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Transaction # Cash Inventory Equipment Supplies Truck Payable Payable Stock

Beginning
Balance $0,000 $0 $0 $0 $0 $0 $0 $0,000

Invested money in
the business $2,000 $2,000

Subtotal $2,000 $0 $0 $0 $0 $0 $0 $2,000



Suppose that in addition to coming up with the money yourself or from your
EXAMPLE 2
parents, you went to a bank and convinced the loan officer to lend you the money. The jour-
nal entry for such a transaction would be:

assets ( ) Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000
liabilities ( ) Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000
Borrowed $2,000 from First National Bank, signing a
12-month note at 12% interest.


Here, the cash account is debited, and the notes payable account is credited. The account-
ing equation captures the economic impact of borrowing the money as follows:


OWNERS
ASSETS LIABILITIES EQUITY

Accounts Notes Capital
Transaction # Cash Inventory Equipment Supplies Truck Payable Payable Stock

Beginning
Balance $0,000 $0 $0 $0 $0 $0 $0,000 $0,000

Invested money in
the business $2,000 $2,000

Borrowed money
from a bank $2,000 $2,000

Subtotal $4,000 $0 $0 $0 $0 $0 $2,000 $2,000



Acquiring Other Assets
Now that you have obtained the funds necessary to start your business, either from owner invest-
ment or by borrowing, you can use that money to acquire other assets needed to operate the busi-
ness. Such assets include supplies (such as fertilizer), inventory (perhaps shrubs that you will plant),
and equipment (for example, a lawnmower and a truck for hauling). These assets may be purchased
with cash or on credit. Credit purchases require payment after a period of time, for example, 30
days. Normally, interest expense is incurred when assets are bought on a time-payment plan that
extends beyond two or three months. (To keep our examples simple here, we will not include in-
terest expense. We will show how to account for interest on page 98, where we discuss the payment
of obligations.) Examples of transactions involving the acquisition of noncash assets follow.

The first thing you need is a lawnmower and some form of transportation. You
EXAMPLE 1
find an old 1988 pickup truck for sale for $800, and you buy it paying cash.
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The Mechanics of Accounting



assets ( ) Truck . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800
assets ( ) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800
Purchased a used truck.


The accounting equation shows:

OWNERS
ASSETS LIABILITIES EQUITY

Accounts Notes Capital
Transaction # Cash Inventory Equipment Supplies Truck Payable Payable Stock

Beginning
Balance $0,000 $0 $0 $0 $000 $0 $0,000 $0,000

Invested money in
the business $2,000 $2,000

Borrowed money
from a bank $2,000 $2,000

Purchased a
truck paying cash $ 800 $800

Subtotal $3,200 $0 $0 $0 $800 $0 $2,000 $2,000


Next, you drive to the local Sears store and purchase a Craftsman lawnmower and gas can for
$250. Instead of paying for the mower with cash, you open a charge account, which will allow
you to pay for the mower in 30 days with no interest charge. (If you wait and pay beyond this 30-
day grace period, an interest charge will apply.) The journal entry to record this purchase is:

Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250
assets ( )
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250
liabilities ( )
Purchased a lawnmower and gas can on account.


The accounting equation shows:

OWNERS
ASSETS LIABILITIES EQUITY

Accounts Notes Capital
Transaction # Cash Inventory Equipment Supplies Truck Payable Payable Stock

Beginning
Balance $0,000 $0 $000 $0 $000 $000 $0,000 $0,000

Invested money in
the business $2,000 $2,000

Borrowed money
from a bank $2,000 $2,000

Purchased a
truck paying cash $ 800 $800

Purchased a mower
on account $250 $250

Subtotal $3,200 $0 $250 $0 $800 $250 $2,000 $2,000
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When you pay for the mower, cash will be reduced, and the liability, Accounts Payable,
will also be reduced, thus keeping the equation in balance.


Off you go to the neighborhood Eagle Hardware & Garden Shop to pur-
EXAMPLE 2
chase fertilizer, gloves, a rake, a shovel, and other assorted supplies. The total cost is $180,
which you pay in cash; an increase in one asset (supplies) results in a decrease in another as-
set (cash).


assets ( ) Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
assets ( ) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
Purchased supplies for cash.



The accounting equation shows:


OWNERS
ASSETS LIABILITIES EQUITY

Accounts Notes Capital
Transaction # Cash Inventory Equipment Supplies Truck Payable Payable Stock

Beginning
Balance $0,000 $0 $000 $000 $000 $000 $0,000 $0,000

Invested money in
the business $2,000 $2,000

Borrowed money
from a bank $2,000 $2,000

Purchased a
truck paying cash $ 800 $800

Purchased a mower
on account $250 $250

Purchased supplies
for cash 180 $180

Subtotal $3,020 $0 $250 $180 $800 $250 $2,000 $2,000




On your way home from the hardware store, you drive past a greenhouse and
EXAMPLE 3
notice a big sign advertising a 50% off sale on shrubs. Since you anticipate that planting
shrubs will be part of your business, you stop and purchase for cash $150 worth of shrubs as
inventory. You plan to make money in two ways with the shrubs: (1) revenue from the labor
associated with planting them and (2) a profit on selling the shrubs for more than you paid.
(This is fair; after all, you are saving your client the time and trouble of having to go to the
greenhouse.)


Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
assets ( )
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
assets ( )
Purchased inventory for cash.
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The accounting equation shows:


OWNERS
ASSETS LIABILITIES EQUITY

Accounts Notes Capital
Transaction # Cash Inventory Equipment Supplies Truck Payable Payable Stock

Beginning
Balance $0,000 $000 $000 $000 $000 $000 $0,000 $0,000

Invested money in
the business $2,000 $2,000

Borrowed money
from a bank $2,000 $2,000

Purchased a
truck paying cash $ 800 $800

Purchased a mower
on account $250 $250

Purchased supplies
for cash 180 $180

Purchased inventory
for cash 150 $150

Subtotal $2,870 $150 $250 $180 $800 $250 $2,000 $2,000




Selling Goods or Providing Services
Now that you have your lawnmower, your transportation, your supplies, and your inventory,
it is time to go to work. The next category of common transactions involves the sale of ser-
vices or merchandise. Revenues are generated and expenses incurred during this process. Some-
times services and merchandise are sold for cash; at other times, they are sold on credit (on
account), and a receivable is established for collection at a later date. Therefore, revenues in-
dicate the source not only of cash but of other assets as well, all of which are received in ex-
change for the merchandise or services provided. Similarly, expenses may be incurred and
paid for immediately by cash, or they may be incurred on credit that is, they may be
charged, with a cash payment to be made at a later date. Illustrative transactions follow.
Note the effect of revenues and expenses on owners equity is indicated in brackets for each
transaction.

