INTRODUCTION TO ACCOUNTING UNIT 5: Debits and Credits TouchText Problems and Exercises Next Debits...

INTRODUCTION TO ACCOUNTING

UNIT 5: Debits and Credits

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Problems and Exercises

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• Debits and Credits• The Trial Balance

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Fixing the Confusion

The reason that transactions don’t add up to zero is because you’re

not doing things the “accounting way”.

Let me introduce you to the world

of debits and credits.

http://dictionary.reference.com/

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T-Accounts: Debits and Credits

Traditionally, every account was written as a “T-account”, with a left side and a right side.

Debits (Dr) are recorded on the left side of the T-account.Credits (Cr) are recorded on the right side of the T-account.

Example: Cash (A)

Debits Credits


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Sources of Funds:Revenues, Liabilities and Owners’ Equity

The primary sources of funds ($$$ IN) to build and operate a business are revenues (customers), liabilities (banks, etc.) and owners’ equity (investors).

These accounts increase on the right credit side of their T-accounts, and decrease on the left debit side of their T-accounts.

Sources of FundsRevenuesLiabilities

Owners’ Equity

Debit CreditFor these accounts,

record increases in the balance as credits.

For these accounts, record decreases in the

balance as debits.


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Sources of Funds:Account Balance

The balance of revenue, liability and owners’ equity accounts is determined by subtracting debits from credits.

Example:(a) The business receives a bank loan for $1,000.(b) The next month, the business pays back $200 of the loan.

Notice that there are no negative numbers.

Recording a (positive) debit takes away from the

account balance.

Bank Loan (L)

$1,000 (Cr)$200 (Dr)

Credit Balance = $800 (Cr)time


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Uses of Funds:Assets and Expenses

The primary uses of funds ($$$ OUT) in building and operating a business are purchases of assets and payments of expenses.

These accounts increase on the left debit side of their T-accounts, and decrease on the right credit side of their T-accounts.

Uses of FundsAssets

ExpensesDebit CreditFor these accounts,

record decreases in the balance as credits.

For these accounts, record increases in the

balance as debits.


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Uses of Funds:Account Balance

The balance of asset and expense accounts is determined by subtracting credits from debits.

Example:(a) The business receives a bank loan of $1,000 cash.(b) Then the business buys an asset for $250 cash.

Cash (A)

$1,000 (Dr)$250 (Cr)

Debit Balance = $750 (Dr)time


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Summary of Debits and Credits

Expenses Revenues

Assets Liabilities

Owners’ Equity

Asset and Expense accounts will always have a debit (Dr) balance.

Revenue, Liability and Owners’ Equity accounts will always have a credit (Cr) balance.

Balance Sheet

Income Statement

Dr

Dr Dr

Dr

Dr

Cr

Cr Cr

Cr

Cr


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Remembering Debits and Credits:Cash is Key

To help remember debits and credits, remember that cash is key.

(Dr) Cash must be offset by … (Cr)

Other Asset (example: sell securities)Revenue (example: sell something to customer)Liability (example: borrow money from bank)Owners’ Equity (example: new investment by owners)

(Cr) Cash must be offset by … (Dr)

Other Asset (example: buy inventory)Expense (example: pay salaries)Liability (example: pay back money to bank)Owners’ Equity (example: owners’ draw or dividend)

Debit Transactions

Credit Transactions


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Debits & Credits: Example

Transaction: Owner invests $10,000 into business.

Journal(enter transactions)

Ledger(update account balances)

(Dr) Cash (A) $10,000 (Cr) Owner’s Capital (OE) $10,000

Debit (Dr) Credit (Cr)10,000

$10,000

Cash (A)


$10,000

Owner's Capital (OE)* In the Journal, the debit entry is places above and to the left of the credit entry.


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(Dr) Electricity (E) $124 (Cr) Cash (A) $124

Example: Pay electricity bill of $124 with cash.

Debit (Dr) Credit (Cr)124

$124

Electricity (E)


124

$9,876

Cash (A)


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(Dr) Inventory (A) $1,545 (Cr) Cash (A) $1,545

Example: Buy $1,545 of inventory (things to sell) with cash.


$1,545

Inventory (A)


1241,545

$8,331

Cash (A)


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(Dr) Accounts Receivable (A) $675 (Cr) Service Income (R) $675

Example: Do work “on credit” for a customer, who now owes you $675.


$675

Acct. Receivable (A)


$675

Service Income (R)


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(Dr) Inventory (A) $1,267 (Cr) Accounts Payable (L) $1,267

Example: Buy $1,267 of inventory on credit.

