Basic Accounting for Practice
Content
2010
Dr. Amit Shrivastava_NMIMS_2010-2011
PTMBA : Section A & B
Financial Accounting
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Financial Accounting PTMBA_ NMIMS_ Section A & B_2010-2011
BASIC ACCOUNTING
Module BA
Apply Basic Accounting Principles
OBJECTIVE
Given transaction descriptions, labeled T accounts, and access to course materials, correctly identify the type of account, determine which account to debit and which to credit, and enter the correct debit and credit amounts. Nineteen of 24 debit/credit entries must be correct.
SAMPLE CRITERION TEST ITEM
Using transaction descriptions and labeled T accounts, identify the accounts as either asset, expense, liability or income and enter the correct debit and credit amounts. 1. A golf course Pro Shop purchased 300 golf balls at $1.00 each for resale to customers and placed them in a Central Storeroom. The golf-ball vendor will be paid next month. Accounts Payable Debit Credit
Central Storeroom Inventory Debit Credit
a. What kind of account is Central Storeroom Inventory?
b. What kind of account is Accounts Payable?
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SIGNOFF REQUIREMENT
Nineteen of 24 debit/credit entries must be made correctly for signoff on this module. A “debit/credit” entry consists of the correct amount entered in the appropriate T account correctly as either a debit or credit. You have just been introduced to the basic duty of fund bookkeeper - to report transaction information to SAP AIMS. For many of you who have on-the-job experience, this module will serve to review some basic accounting ideas and practices. For you newcomers to the field, it will provide the necessary knowledge upon which you will build skills. In this module, we will cover the following accounting basics: • The Balance Sheet Accounts • • Assets Liabilities Net Worth
The Accounting Equation The Operating Statement Accounts Income Expense
•
Recording transaction effects on accounts Debits and Credits
By the end of this module, you will be able to enter simple transaction data in proper format and follow the basic accounting principles.
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THE BALANCE SHEET ACCOUNTS
Every business (including NAFIs) needs to have a means of keeping track of what it owns and what it owes to others. From the bookkeeper’s point of view, the most efficient means of keeping track is by assigning accounts to all things owned and owed that can be expressed in monetary value. The Balance Sheet Accounts are three basic account categories used to record this information. They are called Balance Sheet Accounts because they appear on a business’ Balance Sheet its basic financial statement of what is owned and owed. The three basic categories are: • • • Assets - what the business owns. Liabilities - what the business owes to others. Net Worth - the owner’s share of assets and earnings.
Before we look at each of the above categories, answer the following questions. 1. What are the uses for accounts? Check all that apply. a. Keep track of what is owed b. Record specific accounting data. c. Keep track of what is owned. 2. Check the categories of balance sheet accounts. a. b. c. d. 3. Liabilities Assets Receivables Net Worth
Define the categories you checked in question 2.
Term Definition
Check your answers on page BA-4
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THE BALANCE SHEET ACCOUNTS - Answers:
1. 2. 3.
You should have checked a, b and c. a, b and d (c - receivable - is a type of asset you will learn about later). You should have listed/defined: Assets Liabilities Net Worth - what the business owns - what the business owes others - the owner’s share of assets and earnings
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ASSETS
We have broadly described assets as what a business/NAFI owns. To further define assets, we can say that assets must be of measurable value that can be expressed in a dollar amount. What are some of the most obvious things of value a business owns? Perhaps the most obvious asset of a business is cash. This includes any money on deposit at banks and money held onsite in cash registers or safes. It is easy to list cash at value: ASSETS Cash $ 22,000
Then there is the land a business owns and operates on. You could list its value as: ASSETS Land Cash
NOTE:
$2,500,000 $ 22,000 The dollar value of land is always the initial cost of the land, not the market value.
Assets can be classed as current or fixed. Cash is a current asset. Current assets are either cash or things that can easily be converted to cash, such as retail inventories and receivables (money owed the business by its customers). Land is considered a fixed asset. Fixed assets are of permanent nature, which the business intends to use over an extended period of time.
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ASSETS (cont.)
Below are some examples of current and fixed assets. ASSETS Current Cash Receivables Inventories Fixed Land Buildings Equipment $ 22,000
$2,500,000
Again, all values are expressed in dollar amounts and all assets except cash and receivables are listed at cost. Now answer the questions on page BA-7.
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ASSETS - Questions:
1.
Indicate whether the assets below are current or fixed assets.
Current Fixed
a. b. c. d. e. f. 2.
Buildings Land Receivables Equipment Cash Retail Inventories
Choose the true statement. a. b. Fixed assets are held for quick conversion into cash. Fixed assets are held for use by the business for an extended period of time.
3.
A Recreation Arts/Crafts/Hobbies Activity, has bought $62.50 (cost) worth of yarn to sell in their shop. When all the yarn is sold, they will gross $68.75 (retail value). Which figure would you use for your inventory? Sandy McGuire started a candy business. She bought the building for $75,000. Right now she has $2,000 on deposit in the company bank account and $500 in cash at the store. She paid $1,700 to stock the store with various jellybeans, chocolate bunnies, lollipops, and the like. She hopes to make at least $5,000 from that stock. Using the information above, list the candy store’s assets.
4.
5.
Write a definition of assets.
Check your answers on page BA-8.
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ASSETS - Answers:
1.
a. b. c. d. e. f.
fixed fixed current fixed current current
2. 3. 4.
b $62.50 (Remember, assets are listed at cost). The candy store’s asset listing should look like this: ASSETS Cash Inventories Building $ 2,500 (bank account and cash on hand) $ 1,700 (cost value) $ 75,000
(Later you will learn how to show the candy store’s $75,000 bank loan to buy the store). 5. Assets are things of monetary value owned by a company (or words to that effect).
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LIABILITIES
Liabilities are the funds a business/NAFI owes to others. This debt can be incurred in a number of ways. For example, a business could borrow money from a bank. The business would then be liable to the bank for the funds loaned. A bank loan liability can be expressed: LIABILITIES Bank Loan $ 3,000 A business can also incur liabilities in everyday transactions. For example, if a business purchased office supplies from a vendor and received the supplies before paying for them (it is common business practice to purchase goods and receive the bill later), the business would be liable to the vendor for the amount of the goods purchased. This kind of liability is an Accounts Payable - account payable to a vendor - and is expressed as such. LIABILITIES Accounts Payable Bank Loan $ 250 $ 3,000
Accounts payable to a vendor and bank loans illustrate two types of liability accounts. Accounts Payable is a current liability. Current liabilities include all amounts due within one year, such as vendor accounts, wages due employees, and taxes due the government. A bank loan (if it is longer than one year) is an example of a long-term liability. Below are some examples of current and long-term liabilities: LIABILITIES Current Accounts Payable Wages Payable Taxes Payable Long-Term Bank Loan Now answer the questions on page BA-11. $ 250
$ 3,000
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LIABILITIES - Questions:
1.
The F&FRP Non-Appropriated Fund (NAF) pays social security taxes once every three months. These social security taxes are: a. b. Long-term liabilities. Current liabilities.
2.