As soon as people find out that you are in the lawn care and landscaping busi-
EXAMPLE 1
ness, your phone begins ringing off the hook. Although most of your clients pay you immedi-
ately when you perform the service, some prefer to pay you once a month. As a result, a por-
tion of your revenues is received immediately in cash, while the balance becomes receivables.
The journal entry to record your first week s revenue for lawn care services is:


assets ( ) Cash. . . . . . . . . . . . . . . . . . . . . ................................. 270
assets ( ) Accounts Receivable . . . . . . . . ................................. 80
revenues ( ) [equity ( )] Lawn Care Revenue . . . . . . . ................................. 350
To record revenue for lawn care services.
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Financial Reporting and the Accounting Cycle


As the journal entry illustrates, more than two accounts can be involved in recording a transac-
tion. This type of entry is called a compound journal entry.
compound journal entry A
journal entry that involves Because revenues increase owners equity, the accounting equation shows:
more than one debit or
more than one credit or
Assets Liabilities Owners Equity (Revenues)
both.
(increase $350) (no change) (increase $350)

The detailed effect of this transaction and of each of the following transactions is summarized
in Exhibit 3-5 on page 100.

One of your customers asks if you will plant some shrubs in her backyard. You
EXAMPLE 2
mention that you have some shrubs and describe them to her; she is thrilled that you have just the
shrubs she wants, thereby saving her a trip to the greenhouse. You use one-half of your inventory
of shrubs in this customer s yard, and it takes you three hours to complete the job. She pays you
in cash. In this instance, we are dealing with two different types of revenue profit from the sale
of the shrubs and revenue from your labor. Let s deal with each type of revenue separately.
Sale of Shrubs Sales, whether made on account or for cash, require entries that reflect not
only the sale, but also the cost of the inventory sold. The cost of goods sold is an expense and,
as such, is offset with the sales revenue to determine the profitability of sales transactions. The
special procedures for handling inventory are described in Chapter 7. It is sufficient here to show
an example of the impact of the transaction on the accounting equation.
In this example, you charged your customer $90 for one-half of the shrubs you purchased
earlier.


assets ( ) Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
revenues ( ) [equity ( )] Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
Sold inventory for cash.
expenses ( ) [equity ( )] Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
assets ( ) Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
To record the cost of inventory sold and to reduce inventory
for its cost.


In this example, inventory costing you $75 is being sold for $90. The effect on the ac-
counting equation for each transaction is:

Sales on Account
Assets Liabilities Owners Equity (Revenues)
(increase $90) (no change) (increase $90)
Could the two journal en-
Cost of Goods Sold
tries relating to the sale of inventory be
Assets Liabilities Owners Equity (Expenses)
combined into one journal entry? (decrease $75) (no change) (decrease $75)

Labor for Planting In addition to making a profit on the sale of the shrubs, you also gener-
ated revenue planting them. The journal entry to record this revenue is:

assets ( ) Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
revenues ( ) [equity ( )] Landscaping Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
To record revenue for landscaping services.


The effect of the transaction on the accounting equation is:

Assets Liabilities Owners Equity (Revenues)
(increase $45) (no change) (increase $45)
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In addition to expenses relating to the sale of inventory, other expenses are also
EXAMPLE 3
incurred in operating a business. Examples include gas for your lawnmower and your truck and
the wages you agreed to pay your little brother for working for you (Mom said you had to let
him help). The following journal entries illustrate how these expenses would be accounted for:


Gasoline Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
expenses ( ) [equity ( )]
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
assets ( )
Paid cash for gas for the truck and the mower.
expenses ( ) [equity ( )] Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
assets ( ) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Paid wages expense.


The effect on the accounting equation of the gasoline expense is:

Assets Liabilities Owners Equity (Expense)
(decrease $50) (no change) (decrease $50)

The entry for Wages Expense affects the equation in the same manner, the only difference be-
ing the amount, $60.


Collecting Cash and Paying Obligations
Obviously, once merchandise or services are sold on account, the receivables must be collected.
The cash received is generally used to meet daily operating expenses and to pay other obliga-
tions. Excess cash can be reinvested in the business or distributed to the owners as a return on
their investment.

The collection of accounts receivable is an important aspect of most businesses.
EXAMPLE 1
Receivables are created when you allow certain customers to pay for your services at a later date.
When receivables are collected, that asset is reduced and cash is increased, as shown here.

assets ( ) Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
assets ( ) Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Collected $80 of receivables.


The effect of collecting the receivables on the accounting equation is:

Assets Liabilities Owners Equity
(increase $80; (no change) (no change)
decrease $80)

Note that no revenue is involved here. Revenue is recorded when the original sales trans-
action creates the accounts receivable. The cash collection on account merely involves exchang-
ing one asset for another.

Remember that lawnmower and gas can you purchased on account? Well, now
EXAMPLE 2
you have to pay for them. The entry to record the payment of obligations with cash is:

liabilities ( ) Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250
assets ( ) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250
Paid $250 for the lawnmower and gas can
previously purchased.
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After payment of accounts payable, the accounting equation shows:

Assets Liabilities Owners Equity
(decrease $250) (decrease $250) (no change)


Remember that two parties are always involved in exchange transactions. What one buys,
the other sells. When sales are on credit, the seller will record a receivable and the buyer will
record a payable. The two accounts are inversely related. The seller of merchandise records a re-
ceivable and a sale, and simultaneously records an expense for the cost of goods sold and a re-
duction of inventory (as in Example 2 on page 96). The buyer records the receipt of the mer-
chandise and, at the same time, records an obligation to pay the seller at some future time. When
payment is made, the buyer reduces Accounts Payable and Cash (as in this example), whereas
the seller increases Cash and reduces Accounts Receivable (as in Example 1).

