3-1

Chapter

McGraw-Hill/Irwin

THE ACCOUNTING
CYCLE: CAPTURING
ECONOMIC EVENTS

The McGraw-Hill Companies, Inc.

3-2

The
The Ledger
Ledger

Cash
Accounts
Payable
Capital
Stock

McGraw-Hill/Irwin

Accounts
Accounts are
are
individual
individual records
records
showing
showing increases
increases
and
and decreases.
decreases.
The
The entire
entire group
group of
of
accounts
accounts is
is kept
kept
together
together in
in an
an
accounting
accounting record
record
called
called aa ledger.
ledger.

The McGraw-Hill Companies, Inc.

3-3

The
The Use
Use of
of Accounts
Accounts

Increases are
recorded on one
side of the Taccount, and
decreases are
recorded on the
other side.

McGraw-Hill/Irwin

Title of the Account

Left
or
Debit
Side

Right
or
Credit
Side

The McGraw-Hill Companies, Inc.

3-4

Lets
Lets see
see how
how
debits
debits and
and credits
credits
are
are recorded
recorded in
in the
the
Cash
Cash account
account for
for
JJs
JJs Lawn
Lawn Care
Care
Service.
Service.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

3-5

Debit
Debit and
and Credit
Credit Entries
Entries

Receipts
are on
the debit
side.

5/1
5/1
5/25
5/25
5/29
5/29
5/31
5/31
Bal.
Bal.

McGraw-Hill/Irwin

Cash
Cash
8,000
5/2
8,000
5/2 2,500
2,500 Payments
75
5/8
75
5/8 2,000
2,000 are on the
credit
750
150
750 5/28
5/28
150
side.
5/31
50
5/31
50
4,125
4,125
The
Thebalance
balanceis
isthe
the
difference
differencebetween
between
the
thedebit
debitand
andcredit
credit
entries
entriesin
inthe
the
account.
account.

The McGraw-Hill Companies, Inc.

3-6

Debit
Debit and
and Credit
Credit Rules
Rules
Debits
Debits and
and credits
credits affect
affect accounts
accounts as
as follows:
follows:

A = L + OE
ASSETS

LIABILITIES

EQUITIES

Debit
Credit
for
for
Increase Decrease

Debit
Credit
for
for
Decrease Increase

Debit
Credit
for
for
Decrease Increase

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Double
Double Entry
Entry Accounting
Accounting The
The Equality
Equality of
of
Debits
Debits and
and Credits
Credits

3-7

A = L + OE
=

Debit
balances

Credit
balances

In
In the
the double-entry
double-entry accounting
accounting system,
system,
every
every transaction
transaction is
is recorded
recorded by
by equal
equal
dollar
dollar amounts
amounts of
of debits
debits and
and credits.
credits.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

3-8

Lets record
selected
transactions for
JJs Lawn Care
Service in the
accounts.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.


May
May 1:
1: Jill
Jill Jones
Jones and
and her
her family
family invested
invested $8,000
$8,000
in
in JJs
JJsLawn
Lawn Care
Care Service
Service and
and received
received 800
800 shares
shares
of
of stock.
stock.

Will Cash increase

or decrease?

McGraw-Hill/Irwin

3-9

Will Capital Stock

increase or
decrease?

The McGraw-Hill Companies, Inc.


May
May 1:
1: Jill
Jill Jones
Jones and
and her
her family
family invested
invested $8,000
$8,000
in
in JJs
JJsLawn
Lawn Care
Care Service
Service and
and received
received 800
800 shares
shares
of
of stock.
stock.

3-10

Cash increases
$8,000 with a debit.

Capital Stock
increases $8,000
with a credit.

Cash
5/1 8,000

Capital Stock
5/1 8,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.


May
May 2:
2: JJs
JJs purchased
purchased aa riding
riding lawn
lawn mower
mower
for
for $2,500
$2,500 cash.
cash.

Will Cash increase

or decrease?

McGraw-Hill/Irwin

3-11

Will Tools &

Equipment increase
or decrease?

The McGraw-Hill Companies, Inc.


May
May 2:
2: JJs
JJs purchased
purchased aa riding
riding lawn
lawn mower
mower
for
for $2,500
$2,500 cash.
cash.

