3. 4- LO 2 Describe business events using debit/credit terminology.
4. Debits and Credits 4- Asset accounts increase on the left or debit side and decrease on the right or credit side. Liability accounts increase on the right or credit side and decrease on the left or debit side. Equity accounts increase on the right or credit side and decrease on the left or debit side. In every transaction, the total dollar value of all debits equals the total dollar value of all credits. Debit = Left Credit = Right
40. 4- LO 5 State the need for and record closing entries.
41. The Closing Process 4- Let’s look at the closing entries for Collins Consultants. Establishes zero balances in all revenue, expense, and dividend accounts.
45. 4- LO 8 Describe the components of an annual report, including the management, discussion, and analysis section and the footnotes to financial statements.
46. Components of the Annual Report 4- Notes Management’s Discussion & Analysis Audit Opinion
47. 4- LO 9 Describe the role of the Securities and Exchange Commission in financial reporting.
48. The Securities and Exchange Commission 4- Government Agency Public Companies SEC Rules
Part I A T-account looks like the letter T drawn on a piece of paper. The account title is written across the top of the horizontal bar of the T. Part II The left side of any account is the debit side. Part III The right side of any account is the credit side.
Part I In every transaction, the total dollar value of all debits equals the total dollar value of all credits. But, what do the terms debit and credit mean? Part II Debit means left and credit means right. That is all. Just as we have all agreed that a red light means stop and a green light means go, accountants have agreed to the use of these special terms to refer to different sides of an account. Part III Asset accounts increase on the left or debit side and decrease on the right or credit side. Part IV Liability accounts increase on the right or credit side and decrease on the left or debit side. This is just opposite of the way assets increase and decrease. Part V Like liability accounts, equity accounts also increase on the right or credit side and decrease on the left or debit side.
Let’s see how debits and credits work by looking at transactions for Collins Consultants.
Part I Event one: Collins Consultants was established on January 1, 2008, when it acquired fifteen thousand dollars cash from Collins. Part II This transaction increases the cash asset account and increases the common stock equity account. It is classified as an asset source transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event two: On February 1, Collins Consultants issued a twelve percent ten thousand dollar note payable to the National Bank to borrow cash. Part II This transaction increases the cash asset account and increases the notes payable liability account. It is classified as an asset source transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event three: On February 17, Collins Consultants purchased eight hundred fifty dollars of office supplies on account from Morris Supply Company. Part II This transaction increases the supplies asset account and increases the accounts payable liability account. It is classified as an asset source transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event four: On February 28, Collins Consultants signed a contract to evaluate the internal control system used by Kendall Food Stores. Kendall paid Collins five thousand dollars in advance for these future services. Part II This transaction increases the cash asset account and increases the unearned revenue liability account. It is classified as an asset source transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event five: On March 1, Collins Consultants received eighteen thousand dollars from signing a contract to provide professional advice to Harwood Corporation over a one-year period. Part II This transaction increases the cash asset account and increases the unearned revenue liability account. It is classified as an asset source transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event six: On April 10, Collins Consultants provided two thousand dollars of services to Rex Company on account. Part II This transaction increases the accounts receivable asset account and increases the consulting revenue equity account. It is classified as an asset source transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event seven: On April 29, Collins Consultants performed services and received eight thousand four hundred dollars cash. Part II This transaction increases the cash asset account and increases the consulting revenue equity account. It is classified as an asset source transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event eight: On May 1, Collins Consultants loaned Reston Company six thousand dollars. Reston issued a nine percent note to Collins. Part II This transaction increases the notes receivable asset account and decreases the cash asset account. It is classified as an asset exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event nine: On June 30, Collins purchased office equipment for forty two thousand dollars cash. Part II This transaction increases the office equipment asset account and decreases the cash asset account. It is classified as an asset exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event ten: On July 31, Collins paid three thousand six hundred dollars cash in advance for a one year lease to rent office space for a one-year period beginning August 1. Part II This transaction increases the prepaid rent asset account and decreases the cash asset account. It is classified as an asset exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event eleven: On August 8, Collins Consultants collected one thousand two hundred dollars from Rex Company as partial payment of the accounts receivable (see Event six). Part II This transaction increases the cash asset account and decreases the accounts receivable asset account. It is classified as an asset exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event twelve: On September 4, Collins Consultants paid employees who worked for the company two thousand four hundred dollars in salaries. Part II This transaction increases the cash asset account and decreases equity by increasing the salaries expense account. It is classified as an asset use transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event thirteen: On September 20, Collins Consultants paid a one thousand five hundred dollars cash dividend to its owner. Part II This transaction decreases the cash asset account and decreases equity by increasing the dividends account. It is classified as an asset use transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event fourteen: On October 10, Collins Consultants paid Morris Supply Company the eight hundred fifty dollars owed from purchasing office supplies on account (see Event three). Part II This transaction decreases the cash asset account and decreases the accounts payable liability account. It is classified as an asset use transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event fifteen: On November 15, Collins completed its consulting evaluation of the internal control system used by Kendall Food Stores (see Event four). Part II This transaction decreases the unearned revenue liability account and increases the consulting revenue equity