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McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-1
Chapter Three: Chapter Three: The Accounting Cycle:
Capturing Economic Events
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-2
The Role of Accounting Records
Establishes accountability for assets and transactions.
Establishes accountability for assets and transactions.
Keeps track of routine business activities.
Keeps track of routine business activities.
Obtains detailed information about a particular transaction.
Obtains detailed information about a particular transaction.
Evaluates efficiency and performance within company.
Evaluates efficiency and performance within company.
Maintains evidence of a company’s business activities.
Maintains evidence of a company’s business activities.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-3
The Ledger
The entire group of accounts is kept
together in an accounting record
called a ledger.
The entire group of accounts is kept
together in an accounting record
called a ledger.
Cash
Accounts Payable
Capital Stock
Accounts are individual records showing increases
and decreases.
Accounts are individual records showing increases
and decreases.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-4
The Use of Accounts
Increases are recorded on one
side of the T-account, and decreases are
recorded on the other side.
Left or
Debit Side
Right or
Credit Side
Title of the Account
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-5
Let’s see how debits and credits are recorded in the Cash account for JJ’s Lawn Care
Service.
Let’s see how debits and credits are recorded in the Cash account for JJ’s Lawn Care
Service.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-6
Cash5/1 8,000 5/2 2,500
5/25 75 5/8 2,0005/29 750 5/28 150
5/31 50 5/31 4,125Bal.
Cash5/1 8,000 5/2 2,500
5/25 75 5/8 2,0005/29 750 5/28 150
5/31 50 5/31 4,125Bal.
Receipts are on
the debit side.
Payments are on the
credit side.
The balance is the difference between the debit and credit
entries in the account.
The balance is the difference between the debit and credit
entries in the account.
Debit and Credit Entries
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
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AA = LL + OEOEASSETSASSETS
Debit for
Increase
Credit for
Decrease
EQUITIESEQUITIES
Debit for
Decrease
Credit for
Increase
LIABILITIESLIABILITIES
Debit for
Decrease
Credit for
Increase
Debits and credits affect accounts as follows:Debits and credits affect accounts as follows:
Debit and Credit Rules
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-8
AA = LL + OEOEDebit Debit
balancesbalancesCredit Credit
balancesbalances=In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.
In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits.
Double Entry AccountingThe Equality of Debits and Credits
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-9
Let’s record selected
transactions for JJ’s Lawn Care Service in the
accounts.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-10
May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.
May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.
Will Cash increase or decrease?
Will Capital Stock increase or decrease?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-11
Capital Stock5/1 8,000
Cash5/1 8,000
May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.
May 1: Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.
Cash increases $8,000 with a debit.
Capital Stock increases $8,000
with a credit.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-12
May 2: JJ’s purchased a riding lawn mower for $2,500 cash.
May 2: JJ’s purchased a riding lawn mower for $2,500 cash.
Will Cash increase or decrease?
Will Tools & Equipment increase
or decrease?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-13
May 2: JJ’s purchased a riding lawn mower for $2,500 cash.
May 2: JJ’s purchased a riding lawn mower for $2,500 cash.
Tools & Equipment5/2 2,500
Cash5/1 8,000 5/2 2,500
Cash decreases $2,500 with a credit.
Tools & Equipment increases $2,500
with a debit.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-14
May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000.
May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000.
Will Truck increase or decrease?
Will Cash and Notes Payable
increase or decrease?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-15
May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000.
May 8: JJ’s purchased a $15,000 truck. JJ’s paid $2,000 in cash and issued a note payable for the remaining $13,000.
Truck5/8 15,000
Cash5/1 8,000 5/2 2,500
5/8 2,000
Notes Payable5/8 13,000
Truck increases $15,000 with a debit.
Cash decreases $2,000 with a credit.
Notes Payable increases $13,000
with a credit.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-16
May 11: JJ’s purchased some repair parts for $300 on account.