On page 92, we showed the entry required when cash was borrowed from the
EXAMPLE 3
bank. In that entry, you borrowed $2,000 to be paid over 12 months. Suppose you are required
to make monthly loan payments of $178 with a portion of each payment being attributed to
interest and a portion to reducing the liability just like a mortgage on a house. As the follow-
ing compound journal entry shows, a note payable or similar obligation requires an entry for
payment, as well as for the interest due. Note that interest is the amount charged for using
money, as will be more fully explained in later chapters.

liabilities ( ) Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158
expenses ( ) [equity ( )] Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
assets ( ) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178
Paid first monthly payment on note with interest
($2,000 0.12 1/12).


Analysis of this transaction reveals that assets have decreased for two reasons. First, a por-
tion of a liability has been paid with cash. Second, interest expense at 12% for one month on
the note payable has been paid. This relationship will generally be present in most long-term
and some short-term liability transactions. Since the interest charge is an expense and decreases
owners equity, the impact of the entry on the accounting equation is:

Assets Liabilities Owners Equity (Expense)
(decrease $178) (decrease $158) (decrease $20)


Recall that you obtained financing in two ways to start your business investors
EXAMPLE 4
(you, Mom, and Dad) and the bank. In the previous journal entry, we illustrated how the bank
receives a return on its investment. Well, Mom and Dad would like a return as well. Corpora-
tions that are profitable generally pay dividends to their stockholders. Divi-
Why are dividends NOT dends represent a distribution to the stockholders of part of the earnings of a
company. The following entry illustrates the payment of a cash dividend:
considered to be an expense?


dividends ( ) [equity ( )] Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
assets ( ) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Paid a $50 cash dividend.


As noted earlier, dividends, like revenues and expenses, affect owners equity. Unlike revenues
and expenses, dividends are a distribution of profits and, therefore, are not considered in determin-
ing net income. Because dividends reduce the retained earnings accumulated by a corporation, they
decrease owners equity. The payment of a $50 dividend affects the accounting equation as follows:

Assets Liabilities Owners Equity (Dividends)
(decrease $50) (no change) (decrease $50)
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The Mechanics Of Accounting Chapter 3
The Mechanics of Accounting



See Exhibit 3-5 for a summary of the transactions shown in this chapter and their effect on
the accounting equation.

A Note on Journal Entries
When preparing a journal entry, a systematic method may be used in analyzing every transac-
tion. A journal entry involves a three-step process:
1. Identify which accounts are involved.
2. For each account, determine if it is increased or decreased.
fyi
3. For each account, determine by how much it has changed.
Many students have a little
The answer to step 1 tells you if the accounts involved are asset, liability, or owners
trouble getting used to debits,
equity accounts. The answer to step 2, when considered in light of your answer to step 1,
credits, and journal entries. So
tells you if the accounts involved are to be debited or credited. Consider the instance where
you are not alone if you are
$25,000 is borrowed from a bank. The two accounts involved are Cash and Notes Payable.
feeling a little overwhelmed.
Cash increased, and since Cash is an asset and assets increase with debits, then Cash must
But remember, riding a bike
be debited. Notes Payable increased (we owe more money), and since Notes Payable is a
wasn t easy the first time ei-
liability and liabilities increase with credits, then Notes Payable must be credited. The an-
ther. Like riding a bike, you will swer to step 3 completes the journal entry. Cash is debited for $25,000, and Notes Payable
soon find that debits, credits, is credited for $25,000.
and journal entries aren t that This three-step process will always work, even for complex transactions. Consider the
case where inventory costing $60,000 is sold on account for $75,000. Using the three-
difficult.
step process results in the following:
1. Step 1: What accounts are involved?
Accounts Receivable (an asset), Inventory (an asset), Cost of Goods Sold (an expense
part of owners equity), and Sales Revenue (a revenue account part of owners equity).
2. Step 2: Did the accounts increase or decrease?
Accounts Receivable increased (customers owe us more money). Since Accounts Re-
ceivable is an asset, it is increased with a debit.
Inventory decreased (we don t have it anymore). Since Inventory is an asset, it is de-
creased with a credit.
Cost of Goods Sold increased (an expense causing owners equity to decrease). Since
owners equity decreases with a debit, Cost of Goods Sold must be debited.
Sales Revenue increased (a revenue causing owners equity to increase). Since owners
equity increases with a credit, Sales Revenue must be credited.
3. Step 3: By how much did each account change?
The answer to step 3 results in the following journal entries:

Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000
Sales Revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000

Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000




to summarize
Journal entries are used to summarize the effects of business transactions.
Journal entries are prepared or analyzed by answering three questions: (1)
What accounts are involved? (2) Did those accounts increase or decrease? (3)
By how much did each account change? By correctly answering these three
questions, transactions will be properly accounted for, and the accounting
equation will always balance.
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f100 Part 1 The Mechanics Of Accounting
Financial Reporting and the Accounting Cycle



Summary of Transactions
exhibit 3-5


ASSETS LIABILITIES



Accounts Accounts Notes
Cash Receivable Inventory Equipment Supplies Truck Payable Payable

Balance $2,870 $150 $250 $180 $800 $250 $2,000

Revenue from lawn care 270 80

Sold inventory for cash 90 75

Revenue from landscaping 45

Paid for gasoline 50

Paid wages 60

Collected receivables 80 80

Paid accounts payable 250 250

Paid loan payment 178 158

Paid dividend 50

Total $2,767 $0 $ 75 $250 $180 $800 $ 0 $1,842




business environment essay


In The Hunt for Red October, Jack Ryan, who was
A Bookkeeping Attack Starts a War
Tom Clancy typed the first draft of his trained as a historian, is a part-time analyst for the
first novel, The Hunt for Red October, CIA. By the sixth novel in the series, Debt of Honor, a
on an IBM Selectric typewriter while well-earned reputation for being a good man in a
still holding down his full-time job as storm has landed Ryan, against his wishes, in the
an insurance agent. The book was pub- position of serving as the president s National Secu-
lished in October 1984, and sales took rity Adviser. Jack Ryan s abilities are tested as an in-
off when it became known that the book ternational crisis is touched off when a group of
was President Ronald Reagan s fa- Japanese businessmen gain control of their govern-
vorite. To date, Clancy has published a ment and determine that the only way to save the
total of seven novels featuring the reluctant hero Jack Japanese economy is through neutralization of U.S.
Ryan, and the stories have been so popular that power in the Pacific.
Clancy now commands a record $25 million advance The first act of war against the United States is an
per book. attack not on a military target but instead on the book-
100 f101
The Mechanics Of Accounting Chapter 3
The Mechanics of Accounting