Cash decreases
$2,500 with a credit.

Cash
5/1 8,000
5/2 2,500

McGraw-Hill/Irwin

3-12

Tools & Equipment

increases $2,500
with a debit.
Tools & Equipment
5/2 2,500

The McGraw-Hill Companies, Inc.


May
May 8:
8: JJs
JJs purchased
purchased aa $15,000
$15,000 truck.
truck. JJs
JJs
paid
paid $2,000
$2,000 in
in cash
cash and
and issued
issued aa note
note payable
payable
for
for the
the remaining
remaining $13,000.
$13,000.

Will Truck increase

or decrease?

McGraw-Hill/Irwin

3-13

Will Cash and

Notes Payable
increase or
decrease?

The McGraw-Hill Companies, Inc.


May
May 8:
8: JJs
JJs purchased
purchased aa $15,000
$15,000 truck.
truck. JJs
JJs
paid
paid $2,000
$2,000 in
in cash
cash and
and issued
issued aa note
note payable
payable
for
for the
the remaining
remaining $13,000.
$13,000.

Truck increases
$15,000 with a debit.

Truck
5/8 15,000

3-14

Cash decreases
$2,000 with a credit.
Notes Payable
increases $13,000
with a credit.
Cash
5/1 8,000
5/2 2,500
5/8 2,000
Notes Payable
5/8 13,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.


May
May 11:
11: JJs
JJs purchased
purchased some
some repair
repair parts
parts for
for
$300
$300 on
on account.
account.

3-15

Will Tools &

Equipment increase
or decrease?

McGraw-Hill/Irwin

Will Accounts
Payable increase or
decrease?

The McGraw-Hill Companies, Inc.


May
May 11:
11: JJs
JJs purchased
purchased some
some repair
repair parts
parts for
for
$300
$300 on
on account.
account.

3-16

Tools & Equipment

increases $300 with
a debit.

Accounts Payable
increases $300 with
a credit.

Tools & Equipment

5/2 2,500
5/11
300

Accounts Payable
5/11
300

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.


May
May 18:
18: JJs
JJs sold
sold half
half of
of the
the repair
repair parts
parts to
to
ABC
ABC Lawns
Lawns for
for $150,
$150, aa price
price equal
equal to
to JJs
JJs cost.
cost.
ABC
ABC Lawns
Lawns agrees
agrees to
to pay
pay JJs
JJs within
within 30
30 days.
days.
Will Tools &
Equipment increase
or decrease?

McGraw-Hill/Irwin

3-17

Will Accounts
Receivable increase
or decrease?

The McGraw-Hill Companies, Inc.


May
May 18:
18: JJs
JJs sold
sold half
half of
of the
the repair
repair parts
parts to
to
ABC
ABC Lawns
Lawns for
for $150,
$150, aa price
price equal
equal to
to JJs
JJs cost.
cost.
ABC
ABC Lawns
Lawns agrees
agrees to
to pay
pay JJs
JJs within
within 30
30 days.
days.
Tools & Equipment
decreases $150 with
a credit.
Tools & Equipment
5/2 2,500 5/18
150
5/11
300

McGraw-Hill/Irwin

3-18

Accounts Receivable
increases $150 with
a debit.
Accounts Receivable
5/18
150

The McGraw-Hill Companies, Inc.

3-19

The
The Journal
Journal
In
In an
an actual
actual accounting
accounting system,
system, transactions
transactions
are
are initially
initially recorded
recorded in
in the
the journal.
journal.
GENERAL JOURNAL
Date

Account Titles and Explanation

P
R Debit

Credit

2005
May 1 Cash
Capital Stock

8,000
8,000

Owners invest cash in the business.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

3-20

Posting
involves
copying
information
from the
journal to the
ledger
accounts.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

3-21

GENERAL JOURNAL
Date

Account Titles and Explanation

P
R Debit

Credit

2005
May 1 Cash

8,000

Capital Stock

8,000

Owners invest cash

in the business.
General
Ledger

Date
2005
May 1
McGraw-Hill/Irwin

Cash
Debit
Credit
8,000

Balance
8,000

The McGraw-Hill Companies, Inc.

Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

3-22

GENERAL JOURNAL
Date

Account Titles and Explanation

P
R Debit

Credit

2005
May 1 Cash

8,000

Capital Stock

8,000

Owners invest cash

in the business.
General
Ledger

Date
2005
May 1
McGraw-Hill/Irwin

Capital Stock
Debit
Credit
8,000

Balance
8,000

The McGraw-Hill Companies, Inc.

Posting
Posting Journal
Journal Entries
Entries to
to the
the Ledger
Ledger
Accounts
Accounts

3-23

GENERAL JOURNAL
Date

Account Titles and Explanation

P
R Debit

Credit

2005
May 2 Tools & Equipment
Cash

2,500
2,500

Purchased lawn mower.

Lets
Lets see
see what
what the
the cash
cash account
account looks
looks like
like after
after
posting
posting the
the cash
cash portion
portion of
of this
this transaction
transaction for
for
JJs
JJs Lawn
Lawn Care
Care Service.
Service.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

3-24

Ledger
Ledger Accounts
Accounts After
After Posting
Posting

Date
2005
May 1
2

General Ledger
Cash
Debit
Credit
8,000
2,500

Balance
8,000
5,500

This
This ledger
ledger format
format is
is referred
referred to
to as
as aa
running
running balance.
balance.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

3-25

Ledger
Ledger Accounts
Accounts After
After Posting
Posting

Date
2005
May 1
2

General Ledger
Cash
Debit
Credit
8,000
2,500

Balance
8,000
5,500

TT accounts
accounts are
are simplified
simplified versions
versions of
of
the
the ledger
ledger account
account that
that only
only show
show the
the
debit
debit and
and credit
credit columns.
columns.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

3-26

What
What is
is Net
Net Income?
Income?
Net
Net income
income is
is not
not an
an asset
asset its
its an
an increase
increase in
in
owners
ownersequity
equity from
from profits
profits of
of the
the business.
business.

A = L + OE

Increase

This effects occur as net

income is earned . . .
McGraw-Hill/Irwin

Increase

. . . but this is
what net income
really means.

The McGraw-Hill Companies, Inc.

3-27

Retained
Retained Earnings
Earnings

A = L + OE
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

The McGraw-Hill Companies, Inc.

3-28

The
The Income
Income Statement:
Statement: A
A Preview
Preview
JJ's Lawn Care Service
Income Statement
For the Month Ended May 31, 2005
Sales Revenue
Operating Expense:
Gasoline Expense
Net Income

750

50
700

The
Theincome
incomestatement
statementsummarizes
summarizesthe
the profitability
profitability
of
of aabusiness
businessfor
for aa specified
specifiedperiod
periodof
of time.
time.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

3-29

Accounting
Accounting Periods
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

The McGraw-Hill Companies, Inc.

3-30

Revenue
Revenue and
and Expenses
Expenses

McGraw-Hill/Irwin

The price for

goods sold
and services
rendered during a
given accounting
period.

Increases
owners equity.

The costs of
goods and
services used up
in the process of
earning revenue.

Decreases
owners equity.

The McGraw-Hill Companies, Inc.

The
The Realization
Realization Principle:
Principle: When
When To
To
Record
Record Revenue
Revenue

3-31

Realization Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

The
The Matching
Matching Principle:
Principle: When
When To
To
Record
Record Expenses
Expenses

3-32

Matching Principle
Expenses should be
recorded in the
period in which they
are used up.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Debits
Debits and
and Credits
Credits for
for Revenue
Revenue and
and
Expense
Expense
Expenses
decrease
owners
equity.

EQUITIES
Debit
Credit
for
for
Decrease Increase

Revenues
increase
owners
equity.

EXPENSES

REVENUES

Debit
Credit
for
for
Increase Decrease

Debit
Credit
for
for
Decrease Increase

McGraw-Hill/Irwin

3-33

The McGraw-Hill Companies, Inc.

3-34

Investments
Investments by
by and
and Payments
Payments to
to Owners
Owners
Payments to
owners
decrease
owners
equity.

