Chapter 3 The DoubleEntry Accounting System Copyright 2019

Chapter 3 The Double-Entry Accounting System Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

LO 3 -1: Record business events in T-accounts using debit/credit terminology. 3 -1 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Debit/Credit Terminology • In every transaction, the total dollar value of all debits equals the total dollar value of all credits. Claims Liabilities Assets Equity + = Debit Credit Increase Decrease = Decrease Increase + Debit + Decrease Credit Increase 3 -2 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

The Rules of Debits and Credits • Debits increase asset accounts; credits decrease asset accounts. • Debits decrease liability and stockholders’ equity accounts; credits increase liability and stockholders’ equity accounts. 3 -3 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Double-Entry Accounting • Let’s see how debits and credits work by looking at transactions for Collins Brokerage Services. 3 -4 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Beginning Balances • Collins Brokerage Services began the period with the following balances: $5, 000 in cash, $4, 000 in common stock, and $1, 000 in retained earnings. Claims Assets = Cash Debit Credit Bal. 5, 000 Liab. = + Assets + 5, 000 + Equity Retained Earnings Common Stk. Debit + = Cash + Accts Rec. n/a Credit + 4, 000 Bal. + Debit Credit 1, 000 Bal. = Liab. + Stockholders' Equity = Salaries Payable + Common Stock + Retained Earnings = n/a + 4, 000 + 1, 000 3 -5 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 1 • On January 1, Year 2, Collins acquired $25, 000 from the issue of common stock. • This asset source transaction: (1) increases assets (Cash) and (2) increases stockholders’ equity (Common Stock). Assets Cash Debit = Credit + 25, 000 Assets Cash + 25, 000 + = Prepaid Rent n/a Liab. + = + + = Liab. Salaries Payable = n/a + + Common Stk. Debit Stockholders' Equity Common Retained Stock + Earnings 25, 000 Claims Equity Retained Earnings + n/a Credit + + 25, 000 + Revenue n/a − − Expenses n/a Debit Credit = Net Income = n/a Cash Flow F 25, 000 A 3 -6 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 2 • Collins purchased $850 of supplies on account. • This asset source transaction: (1) increases assets (Supplies) and (2) increases liabilities (Accounts Payable). Assets Claims Supplies Debit +850 Credit Assets Liabilities Accounts Payable Debit Credit +850 = = Liab. + Equity + + + Debit Credit Stockholders' Equity Cash + Supplies = Accounts Payable + Common Stock + Retained Earnings Revenue − n/a + 850 = 850 + n/a n/a − Expenses n/a = Net Income Cash Flow = n/a 3 -7 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 3 • Collins collected $1, 800 as an advance to provide future services over a one-year period starting March 1, Year 2. • This asset source transaction: (1) increases assets (Cash) and (2) increases liabilities (Unearned Revenue). Claims Assets Cash Debit Liabilities Unearned Revenue = Credit + 1, 800 = Debit = Assets = Liab. Cash + Supplies = Unearned Revenue 1, 800 + n/a = 1, 800 + Equity + Credit + + 1, 800 + Debit Credit Stockholders' Equity + Common Stock + Retained Earnings + n/a Revenue n/a − − Expenses n/a = Net Income = n/a Cash Flow O 1, 800 A 3 -8 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 4 • During Year 2, Collins provided $15, 760 of services on account. • This asset source transaction: (1) increases assets (Accounts Receivable) and (2) increases stockholders’ equity (Consulting Revenue). Assets Claims Liabilities Accounts Receivable Debit Credit + 15, 760 Assets = Cash Accounts + Receivable = n/a + 15, 760 = = Liab. + Debit Credit + + + Equity Consulting Revenue Debit Credit +15, 760 Stockholders' Equity Unearned Revenue + Common Stock n/a + n/a Consulting + Revenue + 15, 760 Revenue − 15, 760 − Expenses n/a = Net Income Cash Flow = 15, 760 n/a 3 -9 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 5 • During Year 2, Collins paid $26, 000 cash to purchase land. • This asset exchange transaction: (1) increases assets (Land) and (2) decreases assets (Cash). Assets Claims Cash Land Liabilities + Debit - 26, 000 Assets Equity = Credit = + 26, 000 = Liab. Cash + Land = Unearned Revenue (26, 000) + 26, 000 = n/a + + Debit Credit = + Debit Credit + Stockholders' Equity + Common Stock + Retained Earnings + n/a Revenue n/a − Expenses = Net Income − n/a = n/a Cash Flow (26, 000) IA 3 -10 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 6 • Paid $1, 200 cash for a one-year insurance policy with coverage starting August 1, Year 2. • This asset exchange transaction: (1) increases assets (Prepaid Insurance) and (2) decreases assets (Cash). Assets Claims Liabilities Cash + Prepaid Insurance Debit - 1, 200 Assets Credit = + 1, 200 = Liab. + Equity = + Debit Credit + Stockholders' Equity Cash + Prepd. Insurance = Unearned Revenue + Common Stock + Retained Earnings (1, 200) + 1, 200 = n/a + n/a Revenue n/a − Expenses = Net Income Cash Flow − n/a = n/a (1, 200) O A 3 -11 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 7 • Collected $13, 400 from accounts receivable. • This asset exchange transaction: (1) increases assets (Cash) and (2) decreases assets (Accounts Receivable). Assets Claims Liabilities Cash + + 13, 400 Assets Cash 13, 400 + + Accounts Receivable (13, 400) Accounts Receivable = Debit = Credit - 13, 400 = Liab. + = Unearned Revenue + = n/a + Equity + Debit Credit = Debit + Credit + Stockholders' Equity Common Stock n/a + + Retained Earnings n/a Revenue n/a − − Expenses n/a = = Net Income n/a Cash Flow 13, 400 O A 3 -12 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 8 • Paid $9, 500 for salaries