OWNERS EQUITY

Retained Earnings

Capital Lawn Care Sales Landscaping Cost of Gasoline Wages Interest
Stock Revenue Revenue Revenue Goods Sold* Expense* Expense* Expense* Dividends*

$2,000

350

90 75

45

50

60




20

50

$2,000 $350 $90 $45 $75 $50 $60 $20 $50

*Recall that an increase in these accounts actually decreases owners equity, hence the (minus sign).




the weekend. (Tom Clancy, Debt of Honor,
keeping system used by U.S. stock exchanges. A
computer virus, injected into the program used to p. 312)
record trades on all the major U.S. stock exchanges,
is activated at noon on Friday. The records of all The uncertainty created by the destruction of the stock
trades made after that time are eliminated with this exchange bookkeeping records threatens to throw the
result: U.S. economy into a tailspin and distract U.S. policy
makers from other moves being made by Japan in the
No trading house, institution, or private in- Pacific. Jack Ryan saves the world as we know it and
vestor could know what it had bought or restores the U.S. economy to sound footing by . . .
sold, to or from whom, or for how much, well, it wouldn t be fair to say you ll have to read the
and none could therefore know how much book. Suffice it to say that a key part of the restora-
money was available for other trades, or tion plan is the repair of the stock exchange book-
for that matter, to purchase groceries over keeping system.
101
f102 Part 1 The Mechanics Of Accounting
Financial Reporting and the Accounting Cycle



4 POSTING JOURNAL ENTRIES AND PREPARING
A TRIAL BALANCE
Summarize the resulting
journal entries through
posting and prepare a trial
Once transactions have been analyzed and recorded in a journal, it is necessary to classify and group
balance (step three of the
all similar items. This is accomplished by the bookkeeping procedure of posting all the journal
accounting cycle).
entries to appropriate accounts. As indicated earlier, accounts are records of like items. They show
posting The process of
transaction dates, increases and decreases, and balances. For example, all increases and decreases in
transferring amounts from
cash arising from transactions recorded in the journal are accumulated in one account called Cash.
the journal to the ledger.
Similarly, all sales transactions are grouped together in the sales revenue account.
Posting is no more than sorting all journal entry amounts by account and copying those
amounts to the appropriate account. No analysis is needed; all the necessary analysis is performed
when the transaction is first recorded in the journal.
All accounts are maintained in an accounting record called the general ledger. A ledger
ledger A book of accounts
in which data from transac- is a book of accounts. Exhibit 3-6 shows how the three cash transactions in the general jour-
tions recorded in journals nal would be posted to the cash account in the general ledger, with arrows depicting the post-
are posted and thereby
ing procedures. Observe that a number has been inserted in the posting reference column in
summarized.
both books. This number serves as a cross-reference between the general journal and the ac-
counts in the general ledger. In the journal, it identifies the account to which the journal entry
has been posted. In the ledger, it identifies the page on which the entry appears in the general
journal. For example, the GJ1 notation in the cash account for the July 1 entry means that the
chart of accounts A system-
$2,000 has been posted from page 1 of the general journal. As you will discover, these posting
atic listing of all accounts
references are useful in tracking down mistakes. With a computer system, the software auto-
used by a company.
matically generates these posting references.
A particular company will have as many (or as few) accounts as it needs to provide a rea-
caution sonable classification of its transactions. The list of accounts used by a company is known as
Common mistakes when man- its chart of accounts. The normal order of a chart of accounts is assets (current and long-
ually posting include posting a term), then liabilities (current and long-term), followed by owners equity, sales, and expenses.
Exhibit 3-7 shows some accounts that might appear in a typical company s chart of accounts.
debit to the credit side of an ac-
count, transposing numbers
(e.g., a 45 magically becomes a
Determining Account Balances
54), and posting to the wrong
account (e.g., Supplies instead
At the end of an accounting period, the accounts in the general ledger are reviewed to de-
of Inventory). The lesson be termine each account s balance. Asset, expense, and dividend accounts normally have debit
very careful or mistakes will balances; liability, owners equity, and revenue accounts normally have credit balances. In
creep into your work. Thank- other words, the balance is normally on the side that increases the account.
To illustrate how to determine an account balance, consider the following T-account
fully, posting is a task done al-
depicting all the cash transactions from our landscaping business (with dates being added).
most exclusively by computers
The beginning cash account balance plus all Cash debit entries, less total credits to Cash,
these days.
equals the ending balance in the cash account.

Cash

Beg. Bal. 0
7/1 2,000
7/1 2,000 7/5 800)
7/9 270 7/5 180)
7/14 90 7/7 150)
7/14 45 7/18 50)
7/30 80 7/23 60)
7/31 250)
7/31 178)
7/31 50)

4,485 (1,718)
(1,718)

End. Bal. 2,767
102 f103
The Mechanics Of Accounting Chapter 3
The Mechanics of Accounting



Posting to the General Ledger
exhibit 3-6




JOURNAL Page 1

Post.
Date Description Debits Credits
Ref.
2003
July 1 Cash 101 2,000
Capital Stock 2,000
Issued 200 shares of capital stock at $10 per share.

July 5 Truck 800
Cash 101 800
Purchased a used truck.

July 5 Equipment 250
Accounts Payable 250
Purchased a lawnmower on account.

July 5 Supplies 180
Cash 101 180
Purchased supplies for cash.




ACCOUNT: Cash ACCOUNT NO. 101

Post.
Date Explanation Debits Credits Balance
Ref.
2003
July 1 Balance 0
July 1 Issued 200 shares of capital stock at $10 per share GJ1 2,000 2,000
July 5 Purchased a used truck GJ1 800 1,200
July 5 Purchased supplies GJ1 180 1,020




Illustration of the First Three Steps in the Accounting Cycle
We have introduced the first three steps in the accounting cycle. A simple illustration will help
reinforce what you have learned about the relationship of assets, liabilities, and owners equity,
as well as revenues, expenses, and dividends, and the mechanics of double-entry accounting.
Katherine Kohler established the Double K Corporation in 2003. The following transactions
occurred.
103
f104 Part 1 The Mechanics Of Accounting
Financial Reporting and the Accounting Cycle



Chart of Accounts for a Typical Company
exhibit 3-7



Assets (100 199) Owners Equity (300 399)