Let’s think about Sandy McGuire’s candy store again. We said she bought the building for $75,000. Now let’s assume she got the money with a Small Business Administration loan, payable over 25 years. Of the $1,700 worth of candy the business bought, $1,000 was paid on delivery to the Joyous Jellybean Company; $700 is still owed to Chocolate Unlimited. Using the information above, list the candy store’s liabilities.
3.
Write a definition of liabilities.
Check your answers on page BA-12.
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LIABILITIES - Answers:
1.
Taxes paid every 3 months would be (b), current liabilities, during the time they remain unpaid. Remember, long-term liabilities are payable over a period longer than one year. LIABILITIES Current Accounts Payable Long-Term SBA Loan
NOTE:
2. (The amount owed to an 700 outside vendor. $1,000 was already paid so it is no longer a liability).
$
$ 75,000
You will learn how to show when liabilities are paid in a later section.
3.
Expressed in your own words: Liabilities are what the business owes to others (or words to that effect).
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REVIEW - Questions:
As a review, classify the following accounts into the proper category.
ASSET Current Fixed LIABILITY Current Long-term
a. b. c. d. e. f.
Retail inventories Bank Loan Accounts Receivable Taxes Payable Accounts Payable Cash
Check answers on page BA-14.
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REVIEW - Answers:
a. b. c. d. e. f.
Current asset. Long-term liability. Current asset. Current liability. Current liability. Current asset.
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NET WORTH
Net worth is the owner’s share of assets and earning. Net worth is sometimes also called “owner’s equity”. To a Navy bookkeeper, owner’s equity will be of little concern since the “owner” of all the Messes and Recs is the U. S. Navy, and the Navy does not engage in many of the typical “owner” activities of a private business. The account categories that do appear in the Net Worth section of your Balance Sheet are earnings and profits - whatever is left after liabilities have been paid, or stated another way, the difference between total assets and liabilities for a year. These accounts show the Navy’s share of earnings and profits. NET WORTH Net Profit $ 3,750 Unlike private business, the Navy does not keep profits but uses them to fund operations. These distributions of profit are shown in the “Profit Distribution” accounts. You will not be using the Net Worth Accounts, but they will appear on your Fund’s Balance Sheet as profits that have been distributed to your Fund. Answer the questions on page BA-17.
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NET WORTH - Questions:
1.
What do Net Worth Accounts show? a. b. c. d. What a business owes to outside vendors. Accounts Receivable from customers. Owner’s share of assets and earnings. Loans payable within one year.
2.
In the Commander, Navy Installations Command (CNIC) system, profits are: a. b. c. kept by the owner. distributed to funds for use in operations. returned to the appropriate fund pool.
3.
Here we are at Sandy McGuire’s candy store. After three months of operation, the business has made $5,000 in sales, $3,300 of that becoming profits. Using the information above, list the candy store’s net worth.
4.
Write a definition of net worth.
Answers on page BA-18.
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NET WORTH - Answers:
1. 2. 3.
c.
Owner’s share of assets and earnings.
In the CNIC system, profits are distributed to funds for use in operations, “b”. NET WORTH Net Profit $ 3,300
4.
Net worth is the owner’s share of assets and earnings after liabilities are paid.
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BALANCE SHEET REVIEW
In the next section, we will cover the relationship of the three Balance Sheet account categories in the accounting equation. But first, let’s review the Balance Sheet accounts. Answer the following questions, referring to any portion of the Balance Sheet section as necessary: 1. What are the three main categories of Balance Sheet accounts?
2.
Using A for assets, L for liabilities, and NW for net worth, indicate the correct category for each of the following: a. Accounts Payable b. Inventory c. Cash d. Profit
Check your answers on page BA-20.
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BALANCE SHEET - Answers:
1.
Assets Liabilities Net Worth
2.
a. b. c. d.
L A A NW
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THE ACCOUNTING EQUATION
You know that assets are what the business owns, liabilities are what the business owes, and net worth is what is left after liabilities are paid (profits). You have seen how each account category is individually listed; now let’s look at how they are listed in relation to each other on the Balance Sheet. ASSETS Current Fixed LIABILITIES Current Long-term NET WORTH Profits Total Total
Total Assets equal total Liabilities plus Net Worth. This is where the term “Balance Sheet” comes from - the left (Assets) and right (Liabilities + Net Worth) columns are equal - they “balance”. This relationship is known as the accounting equation.
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ASSETS = LIABILITIES + NET WORTH
Let’s examine this relationship more closely. Let’s start with an illustration of the balance that must always exist between Assets and Liabilities. If a business makes a purchase from a vendor, a debt is incurred. As you know, this is reflected in the Liability account, “Accounts Payable.” LIABILITY Accounts Payable $ 250 You can see how that purchase has increased the liability of the business to the vendor. This liability will not be decreased until the business pays the vendor. Now think a minute - what other account category could possibly be affected by a purchase of goods? If the business has received goods through the purchase, the business has increased its assets - “Inventory” account. ASSETS
Inventory
$ 250
LIABILITIES Accounts Payable
$ 250
(Remember, assets are listed at their cost value). This is a simplified illustration of the way the left and right sides of the Balance Sheet equal each other, and the way every transaction affects at least two accounts: the double-entry system. For every liability incurred, some increase in assets must result. In the illustration above, the increase in Accounts Payable led to an increase in Inventories. An increase in longterm liability - bank loan, for example -would lead to an increase in assets - “cash” or a fixed asset such as land. Again you can see the double-entry system at work. Two accounts are always affected.
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ASSETS = LIABILITIES + NET WORTH (cont.)
Now let’s consider the full accounting equation again. In the CNIC system, the Net Worth accounts are used primarily for recording profits. You may ask, “If you record all your profits in net worth, how will the equation balance? Won’t liabilities and net worth be greater than assets?” This would be true if it were not for the double-entry system mentioned earlier. When a business makes a sale, the funds received go into one of two assets accounts - cash or Accounts Receivable. For example, the cost of goods sold was $100; the retail price was $150, for a profit of $50. Any profit over the cost increases the Asset account by the amount of profit. So to balance out the increase in the Asset account caused by the profit from the sale of goods, the Net Worth account lists the profit. ASSETS LIABILITIES $150 Current Long-term NET WORTH Profits Total $150 Total $ 50 $ 150 $ 100
Cash Accounts Receivable
Now answer the questions on page BA-25.
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ASSETS = LIABILITIES + NET WORTH - Questions:
1.
The double-entry system calls for: a. b. c. d. transactions to be equal. transaction profits to equal assets. transactions to affect two or more accounts. transactions to have two entries.
2.
Consider the following transactions. a. A lamp store buys one dozen lighting fixtures from a vendor. The vendor will bill the lamp store for the purchase. How many accounts in the lamp store are affected by this transaction? (Write the number.)
b.
What are the account categories affected?
Check your answers on page BA-28.
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3.
Set up the following transaction data on the balance sheet below. Fancy Foot Shoe Store operates out of a building bought for $59,000. All of the money used to buy the building came from a bank loan, none of which has been paid off. Fancy Foot has 400 pairs of shoes in stock. The store paid $30 a pair for 200 pairs. Fancy Foot owes Sulton Shoe Importers of Italy $40 a pair for the other 200 pairs. Fancy Foot also owes the government $2,300 in taxes. Fancy Foot has a total of $300 in cash in the store’s cash register. At the end of the day’s operations, the manager made a deposit at the local bank bringing the total funds on deposit to $5,000. There was also $500 worth of charge sales today. The manager figures that Fancy Foot should be showing $9,500 in profits at this time.
