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Lesson 1

Lesson 1 2 There are generally three types of businesses: – Manufacturing Businesses – Merchandising Businesses Wholesale Retail – Service Businesses

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Lesson 1

2• There are generally three types of

businesses: – Manufacturing Businesses– Merchandising Businesses

• Wholesale• Retail

– Service Businesses• Some services involve products

– E.g., restaurants– CD calls them combination businesses

3• We will focus on corporations

– 20% of US businesses

• There are other entities (Business forms)– Different financial statements– Examples:

• Sole proprietorships– 70% of US businesses

• Partnerships– 10% of US businesses

• Other entities as well

4• With Partnerships & Sole Proprietorships

– Owner(s) treated as doing business• Business debts are debts of the owners

– Unlimited Liability

• Corporations– Legal entities separate from their owners.

• Business debts are corporation's debts– not the owner's debts.

• Shareholders have limited liability

• Limited Liability– shareholders can only lose their investment – nothing

more

5

• How will corporation be financed?– Funds from You– Funds from Third Parties

• Debt vs. Equity– Debt - Advantages

» Owner keeps control of corporation– Debt – Disadvantages

» Owner has to repay» Owner has to pay interest

6

– Equity – Advantages• Owner doesn’t have to pay interest

– Dividends do not have to be paid

• Owner doesn’t have to repay

– Equity – Disadvantages• Owner dilutes control over corporation

7

• Once the business is created, the owner receives:– Operating profits / losses– Capital gains / losses when business sold

8

• Accounting– information system

• provides reports to stakeholders• Information on economic activities and

condition of a business

9

• A lot of people interested in how business is doing.– Business Stakeholder

• person or entity that has an interest in the economic performance of the business

• Stakeholders include– owners, – managers, – employees, – customers, – creditors, and – various government agencies

• All stakeholders use accounting data

10Stakeholder Interested In Reason

A. Owner Sales Is advertising effective?

ProfitCan I take home more money

each week?

CashCan I afford to buy more

equipment?

B. Investors/ Stockholders

ProfitIs my investment making

money?

DividendsWhat dividends are being

paid?

C. Bankers DebtsCan this business repay a

loan?

11

Stakeholder Interested In Reason

D. IRS ProfitWhat taxes does this

business owe?

E. Managers ExpensesAm I keeping expenses

within my budget?

SalesWill I be eligible for a

bonus this year?

F. Employees ProfitCan my company afford

raises?

Is my job secure?

12Stakeholder Interested In Reason

G. Customers Amount

spent on warranty

How dependable is this product?

Is the company going to be in business in the future?

H. Competitors Amount

spent on ads

How do I compare to my competitor?

• Competitors get valuable information from financial statements

• So, companies disclose as little detail as possible

13

• Accountants have to act ethically.– Not just a case of morals.– Ethical violation can also lead to civil or

criminal liability for the violation• Civil

– Malpractice– Lose license

• Criminal – Go to Jail

14

• Profession of accounting is varied.– Private accounting

• Accountants work for their clients – e.g., Controllers

– Public accounting• Accountants - independent of clients

– e.g., CPAs

15

• Financial accounting - preparation of general purpose financial statements– primarily for outsiders

• investors, • government regulators, and• creditors

– Done by internal accountants• then certified by the public accountants

16

• Managerial or management accounting– preparation of internal reports

• for the management of the company

• Tax accounting– Preparation of tax returns

• Either private or public accountants

17

• Financial statements prepared using GAAP– Generally Accepted Accounting Principles

(GAAP)– Set of rules that all accountants follow

• in preparing financial statements

18

• Didn’t always have GAAP.

• Basic rules developed during Renaissance

• Up to 1933 - free to use whatever rules you want

19

• With the 1929 crash, federal government passed:– The Securities Act of 1933 and – The Securities Exchange Act of 1934

• Most publicly traded corporations now must follow rules set by Securities Exchange Commission (SEC)– In preparing financial statements

20

• SEC allows accounting profession to establish GAAP– Now set by FASB

• Financial Accounting Standards Board  (FASB)• There were prior organizations

– If the SEC isn't happy with GAAP, then• Can require different rules with governmental

filings and reports to shareholders 

21

• GAAP reflects concepts/assumptions used in preparing financial statements.– Relevance

• Information is relevant if it will influence investment decisions

– Reliability (Credible) • Information should be materially accurate

22– Comparability

• Information is presented so decision makers can recognize similarities, differences, and trends over different time periods or between different companies.

