chapter 4 double entry recording process

Principle of AccountingPrinciple of Accounting

Chapter 4

The double-entry Recording Process

BA in International BusinessForeign Trade University

OutlineOutline• An introduction to double-entry accounting• State the rules of double-entry for the

different types of accounts.• Footing and balancing ledger accounts• The role of trial balance• Detecting errors through a trial balance• Chart of account• Three-column ledger accounts• Accounting for drawings

The AccountThe Account

Cash

Accounting’s main summary deviceis the account, the record of changes.

Accounts are grouped in three broad categories,according to the accounting equation:


Assets are the economic resources that benefit the business now and in the future

CashAccounts receivableInventoryNotes receivablePrepaid expenses

LandBuildingsEquipment, furniture, and fixtures


Liabilities are the debts of the company.

Notes payableAccounts payableAccrued liabilities (for expenses incurred but not paid)Long-term liabilities (bonds)


Stockholders’ (owners’) equity is theowners’ claims to the assets of a corporation.

Transactions are economic events that require recording in the financial statements.

May be external or internal.

Not all activities represent transactions.

Each transaction has a dual effect on the accounting equation.

Accounting TransactionsAccounting TransactionsAccounting TransactionsAccounting Transactions

Question:Question: Are the following events recorded in the accounting records?

Event

Purchased a

computer.

Criterion

Is the financial position (assets, liabilities, or stockholders’ equity) of the company

changed?

Pay rent.

Record/ Don’t Record

Accounting TransactionsAccounting TransactionsAccounting TransactionsAccounting Transactions

Discuss product

design with potential customer.

Double-Entry AccountingDouble-Entry Accounting

Double-entry bookkeeping means to recordthe dual effects of each business transaction.

The T-AccountThe T-Account

Account Title

Debit

LEFT SIDE RIGHT SIDE

Credit

Three parts :

1) the Title of the account

2) a left or Debit side

3) a right or Credit side

Ledger AccountsLedger Accounts• T-accounts and the balance sheet

equation:

Assets = Liabilities + Owners’ Equity

Assets

Increases Decreases

Liabilities

Decreases Increases

Owners’ Equity

Decreases Increases

Debits and CreditsDebits and Credits• Debit (dr.) - an entry or balance on

the left side of an account

• Credit (cr.) - an entry or balance on the right side of an account

• Remember:– Debit is always the left side!– Credit is always the right side!

Recording entries in ledger Recording entries in ledger accountsaccounts

Identify the transaction and state two ledger accounts affected by the transaction

Determine whether each account is increased or decreased by the transaction

State whether the accounts will have a debit or a credit entry

Classify the ledger accounts according to their report classification


Air & Sea received $50,000 from issuing stock.

Assets = Liabilities +Stockholders’

Equity

Debitfor

Increase,50,000

Creditfor

Increase,50,000

Cash Common Stock


Air & Sea purchased land for $40,000 cash.

Common Stock

Bal. 50,000

CashCredit

forDecrease,

40,000

Bal. 50,000

LandDebit

forIncrease,

40,000

Assets = Liabilities +Stockholders’

Equity

Recording TransactionsRecording Transactionsin the Journalin the Journal

Date Accounts and Explanation Debit CreditJournal Page 1

April 2 Cash 50,000Common Stock 50,000

Issued common stock

Analysis chartAnalysis chart• An analysis chart provides an analysis of a

financial transaction to determine the double-entry to be recorded in ledger accounts.

• An analysis chart helps to ensure that the double-entry for each transaction is correctly determined.

• Example

Transaction A/c names Classifica-tion

Increase/Decrease

Debit/Credit

Bought vehicle for $18,000 by cash at bank

VehicleCash at bank

AssetAsset

IncreaseDecrease

DrCr

Double-entry accountingDouble-entry accounting

Cash at bank

Vehicles

Wages

Mar 1 Vehicles 18,000

Mar 4 Wages 400

Mar 1 Cash at bank 18,000

Mar 4 Cash at bank 400

Revenue and Expense Revenue and Expense TransactionsTransactions

• Retained Income is merely accumulated revenues less expenses, but we cannot just increase or decrease the Retained Income account directly.– This would make preparing the income

statement very difficult

• By accumulating revenues and expenses separately, a more meaningful income statement can be easily prepared.


