Basics of Accounting

Accounting Basics
The Debits and Credits of Accounting

What are debits and credits? What are T accounts?
What are debits and credits?

Debits and credits are the terms given to the left and right sides of a T account They are used whenever a business transaction occurs in a company, and they keep the business books in balance.
What are T accounts?

Assets, drawings and expenses have a normal debit balance. Liabilities, owners equity, and revenues have a normal credit balance. Each business transaction must be recorded with a debit and a credit. T accounts are visual illustrations of a greater ledger account.
Assets = Liabilities + Owners Equity
Rules of Debits (Dr.) and Credits (Cr.)

The left side of any account is the debit side. The right side of any account is the credit side. Do not think of the terms debit and credit as meaning increase of decrease Only think of them as meaning left and right.
Accounting Equation
Assets
Debit + Credit -
Liabilities
Debit Credit +
+ Owners Equity
Debit Credit + -
Accounting Equation: Rules of Debits and Credits

ASSETS = LIABILITIES + OWNERS EQUITY
Dr. + Cr. Dr. Cr. +
Capital Dr. Cr. +
Revenue Dr. -
Expenses Dr. +
Cr. +
Cr. -
Debit = Decrease Credit = Increase
Debit = Increase Credit = Decrease
What is the balance for asset accounts?

Assets
Debit Credit
Increase side
Balance side
Decrease side
Assets include such accounts as cash, accounts receivable inventory, supplies, buildings, autos, and land
What is the balance for liability accounts?

Liabilities
Debit Credit
Decrease side
Increase side
Balance side
Liabilities include the companys payables and unearned accounts.
What is the balance for owners equity accounts?

Owners Equity
Debit Credit
Decrease side
Increase side
Balance side
The owners name and the word capital would be the owners equity account entry. Example: Sue Miller, Capital
What is the balance for revenue/income accounts?

Revenues
Debit Credit
Decrease side
Increase side
Balance side
Revenue accounts are mini capital accounts. Some examples are sales, rent income, fees earned, and interest revenue.
What is the balance for expense accounts?

Expenses
Debit Credit
Increase side
Balance side
Decrease side
These accounts include all expenses such as salary, utilities, and rent.
Assets
Cash Accounts Receivable Notes Receivable
Vehicles
Resources owned or controlled by a company
Land
Store Supplies
Buildings Equipment
Liabilities
Accounts Payable Notes Payable
Creditors claims on assets

Taxes Payable Wages Payable
Equity
Contributed Capital Retained Earnings
Owners claim on assets
Dividends
Transaction Analysis: Five Steps

Step 1: Determine which accounts are affected. Step 2: Determine which categories the accounts belong toassets, liabilities, capital, revenue, or expense, Ex. Cash is an asset Step 3: Determine whether the accounts increase or decrease Step 4: What do the rules of debits and credits say Step 5: What does the T account look like?
Transaction Analysis
J. Scott invests $20,000 cash to start the business in exchange for stock.
The accounts involved are: (1) Cash (asset) (2) Common Stock (equity)
J. Scott invests $20,000 cash to start the business in return for stock.
Assets Cash Supplies Equipment (1) $ 20,000 = Liabilities Accounts Notes Payable Payable + Equity Common Stock $ 20,000
$ 20,000 $
$ $
20,000
$ 20,000
$ 20,000
Purchased supplies paying $1,000 cash. The accounts involved are: (1) Cash (asset) (2) Supplies (asset)
Purchased supplies paying $1,000 cash.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 = Liabilities Accounts Notes Payable Payable + Equity Common Stock $ 20,000
$ 19,000 $ 1,000 $ $ 20,000
$ $
20,000
$ 20,000
Adjustments for Financial Reporting
Why do we need adjustments?

Matching Principle
Expenses should be recognized in the same accounting period as are the revenues they generated. (i.e., match revenues and expenses.)
To determine the true earning power of the entity in the past.
The Need for Adjusting Entries

Journal entries are made at the end of each accounting period to bring about a proper matching of revenues and expenses Economic events (i.e., transactions) have been ongoing but never recorded.
Example: the Office Supplies account
The Need for Adjusting Entries

Revenue Example
1/1/98 12/31/98 1/1/99 6/30/98 6/30/99 12/31/99
When the time necessary to earn a revenue extends into the next period . . .
12-Month Magazine Subscription
. . . the adjusting process allows us to separate 1998 subscription revenue from from 1999 subscription revenue as shown.
Adjusting Journal Entries (AJEs)