– Follow same general rules

– Consistency • accounting procedure, once adopted, should

continue to be used. – Rules for changing accounting rules to follow.

23

– Business Entity Concept (Separate Entity Concept)

• Each business accounted for as an individual organization. 

– Even though you are a sole proprietorship» (Not a separate legal entity), » Financial statements only cover the business

operations.  » Do not include your personal assets and income.

24

– Cost Concept  • Most transactions recorded at historical cost.  • building recorded using purchase price, not

FMV

– Objectivity Concept• Accounting reports should be based upon

objective evidence.  

– Conservatism• Accountants should value items

conservatively.  

25

– Unit of Measure Concept• Financial statements prepared using domestic

currency of corporation

– Continuity Assumption (Going Concern Assumption)

• Assume company will not be going out of business. 

• Example– Inventory valued at price paid

» Not liquidation value

26

• CD says Three General Purpose Financial Statements:– Balance Sheet– Income Statement– Statement of Cash Flows

• There is a fourth Corporate Statement– Statement of Retained Earnings

27

• Balance Sheet– prepared as of a given date– usually the end of reporting period.

• Corporations can use calendar year or fiscal year

– Fiscal year is 12-month period other than a calendar year

– reports the financial position of the company as of a given date. 

28

• Balance Sheet reports:– Assets,– Liabilities, and– Net worth of the company. 

• Balance Sheet usually uses original cost – Not FMV– Doesn’t show current value of the

company.

29

• Income Statement– reports results of company’s operations

for the reporting period.  – Dated "For [Period] Ended [Date].“

• Example - "For the Year Ended December 31, 1998." 

30• The Income Statement reports:

– revenues, – expenses and – net income

• This information given for the period in question

31

• Equity section of a corporate balance sheet– Divided into two parts.

• Paid In Capital– Also called “Contributed Capital”

– Shows equity contributed by shareholders

• Retained Earnings– Shows earnings that corporation earns and keeps

» Not paid as dividends

• Statement of Retained Earnings– explains how Retained Earnings changed from

last year to this year. 

32

Statement of Retained Earnings

For the Year Ended __________________

Beginning Balance of Retained Earnings

 XXXXX

Plus Net Income for the Year  XXXXX

Less Dividends for the Year (XXXXX)

Ending Balance of Retained Earnings

 XXXXX

33

• Accrual Method– Used by most publicly traded

corporations.– Revenue - when you earn it

• Not when you receive it

– Expenses when you owe them• Not when you pay them

• Accountants prefer accrual method– Match revenues with expenses that

generated them.

34

• Cash method– Revenue - reported when received– Expenses - reported when paid

• Accounts don’t like Cash method– Companies can manipulate their income.

35• Statement of Cash Flows

– Introduced around 1986– Reports cash inflows and outflows

• From operations– what it does for a living,

• From investing– purchases and sales of equipment, real estate and

other assets

• From financing – stock and debt transactions

• Statement of Cash Flows explains how cash changed during the year.

36Statement of Cash Flows

For the Year Ended _____________

Cash Flows From Operations (Details given line by line like an Income Statement):

 XXXXX

Cash Flows From Investing (Details given line by line like an Income Statement):

 XXXXX

Cash Flows From Financing (Details given line by line like an Income Statement):

(XXXXX)

Cash Flows For the Year:  XXXXX

Plus Balance of Cash at Beginning of Year:  XXXXX

Balance of Cash at End of Year  XXXXX

37

• Notes to the Financial Statements– At end of financial statements– Notes convey great deal of important

information on: • What accounting rules were followed. • Additional details about figures appearing in

statements. • Additional information not appearing in

statements– E.g., lines of credit, bank covenants & contingent

liabilities

38

• Financial statements accompanied by letter from the CPAs preparing the statements.  – Describes how the audit was conducted,– States CPA's opinion on whether financial

reports were prepared in accordance with GAAP

39

• BALANCE SHEET– Imagine that you want to report your

wealth (net worth).• Maybe you want to borrow money• Creditor wants to know you can pay loan back

loan.

– If you own a house you bought for $250,000.

• You could report that – You have this house, and– You have net worth of $250,000.

40

• Owning the house does not mean that you are worth $250,000.– If you borrowed the $250,000 purchase

price from your parents.• You are not worth $250,000.

– You have an asset worth $250,000 and– You have a liability for $250,000. – You have zero net worth.

