilities (unearned revenue). Assets = 1,800 = Liab. + 1,800 + Assets Cash Debit Credit + 1,800 Equity n/a Revenue - Expenses n/a n/a = Liabilities + Unearned Revenue Debit Credit + 1,800 = = Net Income n/a Cash Flow 1,800 OA Equity 3-8 Event 4: Collins provided $15,760 of services on account. 1. Increase assets (accounts receivable). 2. Increase stockholders’ equity (consulting revenue). Assets Accounts Receivable Debit Credit + 15,760 Assets = 15,760 = Liab. n/a + + = Liabilities Debit - Equity 15,760 Asset Source Transaction + Credit + Revenue - Expenses = 15,760 n/a = Equity Consulting Revenue Debit Credit + 15,760 Net Income 15,760 Cash Flow n/a 3-9 Event 5: Collins purchased land for $26,000 cash. Asset Exchange Transaction 1. Increase assets (land). 2. Decrease assets (cash). Assets = Cash Debit + Assets (26,000) + Liabilities + Equity Land Credit 26,000 = 26,000 = Liab. n/a Debit + 26,000 + + Equity n/a Credit - Revenue - Expenses = n/a n/a = Net Income n/a Cash Flow (26,000) IA 3-10 Event 6: Collins paid $1,200 cash for a one-year insurance policy with coverage starting August 1. Asset Exchange Transaction 1. Increase assets (prepaid insurance). 2. Decrease assets (cash). Assets = Cash Debit + Assets (1,200) + + Equity Prepaid Insurance Debit Credit + 1,200 Credit 1,200 = 1,200 = Liabilities Liab. n/a + + Equity n/a Revenue - Expenses = n/a n/a = Net Income n/a Cash Flow (1,200) OA 3-11 Event 7: Collins collected $13,400 from accounts receivable. Asset Exchange Transaction 1. Increase assets (cash). 2. Decrease assets (accounts receivable). Assets Cash Debit + 13,400 Assets 13,400 + Liabilities + Equity Accounts Receivable Debit Credit + 13,400 Credit - = (13,400) = = Liab. n/a + + Equity n/a Revenue - Expenses = n/a n/a = Net Income n/a Cash Flow 13,400 OA 3-12 Event 8: Collins paid $9,500 for salaries expense. 1. Decrease assets (cash). Asset Use Transaction 2. Decrease equity (salaries expense). Assets = Cash Debit Credit + 9,500 Assets = (9,500) = Liab. n/a + + Equity (9,500) Liabilities + Revenue - Expenses = n/a 9,500 = Equity Salaries Expense Debit Credit + 9,500 Net Income (9,500) Cash Flow (9,500) OA 3-13 Event 9: Collins paid an $800 cash dividend. 1. Decrease assets (cash). Asset Use Transaction 2. Decrease equity (dividends). Assets = Cash Debit Credit + 800 Assets = (800) = Liab. n/a + + Equity (800) Liabilities + Revenue - Expenses = n/a n/a = Equity Dividends Debit Credit + 800 Net Income n/a Cash Flow (800) FA 3-14 Event 10: Collins paid $850 to settle accounts payable. 1. Decrease assets (cash). Asset Use Transaction 2. Decrease liabilities (accounts payable). Assets = Cash Debit Credit + 850 Assets = (850) = Liab. + (850) + Equity n/a Liabilities Accounts Payable Debit Credit + 850 + Revenue - Expenses = n/a n/a = Equity Net Income n/a Cash Flow (850) OA 3-15 Event 11: Collins recognized $1,900 of other operating expenses on account. 1. Increase liabilities (accounts payable). 2. Decrease equity (advertising expense). Assets Assets = n/a = Liab. + 1,900 + = Equity (1,900) Claims Exchange Transaction Liabilities + Accounts Payable Debit Credit + 1,900 Revenue - Expenses = n/a 1,900 = Equity Other Oper. Exp. Debit Credit + 1,900 Net Income (1,900) Cash Flow n/a 3-16 Adjustment 1: Collins Consultants recognized $750 accrued interest revenue. 1. Increase assets (interest receivable). Asset Source Transaction 2. Increase equity (interest revenue). = Assets Liabilities + Interest Receivable Equity Interest Revenue Debit Credit Debit Credit + - - + 750 Assets = 750 = 750 Liab. n/a + + Equity 750 Revenue - Expenses = 750 n/a = Net Income 750 Cash Flow n/a 3-17 Adjustment 2: As of December 31, 2013, Collins had earned $1,500 of the $1,800 of revenue that it deferred in Event 3. Claims Exchange Transaction 1. Decrease liabilities (unearned revenue). 