© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter Four The Double-Entry Accounting System.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Chapter Four

The Double-Entry Accounting System

4-2

LO 1

Explain the fundamental

concepts associated with

double-entry accounting systems.

4-3

Debit/Credit Terminology

T-accountDebit

Debit

Credit

Credit

Account Title

4-4

LO 2

Describe business events using debit/credit terminology.

4-5

Debits and Credits

= +Debit Credit Debit Credit Debit Credit

+ - - + - +

EquityAssets Liabilities

Debit = Left Credit = Right

Asset accounts increaseincrease on the left or

debitdebit side and decreasedecrease

on the right or creditcredit side.

Liability accounts increaseincrease on the right or creditcredit side and decreasedecrease

on the left or debitdebit side.

Equity accounts increaseincrease on the right

or creditcredit side and decreasedecrease on the left or

debitdebit side.

In every transaction, the total dollar value of all debits equals the total dollar value of all credits.

Balance Side Balance Side Balance Side

4-6

LO 3

Record transactions in T-

accounts.

4-7

Double-Entry Accounting

Let’s see how debits and

credits work by looking at

transactions for Collins

Consultants.

4-8

Event 1: Collins Consultants was established on January 1, 2008, when it acquired $15,000 cash from Collins.

1. Increase assets (cash).

2. Increase equity (common stock).

Asset Source

Transaction

Assets = Liab. + Equity Revenue - Expenses = Net

Income 15,000 = n/a + 15,000 n/a - n/a = n/a 15,000 FA

Cash Flow

= +

Debit Credit Debit Credit+ - - +15,000 15,000

Assets Liabilities EquityCash Common Stock

You always increase an account on its balance side and decrease it opposite the balance side.

4-9

Event 2: On February 1, Collins Consultants issued a 12%, $10,000 note payable to the National Bank to borrow cash.


2. Increase liabilities (notes payable).

Asset Source

Transaction


Income 10,000 = 10,000 + n/a n/a - n/a = n/a 10,000 FA

Cash Flow

= +


EquityCash Notes Payable

Assets Liabilities

4-10

Event 3: On February 17, Collins Consultants purchased $850 of office supplies on account from Morris Supply Company.

1. Increase assets (supplies).

2. Increase liabilities (accounts payable).

Asset Source

Transaction


Income 850 = 850 + n/a n/a - n/a = n/a n/a

Cash Flow

= +

Debit Credit Debit Credit+ - - +

850 850

Assets Liabilities EquitySupplies Accounts Payable

4-11

Event 4: On February 28, Collins Consultants signed a contract to evaluate the internal control system used by Kendall Food Stores. Kendall paid Collins $5,000 in advance for these future services.


2. Increase liabilities (unearned revenue).

Asset Source

Transaction


Income 5,000 = 5,000 + n/a n/a - n/a = n/a 5,000 OA

Cash Flow

= +


EquityCash Unearned Revenue

Assets Liabilities

4-12

Event 5: On March 1, Collins Consultants received $18,000 from signing a contract to provide professional advice to Harwood Corporation over a one-year period.


2. Increase liabilities (unearned revenue).

Asset Source

Transaction


Income 18,000 = 18,000 + n/a n/a - n/a = n/a 18,000 OA

Cash Flow

= +


Assets Liabilities EquityCash Unearned Revenue

4-13

Event 6: On April 10, Collins Consultants provided $2,000 of services to Rex Company on account.

1. Increase assets (accounts receivable).

2. Increase equity (consulting revenue).

Asset Source

Transaction


Income 2,000 = n/a + 2,000 2,000 - n/a = 2,000 n/a

Cash Flow

= +


EquityAccounts Receivable Consulting Revenue

Assets Liabilities

4-14

Event 7: On April 29, Collins Consultants performed services and received $8,400 cash.



Asset Source

Transaction


Income 8,400 = n/a + 8,400 8,400 - n/a = 8,400 8,400 OA

Cash Flow

= +


Assets Liabilities EquityCash Consulting Revenue

4-15

Event 8: On May 1, Collins Consultants loaned Reston Company $6,000. Reston issued a 9% note to Collins.