expense. • This asset use transaction: (1) decreases assets (Cash) and (2) decreases stockholders’ equity (Salaries Expense). Assets Claims Cash Debit Credit - 9, 500 Assets Liabilities Accounts Payable Debit Credit = = Liab. + Equity Salaries Expense Debit Credit + 9, 500 + + + Stockholders' Equity Cash + Supplies = Accounts Payable + Common Stock + Retained Earnings Revenue − Expenses = Net Income (9, 500) + n/a = n/a + (9, 500) n/a − 9, 500 = (9, 500) Cash Flow O (9, 500) A 3 -13 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 9 • Paid an $800 cash dividend. • This asset use transaction: (1) decreases assets (Cash) and (2) decreases stockholders’ equity (Dividends). Assets Claims Cash = Debit Assets Liabilities Accounts Payable Credit = - 800 = = Liab. Cash + Supplies = Accounts Payable (800) + n/a = n/a + Debit Equity Dividends + Credit + Debit + Credit + 800 Stockholders' Equity + Common Stock + n/a + Retained Earnings Revenue − + (800) n/a − Expenses n/a = Net Income = n/a Cash Flow F (800) A 3 -14 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 10 • Paid $850 to settle accounts payable. • This asset use transaction: (1) decreases assets (Cash) and (2) decreases liabilities (Accounts Payable). Assets Claims Cash Debit = = = Credit 850 Assets = Liab. Cash + Supplies = Accounts Payable (850) + n/a = (850) Liabilities Accounts Payable Debit Credit - 850 + Equity Dividends + + + Debit Credit Stockholders' Equity + Common Stock + n/a + Retained Earnings Revenue − + n/a − Expenses n/a = Net Income = n/a Cash Flow O (850) A 3 -15 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Event 11 • During Year 2, Collins recognized $1, 900 of other operating expenses on account. • This claims exchange transaction: (1) increases liabilities (Accounts Payable) and (2) decreases Equity (Advertising Expense). Claims Assets Cash Debit Credit Assets = Liab. Cash + Supplies = Accounts Payable n/a + n/a = 1, 900 Liabilities Accounts Payable Debit Credit + 1, 900 = = = + Equity Advertising Expense Debit Credit + 1, 900 + + + Stockholders' Equity + Common Stock + n/a + Retained Earnings Revenue − + (1, 900) n/a − Expenses 1, 900 = Net Income Cash Flow = (1, 900) n/a 3 -16 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Adjustment 1 • As of December 31, Year 2, Collins had earned $1, 500 of the $1, 800 of the revenue it deferred in Event 3. • This claims exchange transaction: (1) decreases liabilities (Unearned Revenue) and (2) increases equity (Consulting Revenue). Assets Debit Liabilities Unearned Revenue Debit Credit = = Cash Credit = Assets = Cash + Supplies = n/a + n/a = Liab. + Unearned Revenue + (1, 500) + Claims − 1, 500 Stockholders' Equity Common Retained Stock + Earnings n/a + 1, 500 + + Equity Consulting Revenue Debit Credit + + 1, 500 Revenue − 1, 500 − Expenses n/a = Net Income Cash Flow = 1, 500 n/a 3 -17 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Adjustment 2 • As of December 31, Year 2, Collins had $800 of accrued salaries expenses that will be paid in Year 3. • This claims exchange transaction: (1) increases liabilities (Salaries Payable) and (2) increases equity (Salaries Expense). Assets Cash Debit Credit Assets = Cash + Supplies = Liab. Salaries Payable n/a + n/a = 800 + + + = = Liabilities Salaries Payable Debit Credit = + 800 Stockholders' Equity Common Retained Stock + Earnings n/a + (800) Claims + + Equity Salaries Expense Debit Credit + + 800 Revenue − n/a − Expenses 800 = Net Income Cash Flow = (800) n/a 3 -18 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Adjustment 3 • As of December 31, Year 2, Collins had used $500 of the $1, 200 of insurance coverage that was prepaid in Event 6. • This asset use transaction: (1) decreases assets (Prepaid Insurance) and (2) decreases equity (Insurance Expense). Assets = Prepaid Insurance Debit Credit Assets = Cash Prepaid + Insurance = n/a + (500) = = 500 Claims Liabilities Salaries Payable Debit Credit = Liab. Salaries Payable + n/a + + Stockholders' Equity Common Retained Stock + Earnings n/a + (500) Equity Insurance Expense + + Debit + + 500 Revenue − n/a − Expenses 500 Credit = Net Income Cash Flow = (500) n/a 3 -19 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Adjustment 4 • As of December 31, Year 2, a physical count of supplies on hand revealed that $125 of unused supplies were available for future use. • This asset use transaction: (1) decreases assets (Supplies) and (2) decreases equity (Supplies Expense). • Beg. Bal. + Purch. = Asset Avail. – End. Bal. = Asset Used • 0 + 850 = 850 – 125 = 725 Assets = = Supplies Debit Credit Assets = 725 Cash + Supplies = Liab. Salaries Payable n/a + (725) = n/a Claims Liabilities Salaries Payable Debit Credit = + + + Stockholders' Equity Common Retained Stock + Earnings n/a + (725) + + Equity Supplies Expense Debit Credit + + 725 Revenue − n/a − Expenses 725 = Net Income Cash Flow = (725) n/a 3 -20 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 1 Panel A: Overview of Debit/Credit Relationships Account Assets Debits Credits Increase Decrease Liabilities Decrease Increase Stockholders’ Equity Decrease Increase Common Stock Decrease Increase Retained Earnings Decrease Increase Revenue Decrease Increase Expenses Increase Decrease Dividends Increase Decrease 3 -21 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 1 Panel B: Overview of Debit/Credit Relationships Assets Debit Credit + = = - Liabilities Debit Credit - + + Shareholders’ Equity: Debit Credit - + Specific Equity Accounts Common Stock Debit Credit - + Retained Earnings Debit Credit - + Dividends Debit Credit + Revenues Debit Credit - + Expenses Debit Credit + - 3 -22 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