Current Assets (100 150): 301 Capital Stock
101 Cash 330 Retained Earnings
103 Notes Receivable
105 Accounts Receivable
Sales (400 499)
107 Inventory
400 Sales Revenue
108 Supplies
Long-Term Assets (151 199):
151 Land Expenses (500 599)
152 Buildings
500 Cost of Goods Sold
154 Office Furniture or Equipment
501 Sales Salaries and Commissions
523 Rent Expense
Liabilities (200 299)
525 Travel Expense
528 Advertising Expense
Current Liabilities (200 219):
551 Officers Salaries
201 Notes Payable
553 Administrative Salaries
202 Accounts Payable
570 Payroll Taxes
203 Salaries Payable
571 Office Supplies Expense
204 Interest Payable
573 Utilities Expense
206 Income Taxes Payable
578 Office Equipment Rent Expense
Long-Term Liabilities (220 239):
579 Accounting and Legal Fees
222 Mortgage Payable



a. Initial capital contribution of $20,000, for which she received 1,000 shares of capital stock.
b. Double K Corporation paid $10,000 cash for inventory.
c. Borrowed $20,000 from a bank to buy some land, signing a long-term note with the bank.
d. Land was purchased for $25,000 cash.
e. During the year 2003, Double K Corporation sold 20%, or $2,000, of the inventory pur-
chased. The company sold that inventory for $3,200, and the sale was originally made on
credit.
f. The company paid $200 in selling expenses and $100 in miscellaneous expenses.
g. The company collected the full amount of the account receivable in cash.
The inventory purchases are verified by invoices showing the actual items purchased, dates,
amounts, and so forth. There is a $20,000 note payable to the bank. Other business documents
indicate the sale of inventory and the expenses incurred. Through analysis of these transactions
and supporting documents (step 1), the pertinent facts are obtained and the transactions are
recorded in a journal (step 2). The journal entries to record the transactions of Double K Cor-
poration are as follows. (Note that letters are used in place of dates.)


Business Account Category
Transaction and Direction Journal Entries Debits Credits

Issued stock assets ( ) (a) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
owners equity ( ) (a) Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Issued 1,000 shares of capital stock for $20,000.
Purchased assets ( ) (b) Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000
inventory assets ( ) (b) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000
Purchased $10,000 of inventory for cash.
(continued)
104 f105
The Mechanics Of Accounting Chapter 3
The Mechanics of Accounting




Business Account Category
Transaction and Direction Journal Entries Debits Credits

Borrowed assets ( ) (c) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
money liabilities ( ) (c) Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Borrowed $20,000 from a bank.
Purchased assets ( ) (d) Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000
land assets ( ) (d) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000
Purchased land for cash.
Sold inventory assets ( ) (e) Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . 03,200
revenues ( ) (e) Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . 03,200
Sold inventory for $3,200 on account.
expenses ( ) (e) Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . 02,000
assets ( ) (e) Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 02,000
To record the cost of goods or inventory sold.
Paid expenses expenses ( ) (f) Selling Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 00,200
expenses ( ) (f) Miscellaneous Expenses. . . . . . . . . . . . . . . . . . . . . . . 00,100
assets ( ) (f) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 00,300
Paid selling and miscellaneous expenses.
Collected cash assets ( ) (g) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 03,200
assets ( ) (g) Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . 03,200
Collected accounts receivable.



Next, the transactions are posted to the ledger accounts (step 3, part 1). T-accounts are used
to illustrate this process, with the letters (a) through (g) showing the cross-references to the jour-
nal entries. A balance is shown for the end of the period. (Where only one transaction is in-
volved, the amount of the transaction is also the account balance.)


Cash Accounts Receivable Inventory Land

(a) 20,000 (b) 10,000 (e) 3,200 (g) 3,200 (b) 10,000 (e) 2,000 (d) 25,000
(c) 20,000 (d) 25,000 Bal. 0 Bal. 8,000
(g) 3,200 (f) 300
Bal. 7,900


Notes Payable Capital Stock Sales Revenue Cost of Goods Sold

(c) 20,000 (a) 20,000 (e) 3,200 (e) 2,000




Selling Expenses Miscellaneous Expenses

(f) 200 (f) 100




The effect of these transactions can also be visualized using a spreadsheet format as shown in
Exhibit 3-8.
After the account balances have been determined, a trial balance is usually prepared (step 3,
part 2). A trial balance lists each account with its debit or credit balance, as shown in Exhibit
trial balance A listing of all
account balances; provides 3-9. By adding all the debit balances and all the credit balances, the accountant can see whether to-
a means of testing whether
tal debits equal total credits. Even if the trial balance does show total debits equal to total credits,
total debits equal total cred-
there may be errors. A transaction may have been omitted completely, or it may have been recorded
its for all accounts.
incorrectly or posted to the wrong account. These types of errors will not be discovered by prepar-
105
f106 Part 1 The Mechanics Of Accounting
Financial Reporting and the Accounting Cycle



Effects of Business Transactions on the Accounting Equation
exhibit 3-8


ASSETS LIABILITIES OWNERS EQUITY

Accounts Notes Capital
Transaction # Cash Inventory Land Receivable Payable Stock Retained Earnings

Beginning Sales Cost of Selling Misc.
Balance $00,000 $00,000 $00,000 $0,000 $00,000 $00,,000 Revenue Goods Sold* Expenses* Expenses*

a 20,000 20,000

b 10,000 10,000 0

c 20,000 $20,000

d 25,000 25,000

e 2,000 3,200 3,200 2,000

f 300 200 $ 100

g 3,200 3,200

Total $07,900 $08,000 $25,000 $0,000 $20,000 $20,000 $3,200 $2,000 $200 $100

*Recall that an increase in these accounts actually decreases owners equity, hence the (minus sign).



ing a trial balance; additional analysis would be required. In this case, total debits equal total cred-
its. Thus, the accounting equation is in balance. The balances are taken from each ledger account.
Students frequently mistake a trial balance and the balance sheet for one another. In fact,
they are very different reports. A trial balance is strictly an internal document used to summa-
rize all of the account balances (assets, liabilities, owners equity, revenues, expenses, and divi-
dends) in a company s accounting system. Few people outside a company s accounting depart-
ment ever see the trial balance; most businesspeople never see a real trial balance during their