May 11: JJ’s purchased some repair parts for $300 on account.
Will Tools & Equipment increase
or decrease?
Will Accounts Payable increase or
decrease?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-17
May 11: JJ’s purchased some repair parts for $300 on account.
May 11: JJ’s purchased some repair parts for $300 on account.
Tools & Equipment increases $300 with
a debit.
Accounts Payable increases $300 with
a credit.
Tools & Equipment5/2 2,500
5/11 300
Accounts Payable5/11 300
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-18
May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days.
May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days.
Will Tools & Equipment increase
or decrease?
Will Accounts Receivable increase
or decrease?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-19
May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days.
May 18: JJ’s sold half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. ABC Lawns agrees to pay JJ’s within 30 days.
Tools & Equipment decreases $150 with
a credit.
Accounts Receivable increases $150 with
a debit.
Tools & Equipment5/2 2,500 5/18 150
5/11 300
Accounts Receivable5/18 150
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-20
In an actual accounting system, transactions are initially recorded in the journal.
In an actual accounting system, transactions are initially recorded in the journal.
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
2006
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.
The Journal
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-21
Posting involves copying
information from the
journal to the ledger
accounts.
Posting Journal Entries to the Ledger Accounts
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-22
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
2006
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.General LedgerCash
Date Debit Credit Balance2006
May 1 8,000 8,000
Posting Journal Entries to the Ledger Accounts
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
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GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
2006
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.General LedgerCapital Stock
Date Debit Credit Balance2006
May 1 8,000 8,000
Posting Journal Entries to the Ledger Accounts
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-24
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
2006
May 2 Tools & Equipment 2,500
Cash 2,500
Purchased lawn mower.
Let’s see what the cash account looks like after posting the cash portion of this transaction for
JJ’s Lawn Care Service.
Let’s see what the cash account looks like after posting the cash portion of this transaction for
JJ’s Lawn Care Service.
Posting Journal Entries to the Ledger Accounts
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-25
General LedgerCash
Date Debit Credit Balance2006
May 1 8,000 8,000 2 2,500 5,500
This ledger format is referred to as a running balance.
This ledger format is referred to as a running balance.
Ledger Accounts After Posting
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
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General LedgerCash
Date Debit Credit Balance2006
May 1 8,000 8,000 2 2,500 5,500
T accounts are simplified versions of the ledger account that only show the
debit and credit columns.
T accounts are simplified versions of the ledger account that only show the
debit and credit columns.
Ledger Accounts After Posting
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-27
Net income is not an asset it’s an increase in owners’ equity from profits of the business.
Net income is not an asset it’s an increase in owners’ equity from profits of the business.
AA = LL + OEOEIncrease Decrease
Either (or both) of these effects occur as net income
is earned . . .
Increase
. . . but this is what “net income”
really means.
What is Net Income?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
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AA = LL + OEOERetained Earnings
Capital Stock
Retained Earnings
The balance in the Retained Earnings account represents the total net income of the corporation over the entire lifetime of the business, less all amounts which have
been distributed to the stockholders as dividends.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-29
JJ's Lawn Care ServiceIncome Statement
For the Month Ended May 31, 2006
Sales Revenue 750$ Operating Expense: Gasoline Expense 50 Net Income 700$
The income statement summarizes the profitability of a business for a specified period of time.
The income statement summarizes the profitability of a business for a specified period of time.
The Income Statement: A Preview
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-30
Accounting Periods
Time Period Principle
To provide users of financial statements with timely
information, net income is measured for relatively short accounting periods of equal
length.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-31
Revenue and Expenses
The price for goods sold and services rendered during a given accounting period.
Increases owner’s equity.
The costs of goods and services used up in the process of earning revenue.