41

• What if you have no assets or liabilities.– You have a zero net worth.

• But, you have a credit card & get a cash advance of $10,000.– Are you richer than before cash advance?

• You have $10,000 in cash• You have a $10,000 debt• You still have a zero net worth.

42

• In order to give full disclosure - report your – Assets, – Liabilities and – Net Worth

• Equity

43

• Balance Sheet provide this disclosure– Gives information regarding a firm's assets,

liabilities and equity.

• Firm's assets are paid for with either – Liabilities or– Equity.

• Because of this relationship:– Firm's assets = Firm’s liabilities + Firm’s equity.– This relationship is called “Balance Sheet

Equation”

44

Balance Sheet 

Assets Liabilities

  Owner's Equity

The Balance Sheet Equation is reflected in the Balance Sheet:

Balance Sheets different formats

Left-Right

Top-Bottom

45

• Accounts– Each asset, liability and equity item is represented

by an account– Flexibility in the names given to accounts.– Each account has two sides

• just like the Balance Sheet• Left-hand side is the debit side• Right-hand side is the credit side

– Example – firm has one asset account for Cash

46

Cash 

Debits Credits

• Example – firm has one asset account for Cash

• Debits and credits are netted to give the balance in the account.

• Accounts are kept in the General Ledger of Accounts

47

• Balance Sheet – Summarizes the assets, liabilities and equity

accounts • If account is on the left-hand side of the

Balance Sheet– Asset– Account will normally (not always) have debit

balance. • If an account is on the right-hand side of the

Balance Sheet– Liabilities and equity– Account will normally have credit balance.

48

Cash 

1000

100

1100

• When account has debit balance– E.g., asset– Increase - debit it some more

• Add to the debit balance. – Decrease - credit it

• Adding to the opposite side• Two sides netted• Thereby decreasing that balance.

49

Accounts Payable

1000

100

1100

• When account has a credit balance– E.g., a liability or equity account– Increase - credit it some more– Decrease - debit it

50• Order of accounts on Balance Sheet

follows convention.– Assets listed by how soon they will be

converted into cash.• Current Assets listed first

– Cash is the first line– Assets that will be used, consumed or collected

within one year or business cycle, whichever is longer

• Non-current Assets listed second– Used, consumed or collected after one year or

business cycle

51

– Liabilities listed by how soon they will be paid. 

• Current Liabilities listed first– Will be paid within one year or business cycle

• Non-current Liabilities listed second– Will be paid after one year or business cycle

– Equity accounts are listed by their priority of payment upon liquidation.

– Business cycle• Time it takes to start and complete a

business transaction

52• Business transactions are recorded in

accounts.

• Changes to accounts summarized in the General Journal.– General Journal notes

• which accounts are credited and• which accounts are debited. These General

Journal entries take the following form:

53

D. Name of the Account Debited $ XXX

Cr. Name of the Account Credited $XXX

• General Journal entries take the following form:

54

• ILLUSTRATIONS

55

• Our firm is a corporation.

• Equity in the corporation represented by capital stock.

• There are different types of stock.– Common Stock

• Residual Owners of Corporations• Get what’s left when creditors are paid

56

• When corporation sells stock – it increases its equity. – Cash (or other property) is given to the

corporation• assets (e.g., cash) have increased

– Cash did not come from debt.• Equity is thereby increased.

– The equity account here is Common Stock.

57

Balance Sheet

Cash UP Common Stock UP

 $100,000 $100,000

• $100,000 of common stock is sold. – Two things happen with each transaction.– Here:

• Cash went up, and• Equity went up.

58• Cash

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Cash? (Debit or Credit)

• Common Stock. – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Common Stock? (Debit or

Credit)

59

• Cash– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To increase a debit balance account – DEBIT IT

• Common Stock– Is an equity account– Equity is on the right side of Balance Sheet– Right Side means right (credit) balance– To increase a credit balance account – CREDIT IT

60

D. Cash $100,000

Cr. Common Stock $100,000

Cash

 $100,000

Common Stock

$100,000

61

Balance Sheet

Assets Liabilities

Cash $100,000

Equity

Common Stock $100,000

$100,000 $100,000

62

Balance Sheet

Cash Down

$5,000

Equipment Up

 $5,000

• Purchase of Equipment for $5,000 cash – Two things happen with each transaction.– Here:

• Equipment went up, and• Cash went down.