Trial Balance
exhibit 3-9


Double K Corporation
Trial Balance
December 31, 2003

Debits Credits

Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,900
Accounts Receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000
Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,000
Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,200
Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000
Selling Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
Miscellaneous Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $43,200 $43,200
106 f107
The Mechanics Of Accounting Chapter 3
The Mechanics of Accounting


entire business career. The balance sheet, on the other hand, is a summary document that is fre-
quently provided to interested parties both inside and outside a company.
From the data in the trial balance, an income statement and a balance sheet can be pre-
pared. Exhibit 3-10 shows these two financial statements for Double K Corporation. Notice that
there is no retained earnings account in the trial balance but there is one on the balance sheet.
The reason for this is that all the income statement accounts such as Revenue, Cost of Goods
Sold, and expenses are eventually accumulated into Retained Earnings. That is, earnings are re-


Income Statement and Balance Sheet
exhibit 3-10


Double K Corporation
Income Statement
For the Year Ended December 31, 2003

Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,200
Expenses:
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,000
Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
Miscellaneous expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 2,300
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $0,900
EPS ($900 1,000 shares) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $00.90

Double K Corporation
Balance Sheet
December 31, 2003

Assets Liabilities and Owners Equity
Cash . . . . . . . . . . . . . . . . $ 7,900 Notes payable . . . . . . . . . . . . . . . . . $20,000*
Inventory . . . . . . . . . . . . 8,000 Capital stock (1,000 shares) . . . . . . . 20,000*
Land . . . . . . . . . . . . . . . . 25,000 Retained earnings . . . . . . . . . . . . . . 900*
Total liabilities and
Total assets . . . . . . . . . $40,900 owners equity . . . . . . . . . . . . . . . $40,900*

*Beginning retained earnings net income dividends.




business environment essay


Nonfinancial Data Company annual re- the company s tobacco business were filed against
ports provide more than just the fi- Philip Morris. In its annual report, the company de-
nancial statements and other financial tails the specific charges, the company s defense, the
information. They usually include non- status of various cases, and the state of ongoing ne-
financial information that provides in- gotiations with the government.
sights into unusual circumstances, new Similarly, EXXONMOBIL s 1999 annual report de-
trends, or significant changes, or that re- votes a page to discussing the company s year 2000
late to important social issues, such as plan and includes a brief note about the euro (the new
environmental concerns. currency of much of Europe).
For example, PHILIP MORRIS, INC.,
devoted more than seven pages in its 1999 annual re-
port to litigation. In 1999, 510 new cases relating to Sources: The 1999 annual reports of Philip Morris and ExxonMobil.
107
f108 Part 1 The Mechanics Of Accounting
Financial Reporting and the Accounting Cycle



Statement of Cash Flows
exhibit 3-11


Double K Corporation
Statement of Cash Flows
For the Year Ended December 31, 2003

Operating activities:
Collections from customers . . . . . . . . . . . . . . . . . . . . . . . . . $03,200)
Purchase of inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,000)
Paid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (300) $0(7,100)
Investing activities:
Purchased land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (25,000)
Financing activities:
Issued stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,000)
Borrowed from bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000) 40,000)
Net increase in cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(07,900)
Beginning cash balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0)
Ending cash balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(07,900)




flected on the income statement. The business then decides the amount of those earnings to be
retained. Those earnings that are to be retained are then disclosed on the balance sheet.
Also, the statement of cash flows can be prepared by categorizing the items in the cash ac-
count as operating, investing, or financing, as shown in Exhibit 3-11.
Two final notes: First, the preparation of financial statements is rarely so simple. In reality,
the procedure also involves the adjustment of some ledger accounts, which need to be brought
current before they can be included in the balance sheet or the income statement. In Chapter
4, we will explain how accounts are adjusted (step 4, part 1) so that the financial statements will
accurately reflect the current financial position and operating results of an enterprise.
Second, net income does not usually equal the ending retained earnings balance. Only in
the first year of a company s operations would this be the case. Double K Corporation began
operations in 2003 and paid no dividends during the year; so, its $900 net income on the in-
come statement equals the retained earnings figure on the balance sheet. In future years, the fig-
ures would be different, since retained earnings is an accumulation of earnings from past years
adjusted for dividends and other special items.



to summarize
Once journal entries have been made and posted to the related accounts, ac-
count balances are computed by summing the debit and credit entries in each
account. A trial balance is prepared by listing each account along with its bal-
ance. An income statement and a balance sheet can be prepared from this trial
balance. A statement of cash flows is prepared by analyzing the inflows and
outflows of cash as detailed in the cash account.




5 WHERE DO COMPUTERS FIT IN ALL THIS?
Describe how technology
Students often ask, Do I really need to know the difference between a debit and a credit?
has affected the first three
steps of the accounting Haven t computers taken care of that? Computers have greatly facilitated a business s abil-
cycle.
108 f109
The Mechanics Of Accounting Chapter 3
The Mechanics of Accounting