LO 3 -2: Record transactions using the general journal format. 3 -23 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

The General Journal • Accountants initially record data from source documents into journals, which can be special or general journals. • Providing services for $1, 000 cash on August 1 would be recorded in general journal format as follows: Date Aug. 1 Account Title Cash Service Revenue Debit 1, 000 Credit 1, 000 3 -24 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

General Journal Entries Event No. 1 2 3 4 5 6 7 8 9 10 11 Adj. 2 Adj. 3 Adj. 4 Account Title Cash Common Stock Supplies Accounts Payable Cash Unearned Service Revenue Accounts Receivable Service Revenue Land Cash Prepaid Insurance Cash Accounts Receivable Salaries Expense Cash Dividends Cash Accounts Payable Cash Other Operating Expenses Accounts Payable Unearned Service Revenue Salaries Expense Salaries Payable Insurance Expense Prepaid Insurance Supplies Expense Supplies Debit Credit 25, 000 850 1, 800 15, 760 26, 000 1, 200 13, 400 9, 500 800 850 1, 900 1, 500 800 500 725 3 -25 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 3: General Ledger Assets = Liabilities + Shareholders’ Equity + Common Stock Service Revenue Cash = Accounts Payable Debit Credit 4, 000 Bal. 5, 000 26, 000 [5] [10] 850 [2] 15, 760 [4] 25, 000 [1] 25, 000 1, 200 [6] 1, 900 [11] 1, 500 [Adj. 1] [3] 1, 800 9, 500 [8] 1, 900 Bal. 17, 260 Bal. 29, 000 Bal. [7] 13, 400 800 [9] Salaries Payable Salaries Expense Retained Earnings 1, 000 Bal. 850 [10] 800 [Adj. 2] [8] 9, 500 Dividends Bal. 6, 850 Unearned Service Rev. [Adj. 2] 800 Accounts Receivable Bal [9] 800 [Adj. 1] 1, 500 1, 800 [3] 10, 300 [4] 15, 760 13, 400 [7] Other Oper. Expenses 300 Bal. 2, 360 Prepaid Insurance 500 [Adj. 3] [4] 1, 200 Bal. 700 [2] 850 Bal. 125 Supplies 725 [Adj. 4] [11] 1, 900 Insurance Expense [Adj. 3] 500 Supplies Expense [Adj. 4] 725 Land (5) 26, 000 3 -26 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