AJEs use the same recording format as regular journal entries.
GENERAL JOURNAL
Page:
Date
Description
PR
Debit
Credit
M/DD
Account Name Account Name

journal entry explanation
### ###
$$$ $$$
Types of Adjusting Entries

Deferrals
Entries involving transfer of amounts previously recorded in asset and liability accounts to expense and revenue accounts, respectively
Accruals
Entries involving the initial, or first, recording of assets and liabilities and their related revenues and expenses
Prepaid Expenses
An asset awaiting assignment to an expense.
Prepaid Expense (debit)
Journal entry when payment is made. Cash (credit) The prepaid expense is consumed during the period.
Prepaid Expense (credit)
AJE at end of period

Expense (debit)
Prepaid Expenses
Example On September 1, 1998, Bobs Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month.
GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
Prepare the proper initial journal entry.
Prepaid Expenses
Example On September 1, 1998, Bobs Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month.
GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
1-Sep
Prepaid Rent Cash to record prepayment of twelve months of rent
2,400 2,400
Prepaid Expenses
Example Bobs fiscal year-end is December 31. Record the adjustment necessary on December 31 for the prepaid rent.
GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
Prepare the proper adjusting journal entry.
Prepaid Expenses
Example Bobs fiscal year-end is December 31. Record the adjustment necessary on December 31 for the prepaid rent.
GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
31-Dec
Rent Expense Prepaid Rent to record recognition of four months of rent expense $200 x 4 months = $800
800 800
Prepaid Expense
Example: On September 1, 1998, Bobs Bait Shop prepaid its rent for the next twelve months. Rent is $200 per month. ($200x12 = $2400)
Prepaid Rent (Asset)

+ -
Rent Expense
+ Adjusting 600 -
Balance 2400 Adjusting 600

New balance 220
Supplies Used
Example: the Office Supplies account of Taylor and Associates shows a $275 balance as of December 31. On December 31, Mr. Taylor took an inventory and found $230 worth of office supplies actually left on hand.
Office Supplies Expense
+ +
Office Supplies
-
Adjusting 45
Balance 275
New balance 230
Adjusting 45
Insurance Expired
Example: On December 31, Mr. Taylors Prepaid insurance account shows a balance of $240, which represents a one-year premium paid in advance on December 1. At December 31, one month of the premium has expired, which amounts to $20.
Insurance expense
+ -
Prepaid insurance
+
Balance 240 Adjusting 20 New balance 220
Adjusting 20
Unearned Revenues
Assets that have been received, but have not yet been earned.
Unearned Revenue (credit)
Journal entry when payment is received. Cash (debit) Revenue (credit) The unearned revenue is earned during the period.
Unearned Revenue (debit)
AJE at end of period
Unearned Revenues
Example On 10/1/98, the Cookeville Gazette received $240 for a one-year subscription. The monthly subscription rate is $20.
GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
1-Oct
Cash Unearned Subscriptions to record receipt of one-year subscription payment
240 240
Unearned Revenues
Example The Cookeville Gazettes fiscal year-end is on 12/31/98 (three months later). Record the adjustment necessary at 12/31/98.
GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
31-Dec
Unearned Subscriptions Subscription Revenue to record recognition of three months of subscription earned $20 x 3 months = $60
60 60
Unearned Revenue
Example : On 10/1/98, the Cookeville Gazette received $240 for a one-year subscription. The monthly subscription rate is $20.
Unearned Revenue (liabilities)

Adjusting 60 + Balance 240 -
Revenue
+ Adjusting 60

Basics of Accounting

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Accounting Basics

The Debits and Credits of Accounting

What are debits and credits?

What are T accounts?

Rules of Debits (Dr.) and Credits (Cr.)

Accounting Equation: Rules of Debits and Credits

Capital Dr. Cr. +

Debit = Decrease Credit = Increase

Debit = Increase Credit = Decrease

What is the balance for asset accounts?

What is the balance for liability accounts?

Liabilities include the companys payables and unearned accounts.

What is the balance for owners equity accounts?

What is the balance for revenue/income accounts?

What is the balance for expense accounts?

Resources owned or controlled by a company

Creditors claims on assets

Owners claim on assets

Transaction Analysis: Five Steps

$ 19,000 $ 1,000 $ $ 20,000

Adjustments for Financial Reporting

Why do we need adjustments?

To determine the true earning power of the entity in the past.

The Need for Adjusting Entries

The Need for Adjusting Entries

12-Month Magazine Subscription

Adjusting Journal Entries (AJEs)

Account Name Account Name

Types of Adjusting Entries

Prepaid Expense (credit)

AJE at end of period

Prepare the proper initial journal entry.

Prepaid Rent Cash to record prepayment of twelve months of rent

Prepare the proper adjusting journal entry.

Prepaid Rent (Asset)

Balance 2400 Adjusting 600

Unearned Revenue (debit)

AJE at end of period

Cash Unearned Subscriptions to record receipt of one-year subscription payment

Unearned Revenue (liabilities)

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