EQUITIES
Debit
Credit
for
for
Decrease Increase

DIVIDENDS
Debit
Credit
for
for
Increase Decrease
McGraw-Hill/Irwin

Owners
investments
increase
owners
equity.
CAPITAL STOCK

Debit
Credit
for
for
Decrease Increase

The McGraw-Hill Companies, Inc.

3-35

Lets
Lets analyze
analyze the
the
revenue
revenue and
and
expense
expense
transactions
transactions for
for
JJs
JJs Lawn
Lawn Care
Care
Service
Service for
for the
the
month
month of
of May.
May.
We
We will
will also
also
analyze
analyze aa dividend
dividend
transaction.
transaction.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.


May
May 29:
29: JJs
JJs provided
provided lawn
lawn care
care services
services for
for
aa client
client and
and received
received $750
$750 in
in cash.
cash.

Will Cash increase

or decrease?

McGraw-Hill/Irwin

3-36

Will Sales Revenue

increase or
decrease?

The McGraw-Hill Companies, Inc.


May
May 29:
29: JJs
JJs provided
provided lawn
lawn care
care services
services for
for
aa client
client and
and received
received $750
$750 in
in cash.
cash.

Cash increases
$750 with a debit.

Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000

McGraw-Hill/Irwin

3-37

Sales Revenue
increases $750 with
a credit.
Sales Revenue
5/29
750

The McGraw-Hill Companies, Inc.


May
May 31:
31: JJs
JJs purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
mower
mower and
and the
the truck
truck for
for $50
$50 cash.
cash.

3-38

Will Cash increase

or decrease?

McGraw-Hill/Irwin

Will Gasoline
Expense increase or
decrease?

The McGraw-Hill Companies, Inc.


May
May 31:
31: JJs
JJs purchased
purchased gasoline
gasoline for
for the
the lawn
lawn
mower
mower and
and the
the truck
truck for
for $50
$50 cash.
cash.

3-39

Cash decreases $50

with a credit.

Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
5/31
50

McGraw-Hill/Irwin

Gasoline Expense
increases $50 with a
debit.
Gasoline Expense
5/31
50

The McGraw-Hill Companies, Inc.


May
May 31:
31: JJs
JJs Lawn
Lawn Care
Care paid
paid Jill
Jill Jones
Jones and
and
her
her family
family aa $200
$200 dividend.
dividend.

Will Cash increase

or decrease?

McGraw-Hill/Irwin

3-40

Will Dividends
increase or
decrease?

The McGraw-Hill Companies, Inc.


May
May 31:
31: JJs
JJs Lawn
Lawn Care
Care paid
paid Jill
Jill Jones
Jones and
and
her
her family
family aa $200
$200 dividend.
dividend.

Cash decreases
$200 with a credit.

Cash
5/1 8,000
5/2 2,500
5/29
750
5/8 2,000
5/31
50
5/31
200
McGraw-Hill/Irwin

3-41

Dividends increase
$200 with a debit.

5/31

Dividends
200

The McGraw-Hill Companies, Inc.

3-42

Now,
Now, lets
lets look
look at
at
the
the Trial
Trial Balance
Balance
for
for JJs
JJs Lawn
Lawn Care
Care
Service
Service for
for the
the
month
month of
of May.
May.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

3-43

All balances
JJ's Lawn Care Service
are taken from
Unadjusted Trial Balance
the ledger
May 31, 2005
accounts on
Cash
$ 3,925
May 31 after
Accounts receivable
75
considering all
Tools & equipment
2,650
Truck
15,000
of JJs
Notes payable
$ 13,000
transactions
Accounts payable
150 for the month.
Capital stock
Dividends
Sales revenue
Gasoline expense
Total
McGraw-Hill/Irwin

8,000

200
750
50
$ 21,900 $ 21,900

Proves equality
of debits and
credits.

The McGraw-Hill Companies, Inc.

The Accounting Cycle

Journalize
transactions.

Post entries to
the ledger
accounts.

Prepare trial
balance.

Prepare after-closing Journalize and

post closing
trial
balance.
McGraw-Hill/Irwin
entries.

3-44

Make end-ofyear
adjustments.

Prepare
Prepare adjusted
financial
trial balance.
The McGraw-Hill Companies, Inc.
statements.

3-45

End
End of
of Chapter
Chapter 33

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.