account. It is classified as a claims exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Event sixteen: On December 18, Collins Consultants received a nine hundred dollar bill from Creative Ads for advertisements which had appeared in regional magazines. Collins plans to pay the bill later. Part II This transaction decreases the accounts payable liability account and decreases equity by increasing the advertising expense account. It is classified as a claims exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Adjustment one: Collins Consultants recognized accrued interest on the six thousand dollars note receivable from Reston (see Event eight). Part II This transaction increases the interest receivable asset account and increases the interest revenue equity account. It is classified as an asset source transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Adjustment two: Collins Consultants recognized accrued interest expense on the ten thousand dollar note payable it issued to National Bank (see Event two). Part II This transaction increases the interest payable liability account and decreases equity by increasing the interest expense account. It is classified as a claims exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Adjustment three: Collins Consultants recognized eight hundred dollars of accrued but unpaid salaries. Part II This transaction increases the salaries payable liability account and decreases equity by increasing the salaries expense account. It is classified as a claims exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Adjustment four: Collins Consultants recognized four thousand dollars of depreciation on the office equipment it had purchased on June 30 (see Event nine). Part II This transaction decreases assets by increasing the accumulated depreciation contra asset account and and decreases equity by increasing the depreciation expense account. It is classified as an asset use transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Adjustment five: Collins Consultants recognized rent expense for the portion of prepaid rent used up since entering the lease agreement on July 31 (see Event ten). Part II This transaction decreases the prepaid rent asset account and and decreases equity by increasing the rent expense account. It is classified as an asset use transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Adjustment six: A physical count at the end of the year indicates that one hundred twenty five dollars worth of the supplies purchased on February 17 are still on hand (see Event three). Part II This transaction decreases the supplies asset account and and decreases equity by increasing the supplies expense account. It is classified as an asset use transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
Part I Adjustment seven: Collins Consultants adjusted its accounting records to reflect revenue earned to date on the contract to provide services to Harwood Corporation for a one-year period beginning March 1 (see Event five). Part II This transaction decreases the unearned revenue liability account and and increases the consulting revenue equity account. It is classified as a claims exchange transaction. Part III Here is the effect of this transaction on the financial statements model. Part IV Here is the illustration of the impact on the T-accounts.
The transactions presented in this chapter illustrate the relationships summarized in Panel A of this exhibit. Panel B illustrates these relationships in T-account form. You may want to take a few minutes and review this fundamental information.
Here is a summary of the ledger accounts after recording the transactions for Collins Consultants.
Part I Accountants initially record data from source documents into a journal . Examples of source documents include invoices, time cards, check stubs, and deposit tickets. Transactions are recorded in journals before they are entered into the ledger accounts. Journals are therefore called books of original entry. Part II A company may use a general journal as well as several special journals. Special journals are used to record specific types of repetitive transactions. For example, a company may use a special journal to record cash receipts, another to record cash payments, a third to record purchases on account, and yet another to record sales on account. Transactions that do not fit in a special journal are recorded in the general journal. For simplicity, this text uses only a general journal format. Part III Here is an example of an entry in the general journal. There are columns for the date, account titles, debit amount and credit amount. Notice that the debit accounts are always written first followed by the credit accounts. The credit account titles are indented slightly.
Here is a summary of the general journal entries for Collins Consultants. After the transactions have been recorded in a journal, the dollar amounts of the debits and credits are transferred to the ledger accounts. The process of transferring information from journals to ledgers is called posting. Take a few minutes and review this information and be sure you are comfortable with it before proceeding.
The account balances from the ledgers provide the information for the financial statements. Here is the familiar income statement.
Here is the statement of changes in stockholders’ equity.
Here is the balance sheet.
Finally, here is the statement of cash flows.
Once again, we will review the closing process. Remember that the closing process establishes zero balances in all revenue, expense, and dividend accounts. Let’s look at the closing entries for Collins Consultants.
Here are the closing entries for Collins Consultants. These entries move all the 2008 data from the Revenue, Expense, and Dividend accounts into the Retained Earnings account.
This exhibit illustrates the trial balance for Collins Consultants. Companies frequently prepare a trial balance to verify the equality of debits and credits in the ledger. A trial balance lists all accounts with their balances in separate debit and credit columns. If the debits do not equal the credits, the accountant knows to search for an error.
The annual report is usually printed on color high quality paper and contains lots of photographs. The annual report includes much more than the financial statements. The notes to the financial statements are detailed explanations that help explain the numbers in the financial statements. Management’s discussion and analysis (M D and A) explains management’s take on the past performance of the company and their future plans. The audit opinion is issued by the independent auditor and expresses an opinion on the fairness of the financial statements. We discussed audit opinions in chapter two.
The annual reports of public companies often differ from those of private companies because public companies are registered with the Securities and Exchange Commission and must follow their specific rules. The Securities and Exchange Commission is a governmental entity authorized to establish and enforce accounting rules for public companies. For example, the M D and A section is required by the Securities and Exchange Commission, but not by generally accepted accounting principles. As a result, annual reports of non- Securities and Exchange Commission companies usually do not include M D and A.
This chapter explained how to record transactions using double-entry accounting.