BALANCE SHEET ASSETS LIABILITIES $ $ $ $ TOTAL NET WORTH Profit TOTAL $ TOTAL $ $ $ Current Accounts Payable Taxes Payable Long-Term Bank Loan $ $ $
Current Cash Receivable Inventories Fixed Building
4.
From memory, write the Accounting Equation.
Check your answers on page BA-28.
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ASSETS = LIABILITIES + NET WORTH - Answers:
1. 2.
c a. b. Two accounts are affected by this transaction. The Current Asset Inventory account is affected by the increase in inventory; the Current Liability Accounts Payable is affected because the business now owes the vendor for the lighting fixtures purchased.
3.
BALANCE SHEET ASSETS Current Cash Receivable Inventories Fixed Building $ $ $ $ LIABILITIES
5,300 500 14,000 59,000
Current Accounts Payable Taxes Payable Long-Term Bank Loan
$ $
8,000 2,300 59,000 69,300
$
TOTAL NET WORTH Profit TOTAL $
$
$ TOTAL $
9,500 78,800
78,800
4.
Assets = Liabilities + Net Worth
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THE OPERATING STATEMENT ACCOUNTS: INCOME AND EXPENSE
You learned earlier that the Balance Sheet shows what a business/NAFI owns, owes, and its earnings or profits. A Balance Sheet does not provide a clear breakdown of actual sales activity. For tracking sales activity, businesses use a different document called an Operating Statement. The Operating Statement is composed of two account categories: Income and Expense. Income accounts show the sales-related gross revenue. Expense accounts show all costs associated with the sales, such as cost of goods sold and personnel costs. These two operating statement categories, added to the three balance sheet categories, are the main categories of accounts. Let’s begin with two basic principles that apply to both of the operating statement account categories. 1. 2. Operating Statements cover a period of time. Income and Expenses are always recorded separately.
Both categories are used to record gross amounts - gross income or gross expense. Profit or loss is not a consideration in the individual entries; it is determined after all entries are made. All Income or Expense data is recorded when earned or incurred. This is sometimes called accrual accounting. This means that a business records the revenue for a sale in the Income account at the time of the sale, regardless of when the customer pays. A business records an expense when it “is incurred” - that is when the inventory or service is used. For example, if a business purchased 500 baseballs for $1 each in March but does not sell any until June, and then sells only 200, the baseball expense for March, April, and May will be $0.00 - because no revenue could be associated in these months with the sale of baseballs. However, in June the baseball expense would be $200 - the value of the 200 baseballs sold.
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THE OPERATING STATEMENT ACCOUNTS: INCOME AND EXPENSE (cont.)
NOTE:
You can see that Income and Expense recording is not the same as Asset and Liability recording. For example, the purchase of baseballs would have affected the Asset and Liability accounts as soon as the purchase was made: either a decrease in cash or increase in Accounts Payable to show if the baseballs were paid for in cash or that funds were due to the vendor. Then the Inventory account would be increased to show the receipt of the baseballs. Try to keep the function of the Balance Sheet Accounts and the Operating Statement Accounts clear in your mind.
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INCOME AND EXPENSE - Questions:
Now answer the following questions. 1. Income accounts are used to record: a. b. c. d. 2. Profits. The cost of goods sold. Gross revenue. Revenue after expenses.
Expense accounts are used to record: a. b. c. d. Gross expenses related to the income of the period. Accounts Payable. Long-Term Liabilities. Value of inventory.
3.
The Operating Statement covers: a. b. A company’s assets and liabilities at one moment in time. Transaction information over a period of time.
4.
Income is recorded when: a. b. The sale is made. The customer pays the bill.
5.
Expense is recorded: a. b. In the same period as the revenue it is associated with is earned. In the period when the vendor is paid.
Check your answers on page BA-32.
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INCOME AND EXPENSE - Answers:
1. 2. 3. 4. 5.
c a b a a
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REVIEW THE FIVE CATEGORIES OF ACCOUNTS
You have now been introduced to the five main categories of accounts. Next you will learn how to enter transaction information to these accounts to indicate increases and decreases, using the double-entry principle. Before we go on, answer the following questions, which review the five categories of accounts and the basic principles you have learned this far. What are the five main categories of accounts? Check the column indicating the financial documents they appear on.
Category
Balance Sheet
Operating Statement
Check your answers on page BA-34.
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REVIEW THE FIVE CATEGORIES OF ACCOUNTS - Answers:
Assets Liabilities Net Worth Income Expense
NOTE:
You should have checked Balance Sheet.
You should have checked Operating Statement. Answers may be listed in any order.
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RECORDING TRANSACTION EFFECTS ON ACCOUNTS: DEBITS AND CREDITS
You have learned that businesses use the five basic accounts that appear on the Balance Sheet and the Operating Statement to keep track of what is owned and owed, and the flow of income and expenses resulting from business activity. You have also learned that transactions affect at least two accounts (the double-entry system). Now you are ready to learn how to record the entries that show the effects of a transaction on the accounts. The accounting terms for showing increases and decreases to accounts are “debits” and “credits”. Each of the five account categories has its own pattern for increasing and decreasing. You will learn about that after we go over the basic concept of debiting and crediting an account. On the Balance Sheet, all accounts are listed with a heading and the contents: ASSETS Current Cash Receivables Fixed Land Vehicles $ $ 5,000 2,000
$ 48,000 $ 20,000
In the day-to-day operation of a business, it would be very difficult to prepare a listing like the one above and constantly erase and alter the amounts for each type of asset whenever, for example, the amount of cash changed. It is more logical to keep a running tally of the increases and decreases to each of the accounts as they are affected by the day’s transactions - for example, sales that increases cash, and bill paying that decreases cash.
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RECORDING TRANSACTION EFFECTS ON ACCOUNTS: (cont.)
Let’s take a look at the setup of an account that allows for logical recording of increases and decreases: the “T” account. Cash Debit Credit The “T” account (left) allows for recording increases on one side and decreases on the other. The left side is always a debit and the right side is a credit.
Let’s look at a transaction. A restaurant buys two dozen towels to use in the kitchen at $14 a dozen, and pays cash. We know from the double-entry system that at least two accounts are affected by this transaction. The current asset account “Supplies” should be increased to show the receipt of the towels. The current asset account “Cash” will be decreased to show the restaurant’s expenditure of funds to obtain the towels. Now, how would we record this on the “T” account? SUPPLIES (increase) $28.00 (decrease) (increase) CASH (decrease) $28.00 You can see that we have recorded the relevant information in monetary value, and have fulfilled the requirements of the double-entry system. Now let’s try applying the terms “debit” and “credit” to the above transaction. All asset accounts are increased with debits and decreased with credits; we debited Supplies $28.00 and credited Cash $28.00.
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RECORDING TRANSACTION EFFECTS ON ACCOUNTS: DEBITS AND CREDITS (cont.)
Now you try one: A business buys a riding lawnmower and pays $15,000 by check. Enter this transaction in the “T” accounts below.