Debit (Dr) Credit (Cr)1,5451,267

$2,812

Inventory (A)


$1,267

Acct. Payable (L)


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(Dr) Cash (A) $16,500 (Cr) Bank Loan (L) $16,500

Example: Borrow $16,500 cash from the bank.


1241,545

16,500

$24,831

Cash (A)


$16,500

Bank Loan (L)


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(Dr) Bank Loan (L) $16,500 (Cr) Cash (A) $16,500

Example: Pay back a loan from the bank of $16,500 with cash.


1241,545

16,50016,500

$8,331

Cash (A)


16,500$0

Bank Loan (L)


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(Dr) Owners’ Draw (OE) (Cr) Cash (A) $2,000

Example: The owner takes $2,000 cash out of the business for personal use.

As a contra equity account (see previous unit), Owner’s Draw increases on the debit side.


$2,000

Owners' Draw (OE)


1241,545

16,50016,5002,000

$6,331

Cash (A)


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(Dr) Accounts Payable (L) $169 (Cr) Cash $169

Example: The business pays off a $169 Account Payable with cash.


169$1,098

Acct. Payable (L)


1241,545

16,50016,5002,000169

$6,162

Cash (A)


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(Dr) Cash (A) $67 (Cr) Accounts Receivable (A) $67

Example: A customer pays off her $67 bill to the business with cash.


1241,545

16,50016,5002,000169

67

$6,229

Cash (A)


67$608

Acct. Receivable (A)


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Inventory (A) $1,267Accounts Payable (L) $1,267

Now

Now

Example: Buy $1,267 of inventory on credit.


$2,812

Inventory (A)


$1,267

Acct. Payable (L)


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(Dr) Cash (A) $675(Dr) Cost of Goods Sold (E) $411 (Cr) Inventory (A) $411 (Cr) Sales (R) $675

Example: Sell $411 inventory for $675 cash.

* Note how this transaction makes sense once it is written in debits and credits.


1241,545

16,50016,5002,000169

67675

$6,904

Cash (A)


$675

Sales (R)


411$2,401

Inventory (A)


$411

Cost of Goods Sold (E)

Debits ($675 + $411) = Credits (same)


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Trial Balance and Pre-ClosingFinancial Statements

The Trial Balance

Income Statement

Pre-Closing Balance Sheet

Sales $675Service Income 675Total Revenues $1,350

Cost of Goods Sold 411Electricity 124Total Expenses $535

Net Income $815

Cash 6904 Accounts Payable 1,098Accounts Receivable 608 Bank Loan 0Inventory 2401 Total Liabilities $1,098

Owners' Capital 10,000(less) Owners' Draw 2,000Total Owner's Equity $8,000

Total Assets $9,913 Total Liab. & Equity $9,098

Notice that $9,808 + $815 = $9,913 (same as Assets)

+

Trial Balance Dr CrSales 675Service Income 675Cost of Goods Sold 411Electricity 124Cash 6,904Accounts Receivable 608Inventory 2,401Accounts Payable 1,098Bank Loan 0Owners' Capital 10,000Owners' Draw 2,000Total Dr, Cr $12,448 $12,448

The Trial Balance always balances, and is used frequently by accountants to check their work.


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Now you know why I love

accounting!


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End of Unit 5 Questions and Problems

The following problems require the calculation of various statistics using MS Excel. The problems are linked to actual Excel spreadsheets, where students should do their work.

Exercise: Just as in the examples in this unit….. (a) For each transaction below, make a Journal entry and post it to the Ledger using debits and credits. Create new accounts as necessary, as you go along. Maintain account balances. (b) After the last transaction, list all account balances and place them as appropriate on the financial statements.

(transactions listed next page)


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End of Unit 5 Questions and Problems

1 Owner invests $1,000 cash into new business.2 Business pays $250 for first month's rent, plus $250 refundable deposit, with cash.3 Inventory is purchased for $375 cash.4 Business borrows $750 from bank.5 Internet account is set up with $45 for first month's service.6 Shop furniture is purchased for $3207 $40 of inventory is sold for $65 cash.8 $20 of inventory is sold for $35 on credit.9 The owner takes out $100 cash for personal use.10 $90 of inventory is sold for $135 cash.11 Another $320 of inventory is purchased on credit.12 The customer pays his $35 bill from previous sale with cash.13 The shop window is broken, and is fixed for $42 cash.14 Business partially re-pays $100 of the $320 credit purchase with cash.15 Business partially re-pays $100 of the $750 bank loan with cash.

Transactions


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