LO 3 -3: Prepare a trial balance and explain how it is used to prepare financial statements. 3 -27 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 4: Adjusted Trial Balance COLLINS BROKERAGE SERVICES INC. Adjusted Trial Balance December 31, Year 2 Account Title Debit Cash $ 6, 850 Accounts Receivable 2, 360 Prepaid Insurance 700 Supplies 125 Land 26, 000 Accounts Payable Salaries Payable Unearned Service Revenue Common Stock Retained Earnings Dividends 800 Service revenue Salaries expense 10, 300 Insurance expense 500 Supplies expense 725 Other operating expense 1, 900 Totals $ 50, 260 Credit $1, 900 800 300 29, 000 17, 260 $ 50, 260 3 -28 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 5: Income Statement COLLINS BROKERAGE SERVICES, INC. Income Statement For the Year Ended December 31, Year 2 $ Revenue Expenses: Salaries expense Other operating expenses Insurance Expense Supplies Expense Total Expenses Net Income 17, 260 (10, 000) (1, 900) (500) (725) (13, 425) $ 3, 835 3 -29 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 6: Statement of Changes in Stockholders’ Equity COLLINS BROKERAGE SERVICES, INC. Statement of Changes in Stockholders' Equity For the Year Ended December 31, Year 2 $ Beginning Common Stock 4, 000 Plus: Common Stock Issued 25, 000 Ending Common Stock $ 29, 000 $ Beginning Retained Earnings 1, 000 Plus: Net Income 3, 835 Less: Dividends (800) Ending Retained Earnings 4, 035 Total Stockholders' Equity $ 33, 035 3 -30 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 7: Balance Sheet COLLINS BROKERAGE SERVICES INC. Balance Sheet As of December 31, Year 2 Assets Cash Accounts Payable Prepaid Insurance Supplies Land Total Assets Liabilities Accounts Payable Salaries Payable Unearned Service Revenue Total Liabilities Stockholders' Equity Common Stock Retained Earnings Total Stockholders' Equity Total Liabilities and Stockholders' Equity $ 6, 850 2, 360 700 125 26, 000 $ 36, 035 $1, 900 800 300 $ $ 3, 000 29, 000 4, 035 $ 33, 035 36, 035 3 -31 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 8: Statement of Cash Flows COLLINS BROKERAGE SERVICES INC. Statement of Cash Flows For the Year Ended December 31, Year 2 Cash Flows from Operating Activities Cash Receipts from Customers $ 15, 200 * Cash Payments for Salaries Expense (9, 500) Cash Payments for Insurance Expense (1, 200) Cash Payments for Supplies (850) Net Cash Flow from Operating Activities Cash Flows for Investing Activities Cash Payments to Purchase Land Cash Flows from Financing Activities Cash Receipts from Issue of Common Stock 25, 000 Cash Payments for Dividends (800) Net Cash Flow from Financing Activities Net Increase in Cash Plus Beginning Cash Balance Ending Cash Balance $ 3, 650 (26, 000) $ 24, 200 1, 850 5, 000 6, 850 * $13, 400 accounts receivable collections + $1, 800 unearned service revenue collection 3 -32 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

LO 3 -4: Prepare closing entries in general journal format. 3 -33 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 9: Closing Entries Date 31 31 31 Account Title Service Revenue Retained Earnings Salaries Expense Retained Earnings Other Operating Expenses Retained Earnings Insurance Expense Retained Earnings Supplies Expense Retained Earnings Dividends Debit 17, 260 Credit 17, 260 10, 300 1, 900 500 725 800 3 -34 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Single Compound Entry Date Account Title Dec. 31 Service Revenue Salary Expense Other Operating Expenses Insurance Expense Supplies Expense Dividends Retained Earnings Debit Credit 17, 260 10, 300 1, 900 500 725 800 3, 035 3 -35 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Exhibit 3. 11: Post-Closing Trial Balance COLLINS BROKERAGE SERVICES INC. Post-Closing Trial Balance December 31, 2016 Account Title Debit Credit Cash $ 6, 850 Accounts Receivable 2, 360 Prepaid Insurance 700 Supplies 125 Land 26, 000 Accounts Payable $1, 900 Salaries Payable 800 Unearned Service Revenue 300 Common Stock 29, 000 Retained Earnings 4, 035 Totals $ 36, 035 3 -36 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

End of Chapter 3 Copyright © 2019 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.