VEHICLES Debit Credit Debit
CHECKING ACCOUNT Credit
What specific kind of account is “Vehicles”?
What specific kind of account is “Checking Account”?
Check your answers on page BA-38.
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Answers:
VEHICLES Debit $15,000 Vehicles is a fixed asset account. Checking Account is a current asset account. Credit Debit
CHECKING ACCOUNT Credit $15,000
We debited “Vehicles” to show the increase in the account caused by the purchase of the riding lawnmower. We credited “Checking Account” to show the decrease in funds in the account caused by writing the check to pay for the mower. Total debits equal total credits.
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DEBITING AND CREDITING THE FIVE CATEGORIES
You learned above that asset accounts are increased with debits and decreased with credits. When you consult the “T” accounts below, you’ll see that expense accounts are also increased with debits and decreased with credits. But liability, net worth, and income accounts are decreased with debits and increased with credits. Study these “T” accounts. They are set up the way a balance sheet is set up.
NOTE
1. 2.
We use the standard Latin abbreviation “Dr” for debit and “Cr” for credit, and Accounting usage of the terms “debit” and “credit” is different from everyday usage. The chart below will help you sort it all out. Use it throughout the module...and the test (we won’t tell).
BALANCE SHEET ACCOUNTS
ASSETS Dr increase Cr decrease
LIABILITIES Dr decrease Cr increase
NET WORTH Dr decrease
OPERATING STATEMENT ACCOUNTS
Cr increase
INCOME Dr decrease Cr increase Dr increase
EXPENSE Cr decrease
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DEBITING AND CREDITING THE FIVE CATEGORIES (cont.)
Another way of deciding what type of entry to make is:
MAKING AN ACCOUNT ENTRY
IF ACCOUNT ENTRY IS IN THIS CATEGORY AND THEN
INCOME LIABILITY NET WORTH
You need to increase the account total You need to decrease the account total You need to increase the account total You need to decrease the account total
Use the Credit side (right). Use the Debit side (left). Use the Debit side (left). Use the Credit side (right).
ASSETS EXPENSES
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Questions:
Now, using the “Making an Account Entry” decision table and the “Balance Sheet Accounts” chart respond to each statement by checking the appropriate block. Debit 1. 2. 3. 4. You received a $10 cash payment to be entered in your cash account. Your NAFI owes $500 to Hook-Wink, Inc. (Accts. Payable). The Officers’ Club income this month is $12,365 (Income account). Bills paid by check today totaled $730 (Cash account). Credit
Check your answers on page BA-42.
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Answers:
1. 2. 3. 4.
Dr Cr Cr Cr
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TOTAL DEBITS EQUAL TOTAL CREDITS
A basic principles of debits and credits will help you learn to record transaction data:
Total Debits = Total Credits
This may be as simple as our example of the purchase of towels where only two accounts were affected. In other cases, it may take more than two account entries to get the debits and credits to balance. For example, a business sells two hammers for $5 each. The business paid $4.50 for each hammer. The account entries recording this transaction would be: CASH Debit $10.00 Credit Debit INCOME Credit $10.00
Inventory (hammers) Debit Credit $9.00 Debit $9.00
Cost of Goods Sold Expense Credit
(Remember, inventory is valued at cost to the business, $4.50 each.) Total Debits = Total Credits $19.00 = $19.00
This may seem complicated now, but you will learn more about this and get more practice in Module CC.
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Questions:
Now answer the following questions. You will need to indicate what Debits or Credits are necessary for each transaction. Feel free to refer to the “Balance Sheet Accounts” chart and “Making an Account Entry” decision table. Circle Debit or Credit as appropriate. 1. 2. 3. 4. A business has a salary expense of $2,500. You would Debit/Credit the expense account. A deposit is made to the business’ bank account. Debit/Credit the bank account. Income is received for the sale of retail items. Debit/Credit the retail income account. A sale is made and the business agrees to bill the customer at the beginning of next month. Debit/Credit accounts receivable.
Check your answers on page 46.
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Answers:
1. 2. 3. 4.
Debit will show the increase in the expense account. Debit will show the increase in the bank account. Credit will show an increase in income. Debit will show increase in accounts receivable.
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Questions:
Now try some entries in the T Account below, and answer the questions. 1. A business buys $500 worth of supplies and will pay for them when the bill arrives in two weeks. SUPPLIES Debit Credit Debit ACCOUNTS PAYABLE Credit
a. b. 2.
What specific kind of account is “Supplies”? What specific kind of account is “Accounts Payable”?
A sale brings in $67 in cash income. CASH INCOME Credit Debit Credit
Debit
a. b. 3.
What specific kind of account is “Cash”? What specific kind of account is “Income”?
The government informs a business that it owes $353 in taxes. The business pays by check. CHECKING ACCOUNT TAX EXPENSE Credit Debit Credit
Debit
a. b.
What specific kind of account is “Checking Account”? What specific kind of account is “Tax Expense”?
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4.
A business makes $750 monthly payment on a bank loan. It pays by check. CHECKING ACCOUNT Credit LONG-TERM LOANS PAYABLE Debit Credit
Debit
a. b.
What specific kind of account is “Checking Account”? What specific kind of account is “Long-Term Loans Payable”?
Check your answers on page BA-51 and BA-52.
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Answers:
1. SUPPLIES Debit $500.00 a. b. Credit Debit ACCOUNTS PAYABLE Credit $500.00
Current Asset Account. (Debit Supplies to show increase in supplies caused by purchase.) Current Liability Account. (Credit Accounts Payable to show increase in funds due outside vendors.) Even though both accounts are being increased, a debit and credit still result because of the different methods of showing increases between asset and liability accounts.
NOTE:
2. Cash Debit $67.00 a. b. Credit Debit Income Credit $67.00
Current Asset Account. (Debit Cash to show increase in cash from the sale.) Income Account. (Credit Income to show increase in income caused by the sale.)
3. CHECKING ACCOUNT Debit a. b. Credit $353.00 Debit $353.00 TAX EXPENSE Credit
Current Asset Account. (Credit Checking Account to show decrease in funds caused by writing the check.) Expense Account. (Debit Tax Expense to show increase in tax expense.)
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4. CHECKING ACCOUNT Debit a. b. Credit $750.00 LONG-TERM LOANS PAYABLE Debit Credit $750.00
Current Asset Account. (Credit Checking Account to show decrease in funds caused by writing the check.) Long-Term Liability Account. (Debit Long-Term Loans Payable to show decrease in outstanding loan still due the bank.)
Note that in each of these transactions debits equal credits.
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REVIEW
In this module you have learned about accounts and accounting principles. Check off each of the points below as you review it. Balance Sheet Accounts Assets - recorded at cost-what a business owns Liabilities - what a business owes Net Worth - owner’s share of profits (AssetsLiabilities) Accounting Equation Assets = Liabilities + Net Worth Double-entry system transaction affects at least two accounts Operating Statement Accounts: Income and Expense Income and Expense recorded independently of each other Income and Expense data recorded as earned or incurred Recording Transaction Effect on Accounts: Debits and Credits Debits and Credits in the five account categories Debits = Credits If you feel ready to take the Criterion Test, do so.
