Recording Transactions using. Debit & Credit Approach

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Ethelbert Eaton
6 years ago
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1 Recording Transactions using Debit & Credit Approach Service Company Example The current presentation will cover the basics of recording transactions using the Debit & Credit approach. It may take a little time to get used to thinking in terms of debits and credits. You will need to lose any preconceived ideas about the meaning of the terms Debit and Credit. They are in fact meaningless unless one knows what type of account (e.g., asset, liability) is being debited or credited. You will also want to keep in mind that for any transaction, and all transactions taken together, that debits must always equal credits just like assets must always equal the sum of liabilities and equity. We will use the same transactions as used in the Mike s Barbershop example. This will be done in order to remind you of the meaning of the debits and credits for the financial statements. A couple of initial slides will be devoted to the basics of debits and credits.

2 (1) ASSETS To Demonstrate an Increase in Assets DEBIT the asset account To Demonstrate a Decrease in Assets CREDIT the asset account (2) LIABILITIES To Demonstrate an Increase in Liabilities CREDIT the liability account To Demonstrate a Decrease in Liabilities DEBIT the liability account (3) EQUITY To Demonstrate an Increase in Equity CREDIT the equity account To Demonstrate a Decrease in Equity DEBIT the equity account Notice, the rules for debiting & crediting an equity account also show the rule for income statement accounts. If you recall that the revenues and expenses get incorporated into the retained earnings account within the equity portion of the balance sheet, then we have the following rules. To Demonstrate an Increase in Net Income (e.g., Revenue) CREDIT revenue To Demonstrate a Decrease in Net Income (e.g., Expense) DEBIT expense The following slide summarizes these relationships with (+) for increase (-) for decrease.

3 ASSETS = LIABILITIES + OWNERS EQUITY (+) (-) (-) (+) (-) (+) DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT Dividends Capital Stock Retained Earnings EXPENSES REVENUE Assets: (e.g.,) Liabilities: (e.g.,) Cash & Cash Equivalents Expenses: (e.g.,) Marketable Securities Accounts Payable Cost of Goods Sold Accounts Receivable Wages Payable Selling expenses Inventory Utilities Payable General & Administrative Prepaid Expenses Interest Salaries Prepaid insurance Current portion of L-T debt Wages Other Current Assets Accrued Expenses Interest Pre-Paid Expenses Salaries Taxes Property, Plant, & Equipment (PPE) Unearned Revenue Depreciation & Amortization Land Other Current Liabilities Revenue: (e.g.,) Buildings Notes payable Revenue Less Accumulated Depreciation Mortgages payable Sales Intangibles Bonds Payable Net Sales Goodwill Other Long-Term Liabilities Interest Patents Copyrights Less Accumulated Amortization Other Long-Term Assets

4 1. Mike transfers $500 from the shop s savings account to its checking account.

5 1. Mike transfers $500 from the shop s savings account to its checking account Cash Savings Cash 500 Savings Account 500

6 2. Mike purchases $100 worth of equipment (e.g., scissors, clippers, etc.) for the shop by writing a check.

7 2. Mike purchases $100 worth of equipment (e.g., scissors, clippers, etc.) for the shop by writing a check Equipment -100 Cash Equipment 100 Cash 100

8 3. Mike purchases a blow dryer for the shop. The dryer costs $50. Mike has asked the seller to bill him for the dryer.

9 3. Mike purchases a blow dryer for the shop. The dryer costs $50. Mike has asked the seller to bill him for the dryer. +50 Equipment + 50 Accounts Payable Equipment 50 Accounts Payable 50

10 4. Mike receives the bill for the purchase of the dryer and immediately pays it by putting a check in the mail for the full amount.

11 4. Mike receives the bill for the purchase of the dryer and immediately pays it by putting a check in the mail for the full amount. -50 Cash -50 Accounts Payable Accounts Payable 50 Cash 50

12 5. Mike provides a $15 haircut to a customer that pays cash.

13 5. Mike provides a $15 haircut to a customer that pays cash. +15 Cash +15 Retained Earnings Cash 15 Revenue 15 Notice here that we do not actually credit retained earnings directly. Rather, the credit to retained earnings (and, equity more broadly) is implied by the credit of the revenue account. In actual fact, a business would close the revenue account into the retained earnings account just prior to constructing their financial statements. We ll talk more about closing accounts later, for now note that the same will be true for expenses.

14 6. Mike provides a $20 haircut to a customer. The customer a loyal and steady one for Mike has asked Mike to bill him for the haircut.

15 6. Mike provides a $20 haircut to a customer. The customer a loyal and steady one for Mike has asked Mike to bill him for the haircut. +20 Accounts Receivable +20 Retained Earnings Accounts Receivable 20 Revenue 20

16 7. Mike receives a $20 check from the customer in question 6.

17 7. Mike receives a $20 check from the customer in question Cash -20 Accounts Receivable Cash 20 Accounts Receivable 20

18 8. Mike pays $400 in rent to the owner of his building.

19 8. Mike pays $400 in rent to the owner of his building Cash Retained Earnings Rent Expense 400 Cash 400

20 9. Mike receives his $200 utility bill. However, he does not plan to actually pay this until next month (after he constructs this period s financial statements).

21 9. Mike receives his $200 utility bill. However, he does not plan to actually pay this until next month (after he constructs this period s financial statements) Accounts Payable -200 Retained Earnings Utility Expense 200 Accounts Payable 200

22 10. Mike receives a $5,000 small business loan from his bank.

23 10. Mike receives a $5,000 small business loan from his bank. +5,000 Cash +5,000 Bank Loan Cash 5,000 Bank Loan (or, Long-term Debt) 5,000

24 11. Mike makes the first payment of $300 on his bank loan. Of the entire payment, $200 will go towards the principal of the loan and $100 towards interest on the loan.

25 11. Mike makes the first payment of $300 on his bank loan. Of the entire payment, $200 will go towards the principal of the loan and $100 towards interest on the loan Cash Bank Loan -100 Retained Earnings Bank Loan 200 Interest Expense 100 Cash 300

26 12. The $50 blow dryer that Mike purchased way back in question 3 has worn out completely (it is now worthless with no salvage value at all).

27 12. The $50 blow dryer that Mike purchased way back in question 3 has worn out completely (it is now worthless with no salvage value at all) Equipment -50 Retained Earnings Depreciation Expense 50 Equipment 50

PROBLEM 3-2B. (a) J1 Date Account Titles Ref. Debit Credit May 31 Insurance Expense Prepaid Insurance...

PROBLEM 3-2B. (a) J1 Date Account Titles Ref. Debit Credit May 31 Insurance Expense Prepaid Insurance... PROBLEM 3-2B (a) J1 Date Account Titles Ref. Debit Credit May 31 Insurance Expense... 722 190 Prepaid Insurance... ($2,280 X 1/12) 130 190 31 Supplies Expense... Supplies ($2,200 $)... 631 126 1,450 1,450