1. Increase assets (notes receivable).

2. Decrease assets (cash).

Asset Exchange

Transaction

= Liab. + Equity Revenue - Expenses = Net

Income (6,000) + 6,000 = n/a + n/a n/a - n/a = n/a (6,000) IA

Cash Flow Assets

= +

Debit Credit Debit Credit+ - + -

6,000 6,000

EquityNotes Receivable

AssetsCash

Liabilities

4-16

Event 9: On June 30, Collins purchased office equipment for $42,000 cash.

1. Increase assets (office equipment).


Asset Exchange

Transaction


Income (42,000) + 42,000 = n/a + n/a n/a - n/a = n/a (42,000) IA

Cash Flow Assets

= +


42,000 42,000

Liabilities EquityOffice Equipment

AssetsCash

4-17

Event 10: On July 31, Collins paid $3,600 cash in advance for a one year lease to rent office space for a one-year period beginning August 1.

1. Increase assets (prepaid rent).


Asset Exchange

Transaction


Income (3,600) + 3,600 = n/a + n/a n/a - n/a = n/a (3,600) OA

Cash Flow Assets

= +


3,600 3,600

EquityPrepaid Rent

AssetsCash

Liabilities

4-18

Event 11: On August 8, Collins Consultants collected $1,200 from Rex Company as partial payment of the accounts receivable (see Event 6).


2. Decrease assets (accounts receivable).

Asset Exchange

Transaction


Income 1,200 + (1,200) = n/a + n/a n/a - n/a = n/a 1,200 OA

Cash Flow Assets

= +

Debit Credit Debit Credit+ - + -1,200 1,200

Liabilities EquityAccounts Receivable

AssetsCash

4-19

Event 12: On September 4, Collins Consultants paid employees who worked for the company $2,400 in salaries.


2. Decrease equity (salaries expense).

Asset Use Transaction


Income (2,400) = n/a + (2,400) n/a - 2,400 = (2,400) (2,400) OA

Cash Flow

= +


2,400 2,400

Assets Liabilities EquityCash Salaries Expense

4-20

Event 13: On September 20, Collins Consultants paid a $1,500 cash dividend to its owner.


2. Decrease equity (dividends).



Income (1,500) = n/a + (1,500) n/a - n/a = n/a (1,500) FA

Cash Flow

= +


1,500 1,500

EquityCash Dividends

Assets Liabilities

4-21

Event 14: On October 10, Collins Consultants paid Morris Supply Company the $850 owed from purchasing office supplies on account (see Event 3).


2. Decrease liabilities (accounts payable).



Income (850) = (850) + n/a n/a - n/a = n/a (850) OA

Cash Flow

= +

Debit Credit Debit Credit+ - - +

850 850

EquityCash Accounts Payable

Assets Liabilities

4-22

Event 15: On November 15, Collins completed its consulting evaluation of the internal control system used by Kendall Food Stores (see Event 4).

1. Decrease liabilities (unearned revenue).


Claims Exchange

Transaction


Income n/a = (5,000) + 5,000 5,000 - n/a = 5,000 n/a

Cash Flow

= +

Debit Credit Debit Credit- + - +5,000 5,000

EquityConsulting RevenueUnearned Revenue

Assets Liabilities

4-23

Event 16: On December 18, Collins Consultants received a $900 bill from Creative Ads for advertisements which had appeared in regional magazines. Collins plans to pay the bill later.

1. Increase liabilities (accounts payable).

2. Decrease equity (advertising expense).

Claims Exchange

Transaction


Income n/a = 900 + (900) n/a - 900 = (900) n/a

Cash Flow

= +

Debit Credit Debit Credit- + + -

900 900

EquityAdvertising ExpenseAccounts Payable

Assets Liabilities

4-24

LO 4

Identify the events that need adjusting entries and record them.

4-25

Adjustment 1: Collins Consultants recognized accrued interest on the $6,000 note receivable from Reston (see Event 8).

1. Increase assets (interest receivable).

2. Increase equity (interest revenue).

Asset Source

Transaction


Income 360 = n/a + 360 360 - n/a = 360 n/a

Cash Flow

Principal

Annual interest

rate Time

outstanding = Interest revenue

6,000$ 0.09 8/12 = 360$

= +

Debit Credit Debit Credit

+ - - +

360 360

Assets Liabilities EquityInterest Receivable Interest Revenue

4-26

Adjustment 2: Collins Consultants recognized accrued interest expense on the $10,000 note payable it issued to National Bank (see Event 2).