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Dr. Amit Shrivastava_NMIMS_2010-2011
PTMBA : Section A & B
Financial Accounting
1
Financial Accounting PTMBA_ NMIMS_ Section A & B_2010-2011
BASIC ACCOUNTING
Module BA
Apply Basic Accounting Principles
OBJECTIVE
Given transaction descriptions, labeled T accounts, and access to course materials, correctly identify the type of account, determine which account to debit and which to credit, and enter the correct debit and credit amounts. Nineteen of 24 debit/credit entries must be correct.
SAMPLE CRITERION TEST ITEM
Using transaction descriptions and labeled T accounts, identify the accounts as either asset, expense, liability or income and enter the correct debit and credit amounts. 1. A golf course Pro Shop purchased 300 golf balls at $1.00 each for resale to customers and placed them in a Central Storeroom. The golf-ball vendor will be paid next month. Accounts Payable Debit Credit
Central Storeroom Inventory Debit Credit
a. What kind of account is Central Storeroom Inventory?
b. What kind of account is Accounts Payable?
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SIGNOFF REQUIREMENT
Nineteen of 24 debit/credit entries must be made correctly for signoff on this module. A “debit/credit” entry consists of the correct amount entered in the appropriate T account correctly as either a debit or credit. You have just been introduced to the basic duty of fund bookkeeper - to report transaction information to SAP AIMS. For many of you who have on-the-job experience, this module will serve to review some basic accounting ideas and practices. For you newcomers to the field, it will provide the necessary knowledge upon which you will build skills. In this module, we will cover the following accounting basics: • The Balance Sheet Accounts • • Assets Liabilities Net Worth
The Accounting Equation The Operating Statement Accounts Income Expense
•
Recording transaction effects on accounts Debits and Credits
By the end of this module, you will be able to enter simple transaction data in proper format and follow the basic accounting principles.
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THE BALANCE SHEET ACCOUNTS
Every business (including NAFIs) needs to have a means of keeping track of what it owns and what it owes to others. From the bookkeeper’s point of view, the most efficient means of keeping track is by assigning accounts to all things owned and owed that can be expressed in monetary value. The Balance Sheet Accounts are three basic account categories used to record this information. They are called Balance Sheet Accounts because they appear on a business’ Balance Sheet its basic financial statement of what is owned and owed. The three basic categories are: • • • Assets - what the business owns. Liabilities - what the business owes to others. Net Worth - the owner’s share of assets and earnings.
Before we look at each of the above categories, answer the following questions. 1. What are the uses for accounts? Check all that apply. a. Keep track of what is owed b. Record specific accounting data. c. Keep track of what is owned. 2. Check the categories of balance sheet accounts. a. b. c. d. 3. Liabilities Assets Receivables Net Worth
Define the categories you checked in question 2.
Term Definition
Check your answers on page BA-4
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THE BALANCE SHEET ACCOUNTS - Answers:
1. 2. 3.
You should have checked a, b and c. a, b and d (c - receivable - is a type of asset you will learn about later). You should have listed/defined: Assets Liabilities Net Worth - what the business owns - what the business owes others - the owner’s share of assets and earnings
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ASSETS
We have broadly described assets as what a business/NAFI owns. To further define assets, we can say that assets must be of measurable value that can be expressed in a dollar amount. What are some of the most obvious things of value a business owns? Perhaps the most obvious asset of a business is cash. This includes any money on deposit at banks and money held onsite in cash registers or safes. It is easy to list cash at value: ASSETS Cash $ 22,000
Then there is the land a business owns and operates on. You could list its value as: ASSETS Land Cash
NOTE:
$2,500,000 $ 22,000 The dollar value of land is always the initial cost of the land, not the market value.
Assets can be classed as current or fixed. Cash is a current asset. Current assets are either cash or things that can easily be converted to cash, such as retail inventories and receivables (money owed the business by its customers). Land is considered a fixed asset. Fixed assets are of permanent nature, which the business intends to use over an extended period of time.
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ASSETS (cont.)
Below are some examples of current and fixed assets. ASSETS Current Cash Receivables Inventories Fixed Land Buildings Equipment $ 22,000
$2,500,000
Again, all values are expressed in dollar amounts and all assets except cash and receivables are listed at cost. Now answer the questions on page BA-7.
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ASSETS - Questions:
1.
Indicate whether the assets below are current or fixed assets.
Current Fixed
a. b. c. d. e. f. 2.
Buildings Land Receivables Equipment Cash Retail Inventories
Choose the true statement. a. b. Fixed assets are held for quick conversion into cash. Fixed assets are held for use by the business for an extended period of time.
3.
A Recreation Arts/Crafts/Hobbies Activity, has bought $62.50 (cost) worth of yarn to sell in their shop. When all the yarn is sold, they will gross $68.75 (retail value). Which figure would you use for your inventory? Sandy McGuire started a candy business. She bought the building for $75,000. Right now she has $2,000 on deposit in the company bank account and $500 in cash at the store. She paid $1,700 to stock the store with various jellybeans, chocolate bunnies, lollipops, and the like. She hopes to make at least $5,000 from that stock. Using the information above, list the candy store’s assets.
4.
5.
Write a definition of assets.
Check your answers on page BA-8.
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ASSETS - Answers:
1.
a. b. c. d. e. f.
fixed fixed current fixed current current
2. 3. 4.
b $62.50 (Remember, assets are listed at cost). The candy store’s asset listing should look like this: ASSETS Cash Inventories Building $ 2,500 (bank account and cash on hand) $ 1,700 (cost value) $ 75,000
(Later you will learn how to show the candy store’s $75,000 bank loan to buy the store). 5. Assets are things of monetary value owned by a company (or words to that effect).
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LIABILITIES
Liabilities are the funds a business/NAFI owes to others. This debt can be incurred in a number of ways. For example, a business could borrow money from a bank. The business would then be liable to the bank for the funds loaned. A bank loan liability can be expressed: LIABILITIES Bank Loan $ 3,000 A business can also incur liabilities in everyday transactions. For example, if a business purchased office supplies from a vendor and received the supplies before paying for them (it is common business practice to purchase goods and receive the bill later), the business would be liable to the vendor for the amount of the goods purchased. This kind of liability is an Accounts Payable - account payable to a vendor - and is expressed as such. LIABILITIES Accounts Payable Bank Loan $ 250 $ 3,000
Accounts payable to a vendor and bank loans illustrate two types of liability accounts. Accounts Payable is a current liability. Current liabilities include all amounts due within one year, such as vendor accounts, wages due employees, and taxes due the government. A bank loan (if it is longer than one year) is an example of a long-term liability. Below are some examples of current and long-term liabilities: LIABILITIES Current Accounts Payable Wages Payable Taxes Payable Long-Term Bank Loan Now answer the questions on page BA-11. $ 250
$ 3,000
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LIABILITIES - Questions:
1.
The F&FRP Non-Appropriated Fund (NAF) pays social security taxes once every three months. These social security taxes are: a. b. Long-term liabilities. Current liabilities.
2.