• Revenue and expense accounts are a part of Retained Income.

Retained Income

Expense Revenue

Decrease Increase

Debit

Increase

Credit

Increase


• Summary of revenue and expense transactions:– A credit to a revenue increases the revenue

and increases Retained Income.– A debit to a revenue decreases the revenue

and decreases Retained Income.

– A credit to an expense decreases the expense and increases Retained Income.

– A debit to an expense increases the expense and decreases Retained Income.

Chapter 3-23

AssetsAssets

Debit / Dr. Credit / Cr.

Normal BalanceNormal Balance

Chapter 3-27



ExpenseExpense

Chapter 3-24

LiabilitiesLiabilities



Chapter 3-25



StockholdersStockholders’’ EquityEquity

Chapter 3-26



RevenueRevenue

Normal Balance Credit

Normal Balance Credit

Normal Balance Debit

Normal Balance Debit

Debits and Credits SummaryDebits and Credits SummaryDebits and Credits SummaryDebits and Credits Summary

SO 3 Define debits and credits and explain their use in recording business SO 3 Define debits and credits and explain their use in recording business transactions.transactions.

Debits:

a.increase both assets and liabilities.

b.decrease both assets and liabilities.

c.increase assets and decrease liabilities.

d.decrease assets and increase liabilities.

Review Question

Debits and Credits SummaryDebits and Credits SummaryDebits and Credits SummaryDebits and Credits Summary

SO 3 Define debits and credits and explain their use in recording business SO 3 Define debits and credits and explain their use in recording business transactions.transactions.

Examples – Exercise 4.3Examples – Exercise 4.3Transaction Account

namesClassifi-cation

Increase/Decrease

Debit/Credit

Banked $60,000 cash to start business

Cash at bankCapital

AOE

IncreaseIncrease

DrCr

Paid the 1st month rent $4,000

Expensecash

Bought shop fittings for cash $12,000

Shop fittingCash

Purchased CDs for $4,300 on credit

Stock controlCredit

Sold CDsCost $2,000

Example – Exercise 4.3 Example – Exercise 4.3 (Cont’d)(Cont’d)

Transaction Account names

Classifi-cation

Increase/Decrease

Debit/Credit

Sold CDs for cash $4,300

Paid 1 month’s advertising $600

Borrowed cash from bank $5,000

Sold CDs on credit at cost $600(Record Cost of sale)

Sold CDs on credit for $1,200(Record revenue)

Purchased stock for cash $3,600

Example – Exercise 4.3 Example – Exercise 4.3 (Cont’d)(Cont’d)

Transaction Account names

Classifi-cation

Increase/Decrease

Debit/Credit

Repaid the National Bank $2,000

Paid wages $800

Cash sales of stock at cost $1,200 (record cost of sale)

Cash sales of stock for $2,200 (record revenue)

Purchased inventory on creditfor $3,400

Footing – Example E 4.3Footing – Example E 4.3

Feb 1 Capital $60,000

5 Sales $ 3,400

8 Loan $ 5,000

10 Sales $ 2,200

Feb 2 Rent $ 4,000

3 Shop fittings $ 12,000

6 Advertising $ 600

9 Stock control $ 3,600

14 Loan $ 5,000

15 Wages $ 800

$70,600 $23,000

47,600

Cash at bank

Balancing – Example E 4.3Balancing – Example E 4.3

Feb 1 Capital $60,000

5 Sales $ 3,400

8 Loan $ 5,000

10 Sales $ 2,200

Feb 2 Rent $ 4,000

3 Shop fittings $ 12,000

6 Advertising $ 600

9 Stock control $ 3,600

14 Loan $ 2,000

15 Wages $ 800Balance $ 47,600

$70,600 $70,600

Balance $47,600

Cash at bank

Closing the AccountsClosing the Accounts• Once the financial statements are

prepared, the ledger accounts must be prepared to record the next period’s transactions. This process is called closing the books.– The balances in all “temporary” stockholders’

equity accounts are transferred to a “permanent” stockholders’ equity account.

– The revenue and expense accounts are “reset” to zero and the current net income is transferred to Retained Income.

Closing the AccountsClosing the Accounts• The Closing Process:

– The revenue accounts are closed to Income Summary in the first entry.