1. Increase liabilities (interest payable).

2. Decrease equity (interest expense).

Claims Exchange

Transaction


Income n/a = 1,100 + (1,100) n/a - 1,100 = (1,100) n/a

Cash Flow

Principal

Annual interest

rate Time

outstanding = Interest

expense

10,000$ 0.12 11/12 = 1,100$

= +


- + + -

1,100 1,100

Equity

Interest ExpenseInterest Payable

Assets Liabilities

4-27

Adjustment 3: Collins Consultants recognized $800 of accrued but unpaid salaries.

1. Increase liabilities (salaries payable).

2. Decrease equity (salaries expense).

Claims Exchange

Transaction


Income n/a = 800 + (800) n/a - 800 = (800) n/a

Cash Flow

= +


- + + -

800 800

Assets Liabilities Equity

Salaries ExpenseSalaries Payable

4-28

Adjustment 4: Collins Consultants recognized $4,000 of depreciation on the office equipment it had purchased on June 30 (see Event 9).

1. Decrease assets (accumulated depreciation).

2. Decrease equity (depreciation expense).



Income (4,000) = n/a + (4,000) n/a - 4,000 = (4,000) n/a

Cash Flow

= +


- + + -

4,000 4,000

Equity

Accumulated Depr. Depreciation Expense

Assets Liabilities

(Cost - Salvage Value) = Depreciation Expense($42,000 - $2,000) = $4,000

Useful Life 5 years x 6/12

4-29

Adjustment 5: Collins Consultants recognized rent expense for the portion of prepaid rent used up since entering the lease agreement on July 31 (see Event 10).

1. Decrease assets (prepaid rent).

2. Decrease equity (rent expense).



Income (1,500) = n/a + (1,500) n/a - 1,500 = (1,500) n/a

Cash Flow

= +


1,500 1,500

EquityPrepaid Rent Rent Expense

Assets Liabilities

$ 3,600 12 months 300$ 5 months

$300 per month $1,500 rent expense

4-30

Adjustment 6: A physical count at the end of the year indicates that $125 worth of the supplies purchased on February 17 are still on hand (see Event 3).

1. Decrease assets (supplies).

2. Decrease equity (supplies expense).



Income (725) = n/a + (725) n/a - 725 = (725) n/a

Cash Flow

= +


725 725

Assets Liabilities EquitySupplies Supplies Expense

Beginning Balance

+ Purchases =Asset

Available for Use

-Ending

Balance=

Asset Used

-$ + 850$ = 850$ - 125$ = 725$

4-31

Adjustment 7: Collins Consultants adjusted its accounting records to reflect revenue earned to date on the contract to provide services to Harwood Corporation for a one-year period beginning March 1 (see Event 5).

1. Decrease liabilities (unearned revenue).


Claims Exchange

Transaction


Income n/a = (15,000) + 15,000 15,000 - n/a = 15,000 n/a

Cash Flow

= +

Debit Credit Debit Credit- + - +

15,000 15,000

Assets Liabilities EquityConsulting RevenueUnearned Revenue

$ 18,000 12 months 1,500$ 10 months

$1,500 per month $15,000 revenue

4-32

4-33

4-34

LO 7

Record transactions using

the general journal format.

4-35

The General Journal

Accountants initially record

data from source documents into a

journal.

Special Journals

General Journals

Date Account Title Debit CreditAug. 1 Cash 1,000

Service Revenue 1,000

4-36

4-37

4-38

4-39

4-40

4-41

LO 5

State the need for and record closing

entries.

4-42

The Closing Process

Let’s look at the closing entries for

Collins Consultants.

Establishes zero balances in all

revenue, expense, and dividend accounts.

4-43

4-44

LO 6

Prepare and interpret a trial

balance.

4-45

4-46

LO 8 Describe the components of an

annual report, including the management,

discussion, and analysis section

and the footnotes to financial statements.

4-47

Components of the Annual Report

Notes

Management’s Discussion

& Analysis

Audit Opinion

4-48

LO 9

Describe the role of the Securitiesand Exchange Commission in

financial reporting.

4-49

The Securities and Exchange Commission

Government Agency

Public Companies

SEC Rules

4-50

End of Chapter Four

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter Four The Double-Entry Accounting System.

Documents

total dollar value

total assets abovemattel

operating activitiescash

net cash flow

equity accounts

operating activities1

cash flowsfor

expensesnet income