Let’s think about Sandy McGuire’s candy store again. We said she bought the building for $75,000. Now let’s assume she got the money with a Small Business Administration loan, payable over 25 years. Of the $1,700 worth of candy the business bought, $1,000 was paid on delivery to the Joyous Jellybean Company; $700 is still owed to Chocolate Unlimited. Using the information above, list the candy store’s liabilities.
3.
Write a definition of liabilities.
Check your answers on page BA-12.
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LIABILITIES - Answers:
1.
Taxes paid every 3 months would be (b), current liabilities, during the time they remain unpaid. Remember, long-term liabilities are payable over a period longer than one year. LIABILITIES Current Accounts Payable Long-Term SBA Loan
NOTE:
2. (The amount owed to an 700 outside vendor. $1,000 was already paid so it is no longer a liability).
$
$ 75,000
You will learn how to show when liabilities are paid in a later section.
3.
Expressed in your own words: Liabilities are what the business owes to others (or words to that effect).
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REVIEW - Questions:
As a review, classify the following accounts into the proper category.
ASSET Current Fixed LIABILITY Current Long-term
a. b. c. d. e. f.
Retail inventories Bank Loan Accounts Receivable Taxes Payable Accounts Payable Cash
Check answers on page BA-14.
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REVIEW - Answers:
a. b. c. d. e. f.
Current asset. Long-term liability. Current asset. Current liability. Current liability. Current asset.
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NET WORTH
Net worth is the owner’s share of assets and earning. Net worth is sometimes also called “owner’s equity”. To a Navy bookkeeper, owner’s equity will be of little concern since the “owner” of all the Messes and Recs is the U. S. Navy, and the Navy does not engage in many of the typical “owner” activities of a private business. The account categories that do appear in the Net Worth section of your Balance Sheet are earnings and profits - whatever is left after liabilities have been paid, or stated another way, the difference between total assets and liabilities for a year. These accounts show the Navy’s share of earnings and profits. NET WORTH Net Profit $ 3,750 Unlike private business, the Navy does not keep profits but uses them to fund operations. These distributions of profit are shown in the “Profit Distribution” accounts. You will not be using the Net Worth Accounts, but they will appear on your Fund’s Balance Sheet as profits that have been distributed to your Fund. Answer the questions on page BA-17.
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NET WORTH - Questions:
1.
What do Net Worth Accounts show? a. b. c. d. What a business owes to outside vendors. Accounts Receivable from customers. Owner’s share of assets and earnings. Loans payable within one year.
2.
In the Commander, Navy Installations Command (CNIC) system, profits are: a. b. c. kept by the owner. distributed to funds for use in operations. returned to the appropriate fund pool.
3.
Here we are at Sandy McGuire’s candy store. After three months of operation, the business has made $5,000 in sales, $3,300 of that becoming profits. Using the information above, list the candy store’s net worth.
4.
Write a definition of net worth.
Answers on page BA-18.
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NET WORTH - Answers:
1. 2. 3.
c.
Owner’s share of assets and earnings.
In the CNIC system, profits are distributed to funds for use in operations, “b”. NET WORTH Net Profit $ 3,300
4.
Net worth is the owner’s share of assets and earnings after liabilities are paid.
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BALANCE SHEET REVIEW
In the next section, we will cover the relationship of the three Balance Sheet account categories in the accounting equation. But first, let’s review the Balance Sheet accounts. Answer the following questions, referring to any portion of the Balance Sheet section as necessary: 1. What are the three main categories of Balance Sheet accounts?
2.
Using A for assets, L for liabilities, and NW for net worth, indicate the correct category for each of the following: a. Accounts Payable b. Inventory c. Cash d. Profit
Check your answers on page BA-20.
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BALANCE SHEET - Answers:
1.
Assets Liabilities Net Worth
2.
a. b. c. d.
L A A NW
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THE ACCOUNTING EQUATION
You know that assets are what the business owns, liabilities are what the business owes, and net worth is what is left after liabilities are paid (profits). You have seen how each account category is individually listed; now let’s look at how they are listed in relation to each other on the Balance Sheet. ASSETS Current Fixed LIABILITIES Current Long-term NET WORTH Profits Total Total
Total Assets equal total Liabilities plus Net Worth. This is where the term “Balance Sheet” comes from - the left (Assets) and right (Liabilities + Net Worth) columns are equal - they “balance”. This relationship is known as the accounting equation.
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ASSETS = LIABILITIES + NET WORTH
Let’s examine this relationship more closely. Let’s start with an illustration of the balance that must always exist between Assets and Liabilities. If a business makes a purchase from a vendor, a debt is incurred. As you know, this is reflected in the Liability account, “Accounts Payable.” LIABILITY Accounts Payable $ 250 You can see how that purchase has increased the liability of the business to the vendor. This liability will not be decreased until the business pays the vendor. Now think a minute - what other account category could possibly be affected by a purchase of goods? If the business has received goods through the purchase, the business has increased its assets - “Inventory” account. ASSETS
Inventory
$ 250
LIABILITIES Accounts Payable
$ 250
(Remember, assets are listed at their cost value). This is a simplified illustration of the way the left and right sides of the Balance Sheet equal each other, and the way every transaction affects at least two accounts: the double-entry system. For every liability incurred, some increase in assets must result. In the illustration above, the increase in Accounts Payable led to an increase in Inventories. An increase in longterm liability - bank loan, for example -would lead to an increase in assets - “cash” or a fixed asset such as land. Again you can see the double-entry system at work. Two accounts are always affected.
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ASSETS = LIABILITIES + NET WORTH (cont.)
Now let’s consider the full accounting equation again. In the CNIC system, the Net Worth accounts are used primarily for recording profits. You may ask, “If you record all your profits in net worth, how will the equation balance? Won’t liabilities and net worth be greater than assets?” This would be true if it were not for the double-entry system mentioned earlier. When a business makes a sale, the funds received go into one of two assets accounts - cash or Accounts Receivable. For example, the cost of goods sold was $100; the retail price was $150, for a profit of $50. Any profit over the cost increases the Asset account by the amount of profit. So to balance out the increase in the Asset account caused by the profit from the sale of goods, the Net Worth account lists the profit. ASSETS LIABILITIES $150 Current Long-term NET WORTH Profits Total $150 Total $ 50 $ 150 $ 100
Cash Accounts Receivable
Now answer the questions on page BA-25.
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ASSETS = LIABILITIES + NET WORTH - Questions:
1.
The double-entry system calls for: a. b. c. d. transactions to be equal. transaction profits to equal assets. transactions to affect two or more accounts. transactions to have two entries.
2.
Consider the following transactions. a. A lamp store buys one dozen lighting fixtures from a vendor. The vendor will bill the lamp store for the purchase. How many accounts in the lamp store are affected by this transaction? (Write the number.)
b.
What are the account categories affected?
Check your answers on page BA-28.
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3.
Set up the following transaction data on the balance sheet below. Fancy Foot Shoe Store operates out of a building bought for $59,000. All of the money used to buy the building came from a bank loan, none of which has been paid off. Fancy Foot has 400 pairs of shoes in stock. The store paid $30 a pair for 200 pairs. Fancy Foot owes Sulton Shoe Importers of Italy $40 a pair for the other 200 pairs. Fancy Foot also owes the government $2,300 in taxes. Fancy Foot has a total of $300 in cash in the store’s cash register. At the end of the day’s operations, the manager made a deposit at the local bank bringing the total funds on deposit to $5,000. There was also $500 worth of charge sales today. The manager figures that Fancy Foot should be showing $9,500 in profits at this time.