Decreases owner’s equity.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-32
The Realization Principle: When To Record Revenue
Realization Principle
Revenue should be recognized at the
time goods are sold and services are
rendered.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-33
The Matching Principle: When To Record Expenses
Matching Principle
Expenses should be recorded in the
period in which they are used up.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-34
Debits and Credits for Revenue and Expense
EQUITIESEQUITIES
Debit Debit for for
DecreaseDecrease
Credit Credit for for
IncreaseIncrease
Expenses decrease owner’s equity.
Revenues increase owner’s equity.
EXPENSESEXPENSESEXPENSESEXPENSES
Credit for
Decrease
Credit for
Decrease
Debit for
Increase
Debit for
Increase
REVENUESREVENUES
Debit Debit for for
DecreaseDecrease
Credit Credit for for
IncreaseIncrease
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-35
EQUITIESEQUITIES
Debit Debit for for
DecreaseDecrease
Credit Credit for for
IncreaseIncrease
Payments to owners
decrease owners’ equity.
Owners’ investments
increase owners’ equity.
DIVIDENDSDIVIDENDS
Credit Credit for for
DecreaseDecrease
Debit Debit for for
IncreaseIncrease
Investments by and Payments to Owners
CAPITAL STOCKCAPITAL STOCKCAPITAL STOCKCAPITAL STOCK
Debit for
Decrease
Debit for
Decrease
Credit for
Increase
Credit for
Increase
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-36
Let’s analyze the revenue and
expense transactions for JJ’s Lawn Care Service for the month of May.
We will also analyze a dividend
transaction.
Let’s analyze the revenue and
expense transactions for JJ’s Lawn Care Service for the month of May.
We will also analyze a dividend
transaction.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-37
May 29: JJ’s provided lawn care services for a client and received $750 in cash.
May 29: JJ’s provided lawn care services for a client and received $750 in cash.
Will Cash increase or decrease?
Will Sales Revenue increase or decrease?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-38
Sales Revenue5/29 750
May 29: JJ’s provided lawn care services for a client and received $750 in cash.
May 29: JJ’s provided lawn care services for a client and received $750 in cash.
Cash increases $750 with a debit.
Sales Revenue increases $750 with
a credit.
Cash5/1 8,000 5/2 2,500
5/29 750 5/8 2,000
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-39
May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.
May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.
Will Cash increase or decrease?
Will Gasoline Expense increase or
decrease?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-40
Gasoline Expense5/31 50
May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.
May 31: JJ’s purchased gasoline for the lawn mower and the truck for $50 cash.
Cash decreases $50 with a credit.
Gasoline Expense increases $50 with a
debit.
Cash5/1 8,000 5/2 2,500
5/29 750 5/8 2,000 5/31 50
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-41
May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.
May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.
Will Cash increase or decrease?
Will Dividends increase or decrease?
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-42
Dividends5/31 200
May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.
May 31: JJ’s Lawn Care paid Jill Jones and her family a $200 dividend.
Cash decreases $200 with a credit.
Dividends increase $200 with a debit.
Cash5/1 8,000 5/2 2,500
5/29 750 5/8 2,000 5/31 50 5/31 200
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-43
Now, let’s look at the Trial Balance
for JJ’s Lawn Care Service for the month of May.
Now, let’s look at the Trial Balance
for JJ’s Lawn Care Service for the month of May.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-44
JJ's Lawn Care Service Unadjusted Trial Balance
May 31, 2006Cash 3,925$ Accounts receivable 75 Tools & equipment 2,650 Truck 15,000 Notes payable 13,000$ Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Total 21,900$ 21,900$
All balances are taken from
the ledger accounts on May 31 after
considering all of JJ’s
transactions for the month.
Proves equality of debits and
credits.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-45
Journalize transactions.
Post entries to the ledger accounts.
Prepare trial balance.
Make end-of-year
adjustments.
Prepare adjusted trial balance.
Prepare financial
statements.
Prepare after-closing trial balance.
Journalize and post closing
entries.
The Accounting Cycle
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
3-46
End of Chapter Three