– The expense accounts are closed to Income Summary in the second entry.

– The amount of Net Income (revenues - expenses) is then transferred from Income Summary to Retained Income.

Preparing the Trial BalancePreparing the Trial Balance• Once all transactions have been posted

to the ledger, a trial balance is prepared.

• Trial balance - a list of all of the accounts with their balances – assets first, followed by liabilities, and then stockholders’ equity. It is prepared as a test or check before continuing the recording process.

Preparing the Trial BalancePreparing the Trial Balance• The purposes of the trial balance:

– To help check on accuracy of posting by proving whether the total debits equal the total credits

– To detect errors in double-entry recording– To establish a convenient summary of

balances in all accounts for the preparation of formal financial statements

Trial balance – An exampleTrial balance – An example

Dr Cr

Capital – Mammone 60,000

Rent 4,000

Shop fittings 12,000

Stock control 7,500

Advertising 600

Loan 3,000

Wages 800

Sales 6,800

Costs of sales 3,800

Debtors 1,200

Creditors 7,700

Cash at bank 47,600

77,500 77,500

Trial balance (Cont’d)Trial balance (Cont’d)Some errors may not be detected by a

trial balance:

• Entering an incorrect amount for both the debit and credit.

• Entering a debit or credit in the wrong account.

• The debit and credit entries are reversed.• Omitting a transaction completely.• Compensating errors.

Chart of accountsChart of accounts• An organized index to the ledger

accounts• Groups the account together according

to their accounting report classifications• Facilitate report preparation

Three-column ledger accountsThree-column ledger accounts• A simpler form of ledger with three columns:

debit entry, credit entry and the balance of account.

• Advantage: the balances of all accounts are readily available.

• Ideal for computerized system. Eg: Three-column ledger – Cash at bank account

Date Account Dr Cr Balance

1 Capital 25,000 25,000 Dr

2 Loan 10,000 35,000 Dr

4 Loan 500 34,500 Dr

5 Stock control 600 33,900 Dr

Accounting for DrawingsAccounting for Drawings• Drawings: withdrawals of assets by the

owner for personal use.• The balance of drawings is accounted for

as a deduction against the owners’ equity.Example:

– The proprietor withdraws $500 cash for personal use.– Balances of accounts under owners’ equity section are

as follows:Capital account: $50,000Profit earned for the year: $20,000Drawings for the year: $10,000Requirement: Record the transaction and prepare an

extract of the statement of financial position, owners’ equity section.

Accounting for Drawings Accounting for Drawings (Cont’d)(Cont’d)

Dr Drawings a/c $500 Cr Cash at bank a/c $500

Extract statement of financial positionOwners’ equity

Capital $50,000Plus Net profit $20,000 $70,000Less Drawings $10,000 $60,000

Flow of Accounting DataFlow of Accounting Data

TransactionOccurs

TransactionAnalyzed

TransactionEntered inthe Journal

AmountsPosted to

the Ledger

Ledger AccountsLedger Accounts• Ledger - a group of related accounts kept

current in a systematic manner– Think of a ledger as a book with one page for

each account.– The ledger is a company’s “books.”

• General ledger - the collection of accounts that accumulates the amounts reported in the major financial statements

Ledger

The General Ledger

HomeworkHomework

Exercise 4.5Exercise 4.9Exercise 4.11

QuizQuizGive appropriate terms for the below definitions.1. A numerical list of all the accounts used by a company.2. An entry on the left side of an account.3. A list of each account and its balance at a specific point

in time used to prove the equality of debits and credits.4. A system of accounting in which every transaction is

recorded with equal debits and credits. 5. An entry on the right side of an account.6. An analysis of a financial transaction leading to

determine the double-entry to be recorded in ledger accounts.

QuizQuizGive appropriate terms for the below definitions.1. A numerical list of all the accounts used by a company.

(chart of account)2. An entry on the left side of an account.(debit)3. A list of each account and its balance at a specific point

in time used to prove the equality of debits and credits.(balancing ledger accounts)

4. A system of accounting in which every transaction is recorded with equal debits and credits. (trail balance)

5. An entry on the right side of an account (credit)6. An analysis of a financial transaction leading to

determine the double-entry to be recorded in ledger accounts. (an analysis chart)

chapter 4 double entry recording process

Economy & Finance