ity to quickly process huge amounts of information without making mathematical errors.
Most computers can make millions of calculations per second and produce more documents
in ten minutes than a person could in an entire week. The time spent posting journal entries
and summarizing accounts into a trial balance has been greatly reduced as a result of com-
puters.
But computers still can t think. That s your job. Walk up to a computer terminal and show
it a sales invoice and the computer will just sit there and wait. Wait for what? For the answers
to three questions: (1) What accounts are involved? (2) Did those accounts increase or decrease?
(3) By how much did each account change?
Let s consider how the best-selling money management software package, Quicken¬, has
changed the accounting process. Quicken works a lot like a check register. For each check, you
indicate the date, the check number, the payee, and the amount. Quicken then prompts you to
indicate the nature of the expenditure by selecting from a list of accounts. For example, if the
expenditure relates to your purchase of groceries, you would select the account Food. Thus,
all your transactions relating to Food will be grouped together, allowing you to quickly de-
termine all food expenditures.
Now let s review what Quicken has done. First of all, since you indicated the transaction
involved a check, Quicken knows that cash decreased. Quicken is programmed to know that
when cash decreases, it involves a credit to the cash account. Quicken also has been programmed
to know that debits have to equal credits, and since Cash was credited, the program knows that
something was debited. Since you indicated Food (an expense) was the other account, Quicken
debits that account, causing your expense account to increase (we now know that expenses in-
crease with debits). Instead of telling Quicken which accounts to debit and credit, you are re-
quired to identify the accounts (question 1) and indicate if they increased or decreased (ques-
tion 2). Quicken is able to determine, based on the answer to these two questions, which accounts
were debited and which accounts were credited.
So has Quicken fundamentally changed the accounting process? No. It has increased the
accuracy and speed with which the posting process is done, as well as the speed with which a
variety of reports can be prepared. Quicken has also eliminated the need for the user to specify
debit or credit. Because computers are so fast, the two-step process of identifying accounts and
the direction of their change can be done as quickly as you can say credit Cash. So why don t
accountants get rid of these 500-year-old terms, debit and credit? The reason is that all ac-
countants are familiar with and comfortable using these terms. When someone says credit Cash,
accountants everywhere know exactly what that means. Thus, debit and credit provide a useful
shorthand method of communication.
It should be noted that computers also bring with them several disadvantages. The acronym
GIGO (garbage in, garbage out) refers to the problems that result when data are entered in-
correctly. If you tell the computer the wrong account or wrong amount, all the related accounts
and reports will be wrong. If bookkeepers or accountants had been doing the posting, they might
have caught an unrealistic figure or account and corrected the mistake at its source; computers
accept data without question.
A related problem has to do with fixing an error once it has been identified. Unlike some-
one familiar with the accounting process, a computer cannot grasp the double-entry nature of
accounting and realize that, for example, an incorrect amount may be posted to two accounts,
not just one. As an example, suppose a customer calls and notifies you of an error in her ac-
count a sale to her was incorrectly recorded as $100 instead of $10. You can correct the cus-
tomer s account by making a $90 adjustment to Accounts Receivable, but Sales would need to
be adjusted by $90 as well. A computer couldn t extrapolate this and would end up overlook-
ing this Sales adjustment.
The computer has enhanced step 3 of the accounting cycle summarizing. In fact, only in
the smallest of businesses will you find the posting of journal entries and the preparation of a
trial balance being done by hand. But in every business, from the largest to the smallest, you
will find accountants still actively involved in analyzing transactions and turning those transac-
tions into journal entries and eventually into useful accounting reports.
109
f110 The Mechanics Of Accounting
Part 1 EOC Financial Reporting and the Accounting Cycle




to summarize
The computer has changed certain aspects of the accounting cycle. The post-
ing process has been substantially improved through the use of computers. In
addition, computers have made the preparation of reports and statements eas-
ier. But computers have not replaced the need to analyze transactions and de-
termine their effect on the accounting equation.




review of learning objectives

Understand the process of transforming transaction business events are recorded in the accounting system using
1 data into useful accounting information. The objec- journal entries. Journal entries detail the accounts involved in
tive of the accounting process is to gather and transform trans- a transaction, whether the accounts increased or decreased, and
action data into useful information that measures and com- the amount by which each account is affected. Each journal
municates the results of business activity. The accounting entry requires an equal amount of debits and credits. This
system used to keep track of the many financial activities of a equality ensures that the accounting equation will always be
business should be tailor-made for that business and may be in balance.
a manual or an automated system, depending on the organi-
zation s needs. Summarize the resulting journal entries through post-
4 ing and prepare a trial balance (step three of the ac-
Analyze transactions and determine how those trans- counting cycle). Once journal entries are made, they are
2 actions affect the accounting equation (step one of posted to individual accounts. The posting process involves
the accounting cycle). The procedures for processing ac- simply copying each debit and credit from a journal entry into
counting data are based on double-entry accounting and the the associated account. A trial balance can be prepared to en-
fundamental accounting equation: Assets Liabilities sure that debits equal credits and that the accounting equation
Owners Equity. Revenues increase retained earnings, whereas is in balance. From the trial balance, the primary financial
expenses and dividends decrease retained earnings. Thus, these statements can be prepared.
accounts have a direct impact on the amount of owners eq-
uity. In terms of the increase/decrease relationship of accounts, Describe how technology has affected the first three
5
assets, expenses, and dividends are increased by debits; liabil- steps of the accounting cycle. Computers have changed
ities, owners equity, and revenues are increased by credits. The the speed at which journal entries are processed through the
double-entry system of accounting ensures that the account- accounting system. In most accounting systems, the posting
ing equation will always balance because debit entries require process is done using computers. Computers ensure that no
equal credit entries; that is, total debits must always equal to- errors are made in transferring amounts from the journal en-
tal credits when transactions are properly recorded. tries to the accounts. Computers are also able to determine ac-
count balances and prepare reports quickly. Accountants are
Record the effects of transactions using journal en- still required for the analysis and input of information into the
3 tries (step two of the accounting cycle). The effects of accounting system.




key terms and concepts

account 84 credit 86 journalizing 90
accounting cycle 79 debit 86 ledger 102
business documents 80 dividends 88 posting 102
chart of accounts 102 journal 90 T-account 86
compound journal entry 96 journal entry 90 trial balance 105
110 f111
The Mechanics Of Accounting EOC Chapter 3
The Mechanics of Accounting




review problem

The First Three Steps in Journal entries are given below for January 2003, the first month of operation for the Svendsen
the Accounting Cycle Service Company.
Jan. 2 Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Issued capital stock for cash.
Jan. 2 Insurance Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500
Purchased a one-month insurance policy.
Jan. 2 Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750
Paid rent for the month of January.
Jan. 3 Shop Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Purchased shop equipment for cash.
Jan. 4 Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Purchased shop supplies on account.
Jan. 5 Automotive Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,500
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500
Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Purchased a truck. Paid $3,500 cash and issued a 30-day
note for the balance.
Jan. 8 Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,750
Service and Repair Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . 1,750
Received cash for repairs.
Jan. 9 Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
Paid cash for radio spot announcements.
an..12 Automotive Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
Paid gas, oil, and service costs on the truck.
an. 14 Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Paid $3,000 on account.
an. 16 Accounts Receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200
Service and Repair Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200
Repaired truck for Acme Drilling Company on account.
an. 18 Telephone Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Paid for installation and telephone service for one month.
an. 19 Automotive Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
Paid for minor repairs on the truck.
an. 20 Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Notes Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,450
Service and Repair Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . 2,450
Collected $1,000 cash from Jones for truck repairs;
accepted a 60-day note for the balance. (continued)
111
f112 The Mechanics Of Accounting
Part 1 EOC Financial Reporting and the Accounting Cycle


Jan. 24 Repairs and Maintenance Expense . . . . . . . . . . . . . . . . . . . . . . . 150
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
Paid cleaning and painting expenses on the building.
Jan. 25 Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
Service and Repair Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
Received cash for repairs and services from Hamilton, Inc.
Jan. 27 Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,500
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,500
Purchased shop supplies.
Jan. 29 Office Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,250
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,250
Purchased a computer.
Jan. 30 Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200
Collected receivables from Acme Drilling Company.
Jan. 31 Utilities Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900
Paid the monthly utility bill.
Jan. 31 Automotive Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350
Paid for gas, oil, and servicing of the truck.