63• Equipment

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Equipment? (Debit or Credit)

• Cash – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you decrease Cash? (Debit or Credit)

64

• Equipment– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To increase a debit balance account – DEBIT IT

• Cash– Is an asset– Assets are on the left side of Balance Sheet– Left Side means left (debit) balance– To decrease a debit balance account – CREDIT IT

65

D. Equipment $5,000

Cr. Cash $5,000

Cash

$100,000 $5,000

Equipment

$5,000

66

Balance Sheet

Assets Liabilities

Cash $95,000

Equipment $5,000 Equity

Common Stock $100,000

$100,000 $100,000

67

Balance Sheet

Equipment Up Notes Payable UP

 $10,000 $10,000

• Purchase of Equipment in exchange for a promissory note for $10,000 – Two things happen with each transaction.– Here:

• Equipment went up, and• Notes Payable went up.

68• Equipment

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Equipment? (Debit or Credit)

• Notes Payable – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Notes Payable? (Debit or

Credit)

69

• Equipment– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To increase a debit balance account – DEBIT IT

• Notes Payable– Is a liability– Liabilities are on the right side of Balance Sheet– Right Side means right (credit) balance– To increase a debit balance account – CREDIT IT

70

D. Equipment $10,000

Cr. Notes Payable $10,000

Notes Payable

$10,000

Equipment

$5,000

$10,000

71

Balance Sheet

Assets Liabilities

Cash $95,000 Notes Payable $10,000

Equipment $15,000 Equity

Common Stock $100,000

$110,000 $110,000

72

Balance Sheet

Supplies Up Accounts Payable UP

 $10,000 $10,000

• Purchase of Supplies for $10,000 on credit (no formal promissory note is given) – Two things happen with each transaction.– Here:

• Supplies went up, and• Accounts Payable went up.

73• Supplies

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Supplies? (Debit or Credit)

• Accounts Payable – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Accounts Payable? (Debit or

Credit)

74

• Supplies– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To increase a debit balance account – DEBIT IT

• Accounts Payable– Is a liability– Liabilities are on the right side of Balance Sheet– Right Side means right (credit) balance– To increase a crebit balance account – CREDIT IT

75

D. Supplies $10,000

Cr. Accounts Payable $10,000

Accounts Payable

$10,000

Supplies

$10,000

76

Balance Sheet

Assets Liabilities

Cash $95,000 Accounts Payable $10,000

Supplies $10,000 Notes Payable $10,000

Equipment $15,000 Equity

Common Stock $100,000

$120,000 $120,000

77

• Purchase of Land and Building for $100,000. – When you pay one price for a bundle of assets

• Allocate the purchase price according to FMV.

– Assume:• Land is worth $10,000• Building is worth $90,000• Price $100,000 is paid:

– Cash ($20,000) and

– Promissory note ($80,000).

78

Balance Sheet

Cash Down Notes Payable UP

$20,000 $80,000

Land Up

$10,000

Buildings Up

 $90,000

• Purchase of Land and Buildings for $100,000– Two things happen with each transaction.– Here:

• Land & Buildings went up, and• Cash went down & Notes Payable went up.

79• Cash

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you decrease Cash? (Debit or Credit)

• Land – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Land? (Debit or Credit)

80• Buildings

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Buildings? (Debit or Credit)

• Notes Payable – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Notes Payable? (Debit or

Credit)

81

• Cash– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To decrease a debit balance account – CREDIT IT

• Land– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To increase a debit balance account – DEBIT IT

82

• Buildings– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To increase a debit balance account – DEBIT IT

• Notes Payable– Is a liability– Liabilities are on the right side of Balance Sheet– Right Side means right (credit) balance– To increase a debit balance account – CREDIT IT

83

D. Land $10,000

Buildings $90,000

Cr. Cash $20,000

Notes Payable $80,000

Buildings

$90,000

Land

$10,000

84

D. Land $10,000

Buildings $90,000

Cr. Cash $20,000

Notes Payable $80,000

Notes Payable

$10,000

$80,000

Cash

$100,000 $5,000

$20,000

85

Balance Sheet

Assets Liabilities

Cash $75,000 Accounts Payable $10,000

Supplies $10,000 Notes Payable $90,000

Equipment $15,000

Land $10,000 Equity

Buildings $90,000 Common Stock $100,000

$200,000 $200,000

86

Balance Sheet

Cash Down Notes Payable Down

 $6,000 $6,000

• Pay the principal of $6,000 on a promissory note – Two things happen with each transaction.– Here:

• Cash went down, and• Notes Payable went down.