2. Increase equity (consulting revenue). $ 1,800 12 months = $150 per month $ 150 10 months = $1,500 revenue Assets Assets = n/a = Liab. + (1,500) + = Equity 1,500 Liabilities Unearned Revenue Debit Credit + 1,500 + Revenue - Expenses = 1,500 n/a = Equity Consulting Revenue Debit Credit + 1,500 Net Income 1,500 Cash Flow n/a 3-18 Adjustment 3: As of December 31, 2013, Collins had $800 of accrued salaries expense that will be paid in 2014. 1. Increase liabilities (salaries payable). Claims Exchange Transaction 2. Decrease equity (salaries expense). Assets = n/a = Liab. + 800 + Assets Equity (800) Revenue - Expenses = n/a 800 = = Liabilities Net Income (800) + Salaries Payable Cash Flow n/a Equity Salaries Expense Debit Credit Debit Credit - + + - 800 800 3-19 Adjustment 4: As of December 31, 2013, Collins had used $500 of the $1,200 of insurance coverage that it had paid for in Event 6. 1. Decrease assets (prepaid insurance). Asset Use Transaction 2. Decrease equity (insurance expense). $ 1,200 12 months = $100 per month $ 100 5 months = $500 insurance expense Assets Prepaid Insurance Debit Credit + 500 Assets = (500) = Liab. n/a + + = Equity (500) Liabilities + Revenue - Expenses = n/a 500 = Equity Insurance Expense Debit Credit + 500 Net Income (500) Cash Flow n/a 3-20 Adjustment 5: As of December 31, 2013, a physical count of supplies on hand revealed that $125 worth of supplies were available for future use. 1. Decrease assets (supplies). Asset Use Transaction 2. Decrease equity (supplies expense). Asset Ending Asset Available = Balance Used for Use 850 = $ 850 - $ 125 = $ 725 Beginning + Purchases = Balance $ - + $ Assets Supplies Debit Credit + 725 Assets = (725) = Liab. n/a + + = Equity (725) Liabilities + Revenue - Expenses = n/a 725 = Equity Supplies Expense Debit Credit + 725 Net Income (725) Cash Flow n/a 3-21 LO 3 Record transactions using the general journal format and show their effect on the financial statements. 3-22 The General Journal Accountants initially record data from source documents into a journal. Special Journals General Journals Date Aug. 1 Account Title Cash Service Revenue Debit 1,000 Credit 1,000 3-23 3-24 3-25 3-26 LO 4 Prepare a trial balance and explain how it is used to prepare financial statements. 3-27 3-28 3-29 3-30 3-31 3-32 3-33 LO 5 Use a return on assets ratio, debt to assets ratio, and a return on equity ratio to analyze financial statements. 3-34 Return on Assets Ratio Evaluating performance requires considering the size of the investment base used to produce the income. Net Income Total Assets This ratio measures the relationship between the level of income and the size of the investment. A larger ratio means the company did a better job of managing its assets. 3-35 Debt to Assets Ratio Borrowing money is risky business. This ratio helps evaluate the level of debt risk. Total Debt Total Assets A smaller ratio indicates that there is less debt risk for the company. 3-36 Return on Equity Ratio Owners are interested in this ratio to determine their return on their investment in the company. Net Income Stockholders’ Equity A larger ratio indicates that the owners have a higher return on their investment. 3-37 Stockholders vs. Creditors Stockholders like a lot of debt if the company can take advantage of positive financial leverage. Creditors prefer less debt and more equity because equity represents a buffer of protection. 3-38 End of Chapter Three 3-39