BALANCE SHEET ASSETS LIABILITIES $ $ $ $ TOTAL NET WORTH Profit TOTAL $ TOTAL $ $ $ Current Accounts Payable Taxes Payable Long-Term Bank Loan $ $ $
Current Cash Receivable Inventories Fixed Building
4.
From memory, write the Accounting Equation.
Check your answers on page BA-28.
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ASSETS = LIABILITIES + NET WORTH - Answers:
1. 2.
c a. b. Two accounts are affected by this transaction. The Current Asset Inventory account is affected by the increase in inventory; the Current Liability Accounts Payable is affected because the business now owes the vendor for the lighting fixtures purchased.
3.
BALANCE SHEET ASSETS Current Cash Receivable Inventories Fixed Building $ $ $ $ LIABILITIES
5,300 500 14,000 59,000
Current Accounts Payable Taxes Payable Long-Term Bank Loan
$ $
8,000 2,300 59,000 69,300
$
TOTAL NET WORTH Profit TOTAL $
$
$ TOTAL $
9,500 78,800
78,800
4.
Assets = Liabilities + Net Worth
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THE OPERATING STATEMENT ACCOUNTS: INCOME AND EXPENSE
You learned earlier that the Balance Sheet shows what a business/NAFI owns, owes, and its earnings or profits. A Balance Sheet does not provide a clear breakdown of actual sales activity. For tracking sales activity, businesses use a different document called an Operating Statement. The Operating Statement is composed of two account categories: Income and Expense. Income accounts show the sales-related gross revenue. Expense accounts show all costs associated with the sales, such as cost of goods sold and personnel costs. These two operating statement categories, added to the three balance sheet categories, are the main categories of accounts. Let’s begin with two basic principles that apply to both of the operating statement account categories. 1. 2. Operating Statements cover a period of time. Income and Expenses are always recorded separately.
Both categories are used to record gross amounts - gross income or gross expense. Profit or loss is not a consideration in the individual entries; it is determined after all entries are made. All Income or Expense data is recorded when earned or incurred. This is sometimes called accrual accounting. This means that a business records the revenue for a sale in the Income account at the time of the sale, regardless of when the customer pays. A business records an expense when it “is incurred” - that is when the inventory or service is used. For example, if a business purchased 500 baseballs for $1 each in March but does not sell any until June, and then sells only 200, the baseball expense for March, April, and May will be $0.00 - because no revenue could be associated in these months with the sale of baseballs. However, in June the baseball expense would be $200 - the value of the 200 baseballs sold.
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THE OPERATING STATEMENT ACCOUNTS: INCOME AND EXPENSE (cont.)
NOTE:
You can see that Income and Expense recording is not the same as Asset and Liability recording. For example, the purchase of baseballs would have affected the Asset and Liability accounts as soon as the purchase was made: either a decrease in cash or increase in Accounts Payable to show if the baseballs were paid for in cash or that funds were due to the vendor. Then the Inventory account would be increased to show the receipt of the baseballs. Try to keep the function of the Balance Sheet Accounts and the Operating Statement Accounts clear in your mind.
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INCOME AND EXPENSE - Questions:
Now answer the following questions. 1. Income accounts are used to record: a. b. c. d. 2. Profits. The cost of goods sold. Gross revenue. Revenue after expenses.
Expense accounts are used to record: a. b. c. d. Gross expenses related to the income of the period. Accounts Payable. Long-Term Liabilities. Value of inventory.
3.
The Operating Statement covers: a. b. A company’s assets and liabilities at one moment in time. Transaction information over a period of time.
4.
Income is recorded when: a. b. The sale is made. The customer pays the bill.
5.
Expense is recorded: a. b. In the same period as the revenue it is associated with is earned. In the period when the vendor is paid.
Check your answers on page BA-32.
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INCOME AND EXPENSE - Answers:
1. 2. 3. 4. 5.
c a b a a
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REVIEW THE FIVE CATEGORIES OF ACCOUNTS
You have now been introduced to the five main categories of accounts. Next you will learn how to enter transaction information to these accounts to indicate increases and decreases, using the double-entry principle. Before we go on, answer the following questions, which review the five categories of accounts and the basic principles you have learned this far. What are the five main categories of accounts? Check the column indicating the financial documents they appear on.
Category
Balance Sheet
Operating Statement
Check your answers on page BA-34.
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REVIEW THE FIVE CATEGORIES OF ACCOUNTS - Answers:
Assets Liabilities Net Worth Income Expense
NOTE:
You should have checked Balance Sheet.
You should have checked Operating Statement. Answers may be listed in any order.
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RECORDING TRANSACTION EFFECTS ON ACCOUNTS: DEBITS AND CREDITS
You have learned that businesses use the five basic accounts that appear on the Balance Sheet and the Operating Statement to keep track of what is owned and owed, and the flow of income and expenses resulting from business activity. You have also learned that transactions affect at least two accounts (the double-entry system). Now you are ready to learn how to record the entries that show the effects of a transaction on the accounts. The accounting terms for showing increases and decreases to accounts are “debits” and “credits”. Each of the five account categories has its own pattern for increasing and decreasing. You will learn about that after we go over the basic concept of debiting and crediting an account. On the Balance Sheet, all accounts are listed with a heading and the contents: ASSETS Current Cash Receivables Fixed Land Vehicles $ $ 5,000 2,000
$ 48,000 $ 20,000
In the day-to-day operation of a business, it would be very difficult to prepare a listing like the one above and constantly erase and alter the amounts for each type of asset whenever, for example, the amount of cash changed. It is more logical to keep a running tally of the increases and decreases to each of the accounts as they are affected by the day’s transactions - for example, sales that increases cash, and bill paying that decreases cash.
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RECORDING TRANSACTION EFFECTS ON ACCOUNTS: (cont.)
Let’s take a look at the setup of an account that allows for logical recording of increases and decreases: the “T” account. Cash Debit Credit The “T” account (left) allows for recording increases on one side and decreases on the other. The left side is always a debit and the right side is a credit.
Let’s look at a transaction. A restaurant buys two dozen towels to use in the kitchen at $14 a dozen, and pays cash. We know from the double-entry system that at least two accounts are affected by this transaction. The current asset account “Supplies” should be increased to show the receipt of the towels. The current asset account “Cash” will be decreased to show the restaurant’s expenditure of funds to obtain the towels. Now, how would we record this on the “T” account? SUPPLIES (increase) $28.00 (decrease) (increase) CASH (decrease) $28.00 You can see that we have recorded the relevant information in monetary value, and have fulfilled the requirements of the double-entry system. Now let’s try applying the terms “debit” and “credit” to the above transaction. All asset accounts are increased with debits and decreased with credits; we debited Supplies $28.00 and credited Cash $28.00.
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RECORDING TRANSACTION EFFECTS ON ACCOUNTS: DEBITS AND CREDITS (cont.)
Now you try one: A business buys a riding lawnmower and pays $15,000 by check. Enter this transaction in the “T” accounts below.