87• Cash

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you decrease Cash? (Debit or Credit)

• Notes Payable – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you decrease Notes Payable? (Debit or

Credit)

88

• Cash– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To decrease a debit balance account – CREDIT IT

• Notes Payable– Is a liability– Liabilities are on the right side of Balance Sheet– Right Side means right (credit) balance– To decrease a credit balance account – DEBIT IT

89

D. Notes Payable $6,000

Cr. Cash $6,000

Notes Payable

$6,000 $10,000

$80,000

Cash

$100,000 $5,000

$20,000

$6,000

90

Balance Sheet

Assets Liabilities

Cash $69,000 Accounts Payable $10,000

Supplies $10,000 Notes Payable $84,000

Equipment $15,000

Land $10,000 Equity

Buildings $90,000 Common Stock $100,000

$194,000 $194,000

91

• Income Statement – Equity increased by:

• Contributions from its owners (e.g., the sale of stock)

– Contributed Capital.

• Firm generating profits from its operations– If the firm distributes those profits to stockholders –

dividends– If firm keeps profits - Retained Earnings.

92• Profits reflected in accounts

– Inflows reflected in revenue accounts– Outflows reflected in expense accounts.

• Revenues less expenses give you the firm's Net Income.

• Income Statement summarizes these revenue & expense accounts

93

• Revenues– CD defines as “the amount of inflowing assets

from the sale or providing of goods or services to customers.

94• Revenues

– Increase a firm's equity or net worth.

• Equity appears on the right-hand side of the Balance Sheet– It normally has a credit (right) balance– Increased with a credit– Decreased with a debit

• Because revenues increase equity– Revenues will normally have a credit (right) balance.

• Because expenses decrease equity– Expenses will normally have a debit (left) balance.

95

• Illustration Continued

96

Balance Sheet

Accounts Receivable

Up Retained Earnings Up

 $50,000 $50,000

• Our firm earns consulting commissions of $50,000. The client has not yet paid these commissions – Two things happen with each transaction.– Here:

• Consulting Revenue went up (Retained Earnings Up), and• Accounts Receivable went up.

97• Accounts Receivable

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Accounts Receivable?

(Debit or Credit)

• Consulting Revenue – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Consulting Revenue? (Debit

or Credit)

98

• Accounts Receivable– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To increase a debit balance account – DEBIT IT

• Consulting Revenue– Is a Revenue Account– Revenues increase Equity– Equity accounts are on the right side of Balance

Sheet– Right Side means right (credit) balance– To increase a credit balance account – CREDIT IT

99

D. Accounts Receivable $50,000

Cr. Consulting Revenue $50,000

Consulting Revenue

$50,000

Accounts Receivable

$50,000

100

Balance Sheet

Assets Liabilities

Cash $69,000 Accounts Payable $10,000

Accounts Rec. $50,000 Notes Payable $84,000

Supplies $10,000

Equipment $15,000 Equity

Land $10,000 Common Stock $100,000

Buildings $90,000 Retained Earnings $50,000

$244,000 $244,000

101

Balance Sheet

Cash Down Retained Earnings Down

 $20,000 $20,000

• The firm pays salaries of $20,000 – Two things happen with each transaction.– Here:

• Salary Expense went up (Retained Earnings Down), and• Cash went down

102• Cash

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you decrease Cash? (Debit or Credit)

• Salary Expense – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Salary Expense? (Debit or

Credit)

103

• Cash– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To decrease a debit balance account – CREDIT IT

• Salary Expense– Is an Expense – Expenses decrease Equity– Equity accounts are on the right side of Balance

Sheet– Right Side means right (credit) balance– To decrease a credit balance account – DEBIT IT

104

D. Salary Expense $20,000

Cr. Cash $20,000

Salary Expense

$20,000

Cash

$100,000 $5,000

$20,000

$6,000

$20,000

105

Balance Sheet

Assets Liabilities

Cash $49,000 Accounts Payable $10,000

Accounts Rec. $50,000 Notes Payable $84,000

Supplies $10,000

Equipment $15,000 Equity

Land $10,000 Common Stock $100,000

Buildings $90,000 Retained Earnings $30,000

$224,000 $224,000

106

Balance Sheet

Supplies Down Retained Earnings Down

 $3,000 $3,000

• The firm uses $3,000 of its supplies – Two things happen with each transaction.– Here:

• Supplies Expense went up (Retained Earnings Down), and• Supplies went down

107• Supplies

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you decrease Supplies? (Debit or Credit)

• Supplies Expense – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Supplies Expense? (Debit or

Credit)

108

• Supplies– Is an asset– Assets are on left side of Balance Sheet– Left Side means left (debit) balance– To decrease a debit balance account – CREDIT IT

• Supplies Expense– Is an Expense – Expenses decrease Equity– Equity accounts are on the right side of Balance

Sheet– Right Side means right (credit) balance– To decrease a credit balance account – DEBIT IT

109

D. Supplies Expense $3,000

Cr. Supplies $3,000

Salary Expense

$3,000

Supplies

$10,000 $3,000

110

Balance Sheet

Assets Liabilities

Cash $49,000 Accounts Payable $10,000

Accounts Rec. $50,000 Notes Payable $84,000

Supplies $7,000

Equipment $15,000 Equity

Land $10,000 Common Stock $100,000

Buildings $90,000 Retained Earnings $27,000

$221,000 $221,000

111

Balance Sheet

Rent Payable Up

$10,000

Retained Earnings Down

$3,000

• The firm owes one month’s rent – Two things happen with each transaction.– Here:

• Rent Expense went up (Retained Earnings Down), and• Rent Payable went up

112• Rent Payable

– What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Rent Payable? (Debit or

Credit)

• Rent Expense – What kind of account is it?– On what side of Balance Sheet is it located?– What kind of balance does this account normally

have? – How do you increase Rent Expense? (Debit or

Credit)

113

• Rent Payable– Is a liability– Liabilities are on right side of Balance Sheet– Right Side means right (credit) balance– To increase a credit balance account – CREDIT IT

• Rent Expense– Is an Expense – Expenses decrease Equity– Equity accounts are on the right side of Balance

Sheet– Right Side means right (credit) balance– To decrease a credit balance account – DEBIT IT

114

D. Rent Expense $5,000

Cr. Rent Payable $5,000

Rent Expense

$5,000

Rent Payable

$5,000

115

Balance Sheet

Assets Liabilities

Cash $49,000 Accounts Payable $10,000

Accounts Rec. $50,000 Rent Payable $5,000

Supplies $7,000 Notes Payable $84,000

Equipment $15,000 Equity

Land $10,000 Common Stock $100,000

Buildings $90,000 Retained Earnings $22,000

$221,000 $221,000

116

• Trial Balance – At the end of the accounting period– Done to help in locating errors– Total all accounts with debit balances– Total all accounts with credit balances– The totals should equal – A number of trial balances are conducted

during the accounting cycle.

117

Trial Balance

Cash $49,000 Accounts Payable $10,000

Accounts Rec. $50,000 Rent Payable $5,000

Supplies $7,000 Notes Payable $84,000

Equipment $15,000 Common Stock $100,000

Land $10,000 Consulting Rev. $50,000

Buildings $90,000

Salary Expense $20,000

Supplies Exp. $3,000

Rent Expense $5,000

$249,000 $249,000

118

• Closing Entries – Have to reflect the revenues and expenses

in Retained Earnings– Close revenue and expense accounts to

the Income Summary account. – Then close Income Summary to Retained

Earnings

119

D. Consulting Revenue $50,000

Cr. Income Summary $5,000

Income Summary

$50,000

Consulting Revenue

$50,000 $50,000

• Close Consulting Revenue to Income Summary

120

D. Income Summary $20,000

Cr. Salary Expense $20,000

Income Summary

$20,000 $50,000

Salary Expense

$20,000 $20,000

• Close Salary Expense to Income Summary

121

D. Income Summary $3,000

Cr. Supplies Expense $3,000

Income Summary

$20,000 $50,000

$3,000

Salary Expense

$3,000 $3,000

• Close Supplies Expense to Income Summary

122

D. Income Summary $5,000

Cr. Rent Expense $5,000

Income Summary

$20,000 $50,000

$3,000

$5,000

Rent Expense

$5,000 $5,000

• Close Rent Expense to Income Summary

123

D. Income Summary $22,000

Cr. Retained Earnings $22,000

Income Summary

$20,000 $50,000

$3,000

$5,000

$22,000 $22,000

Retained Earnings

$22,000

• Close Income Summary to Retained Earnings