Required: Set up T-accounts, post all journal entries to the accounts, balance the accounts, and prepare a
trial balance.

Solution The first step in solving this problem is to set up T-accounts for each item; then post all jour-
nal entries to the appropriate ledger accounts, as shown. Once the amounts are properly posted,
account balances can be determined.


Cash Notes Receivable Accounts Receivable Supplies

1/2 40,000 1/2 500 1/20 1,450 1/16 1,200 1/30 1,200 1/4 3,000
1/8 1,750 1/2 750 1/27 2,500
Bal. 0
1/20 1,000 1/3 8,000 Bal. 5,500
1/25 1,500 1/5 3,500
1/30 1,200 1/9 300
1/12 200
1/14 3,000
1/18 75
1/19 180
Shop Equipment Automotive Equipment Office Equipment
1/24 150
1/27 2,500
1/3 8,000 1/5 11,500 1/29 1,250
1/29 1,250
1/31 900
1/31 350
Bal. 23,795



Service and Repair
Notes Payable Accounts Payable Capital Stock Revenue

1/5 8,000 1/14 3,000 1/4 3,000 1/2 40,000 1/8 1,750
1/16 1,200
Bal. 0
1/20 2,450
1/25 1,500
Bal. 6,900

(continued)
112 f113
The Mechanics Of Accounting EOC Chapter 3
The Mechanics of Accounting


Insurance Expense Rent Expense Advertising Expense Automotive Expense

1/2 500 1/2 750 1/9 300 1/12 200
1/19 180
1/31 350
Bal. 730

Repairs and Maintenance
Telephone Expense Expense Utilities Expense

1/18 75 1/24 150 1/31 900




The final step is to prepare a trial balance to see whether total debits equal total credits for
all accounts. List all the accounts with balances; then enter the balance in each account.


Svendsen Service Company
Trial Balance
January 31, 2003
Debits Credits

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $23,795
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0
Notes Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,450
Supplies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,500
Shop Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Automotive Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,500
Office Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,250
Accounts Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $00,000
Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Service and Repair Revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,900
Insurance Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500
Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750
Advertising Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
Automotive Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 730
Telephone Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Repairs and Maintenance Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900
Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $54,900 $54,900




discussion questions

1. What is the basic objective of the accounting cycle? 4. In a double-entry system of accounting, why must total
2. Explain the first three steps in the accounting cycle. debits always equal total credits?
3. What are the advantages of a computer-based account- 5. Explain the increase/decrease, debit/credit relationship
ing system? Does such a system eliminate the need for of asset, liability, and owners equity accounts.
human judgment? Explain.
113
f114 The Mechanics Of Accounting
Part 1 EOC Financial Reporting and the Accounting Cycle



6. How are revenues, expenses, and dividends related to c. Cash sales of goods for more than their cost.
the basic accounting equation? d. Payment of monthly utility bills.
7. In what ways are dividend and expense accounts simi- e. Purchase of a building with a down payment of
lar, and in what ways are they different? cash plus a mortgage.
8. How does understanding the mechanics of accounting f. Cash investment by a stockholder.
help a businessperson who has no intention of practic- g. Payment of a cash dividend.
ing accounting? h. Sale of goods on account for more than their cost.
9. Distinguish between a journal and a ledger. i. Sale of land at less than its cost.
10. Assume that Company A buys $1,500 of merchandise 12. What is a chart of accounts? What is its purpose?
from Company B for cash. The merchandise originally 13. If a trial balance appears to be correct (debits equal
cost Company B $1,000. What entries should the buyer credits), does that guarantee complete accuracy in the
and seller make, and what is the relationship of the ac- accounting records? Explain.
counts for this transaction? 14. What is the difference between a trial balance and a
11. Indicate how each of the following transactions affects balance sheet?
the accounting equation. 15. Have computers eliminated the need to analyze transac-
a. Purchase of supplies on account. tions? Explain.
b. Payment of wages.




discussion cases

CASE 3-1 HOW DOES MICROSOFT (AND OTHER COMPANIES) DO IT?
MICROSOFT s revenues exceeded $19 billion in 1999. These revenues were generated by mil-
lions of transactions all over the world in the United States, Canada, Europe, South America,
and Asia. What is the process used by Microsoft to transform this tremendous amount of trans-
action data into summarized information reported to the general public in the form of finan-
cial statements?



CASE 3-2 ADVANTAGES AND DISADVANTAGES OF A COMPUTERIZED
ACCOUNTING SYSTEM
Your soon-to-be father-in-law owns a small retail store. He has manually kept his business ac-
counting records for over 20 years, but he is currently thinking about switching to a comput-
erized accounting system. What advice would you give him about the advantages and the dis-
advantages of using a computerized accounting system?

WHEN IS A DEBIT A DEBIT?
CASE 3-3
Your new roommate, Susan, is confused. She has just received a notice from her bank indicat-
ing that her account has been debited for the cost of new checks. This has reduced her cash ac-
count. Susan just learned in her introductory accounting class that debiting Cash increases the
account. She wonders why the bank has reduced her account by debiting it. How can you help
Susan understand this situation?

CASE 3-4 UNDERSTANDING THE MECHANICS OF ACCOUNTING
As the CFO (Chief Financial Officer) of Rollins Engineering Company, you are looking for
someone to fill the position of office manager. Part of the job description is to maintain the
company s accounting records. This means that the office manager must be able to journalize
transactions, post them to the ledger accounts, and prepare monthly trial balances. You have
just interviewed the first applicant, Jay McMahon, who claims that he has studied accounting.
As an initial check on his understanding of the basic mechanics of accounting, you give Jay a
list of accounts randomly ordered and with assumed balances and ask him to prepare a trial bal-
ance. Jay prepares the following.
114 f115
The Mechanics Of Accounting EOC Chapter 3
The Mechanics of Accounting



Trial Balance

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