VEHICLES Debit Credit Debit
CHECKING ACCOUNT Credit
What specific kind of account is “Vehicles”?
What specific kind of account is “Checking Account”?
Check your answers on page BA-38.
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Answers:
VEHICLES Debit $15,000 Vehicles is a fixed asset account. Checking Account is a current asset account. Credit Debit
CHECKING ACCOUNT Credit $15,000
We debited “Vehicles” to show the increase in the account caused by the purchase of the riding lawnmower. We credited “Checking Account” to show the decrease in funds in the account caused by writing the check to pay for the mower. Total debits equal total credits.
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DEBITING AND CREDITING THE FIVE CATEGORIES
You learned above that asset accounts are increased with debits and decreased with credits. When you consult the “T” accounts below, you’ll see that expense accounts are also increased with debits and decreased with credits. But liability, net worth, and income accounts are decreased with debits and increased with credits. Study these “T” accounts. They are set up the way a balance sheet is set up.
NOTE
1. 2.
We use the standard Latin abbreviation “Dr” for debit and “Cr” for credit, and Accounting usage of the terms “debit” and “credit” is different from everyday usage. The chart below will help you sort it all out. Use it throughout the module...and the test (we won’t tell).
BALANCE SHEET ACCOUNTS
ASSETS Dr increase Cr decrease
LIABILITIES Dr decrease Cr increase
NET WORTH Dr decrease
OPERATING STATEMENT ACCOUNTS
Cr increase
INCOME Dr decrease Cr increase Dr increase
EXPENSE Cr decrease
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DEBITING AND CREDITING THE FIVE CATEGORIES (cont.)
Another way of deciding what type of entry to make is:
MAKING AN ACCOUNT ENTRY
IF ACCOUNT ENTRY IS IN THIS CATEGORY AND THEN
INCOME LIABILITY NET WORTH
You need to increase the account total You need to decrease the account total You need to increase the account total You need to decrease the account total
Use the Credit side (right). Use the Debit side (left). Use the Debit side (left). Use the Credit side (right).
ASSETS EXPENSES
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Questions:
Now, using the “Making an Account Entry” decision table and the “Balance Sheet Accounts” chart respond to each statement by checking the appropriate block. Debit 1. 2. 3. 4. You received a $10 cash payment to be entered in your cash account. Your NAFI owes $500 to Hook-Wink, Inc. (Accts. Payable). The Officers’ Club income this month is $12,365 (Income account). Bills paid by check today totaled $730 (Cash account). Credit
Check your answers on page BA-42.
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Answers:
1. 2. 3. 4.
Dr Cr Cr Cr
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TOTAL DEBITS EQUAL TOTAL CREDITS
A basic principles of debits and credits will help you learn to record transaction data:
Total Debits = Total Credits
This may be as simple as our example of the purchase of towels where only two accounts were affected. In other cases, it may take more than two account entries to get the debits and credits to balance. For example, a business sells two hammers for $5 each. The business paid $4.50 for each hammer. The account entries recording this transaction would be: CASH Debit $10.00 Credit Debit INCOME Credit $10.00
Inventory (hammers) Debit Credit $9.00 Debit $9.00
Cost of Goods Sold Expense Credit
(Remember, inventory is valued at cost to the business, $4.50 each.) Total Debits = Total Credits $19.00 = $19.00
This may seem complicated now, but you will learn more about this and get more practice in Module CC.
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Questions:
Now answer the following questions. You will need to indicate what Debits or Credits are necessary for each transaction. Feel free to refer to the “Balance Sheet Accounts” chart and “Making an Account Entry” decision table. Circle Debit or Credit as appropriate. 1. 2. 3. 4. A business has a salary expense of $2,500. You would Debit/Credit the expense account. A deposit is made to the business’ bank account. Debit/Credit the bank account. Income is received for the sale of retail items. Debit/Credit the retail income account. A sale is made and the business agrees to bill the customer at the beginning of next month. Debit/Credit accounts receivable.
Check your answers on page 46.
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Answers:
1. 2. 3. 4.
Debit will show the increase in the expense account. Debit will show the increase in the bank account. Credit will show an increase in income. Debit will show increase in accounts receivable.
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Questions:
Now try some entries in the T Account below, and answer the questions. 1. A business buys $500 worth of supplies and will pay for them when the bill arrives in two weeks. SUPPLIES Debit Credit Debit ACCOUNTS PAYABLE Credit
a. b. 2.
What specific kind of account is “Supplies”? What specific kind of account is “Accounts Payable”?
A sale brings in $67 in cash income. CASH INCOME Credit Debit Credit
Debit
a. b. 3.
What specific kind of account is “Cash”? What specific kind of account is “Income”?
The government informs a business that it owes $353 in taxes. The business pays by check. CHECKING ACCOUNT TAX EXPENSE Credit Debit Credit
Debit
a. b.
What specific kind of account is “Checking Account”? What specific kind of account is “Tax Expense”?
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4.
A business makes $750 monthly payment on a bank loan. It pays by check. CHECKING ACCOUNT Credit LONG-TERM LOANS PAYABLE Debit Credit
Debit
a. b.
What specific kind of account is “Checking Account”? What specific kind of account is “Long-Term Loans Payable”?
Check your answers on page BA-51 and BA-52.
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Answers:
1. SUPPLIES Debit $500.00 a. b. Credit Debit ACCOUNTS PAYABLE Credit $500.00
Current Asset Account. (Debit Supplies to show increase in supplies caused by purchase.) Current Liability Account. (Credit Accounts Payable to show increase in funds due outside vendors.) Even though both accounts are being increased, a debit and credit still result because of the different methods of showing increases between asset and liability accounts.
NOTE:
2. Cash Debit $67.00 a. b. Credit Debit Income Credit $67.00
Current Asset Account. (Debit Cash to show increase in cash from the sale.) Income Account. (Credit Income to show increase in income caused by the sale.)
3. CHECKING ACCOUNT Debit a. b. Credit $353.00 Debit $353.00 TAX EXPENSE Credit
Current Asset Account. (Credit Checking Account to show decrease in funds caused by writing the check.) Expense Account. (Debit Tax Expense to show increase in tax expense.)
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4. CHECKING ACCOUNT Debit a. b. Credit $750.00 LONG-TERM LOANS PAYABLE Debit Credit $750.00
Current Asset Account. (Credit Checking Account to show decrease in funds caused by writing the check.) Long-Term Liability Account. (Debit Long-Term Loans Payable to show decrease in outstanding loan still due the bank.)
Note that in each of these transactions debits equal credits.
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REVIEW
In this module you have learned about accounts and accounting principles. Check off each of the points below as you review it. Balance Sheet Accounts Assets - recorded at cost-what a business owns Liabilities - what a business owes Net Worth - owner’s share of profits (AssetsLiabilities) Accounting Equation Assets = Liabilities + Net Worth Double-entry system transaction affects at least two accounts Operating Statement Accounts: Income and Expense Income and Expense recorded independently of each other Income and Expense data recorded as earned or incurred Recording Transaction Effect on Accounts: Debits and Credits Debits and Credits in the five account categories Debits = Credits If you feel ready to take the Criterion Test, do so.
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